The majority of entrepreneurial minded individuals dream about one day managing their own business.  Acquiring a franchise, as opposed to starting a business from scratch, is one of those options. The following basics are covered in this article: a review of the tenets involved with franchising, industry terminology definitions, pro’s and con’s of buying a new franchise or a resale, and recommendations for performing due diligence as it relates to evaluating the numerous choices available.

What is a franchise?

A franchise is a right legally granted to a group or individual which empowers them to represent a specific company’s products or services within a defined territory or location.  Companies leverage franchising to expand their market presence in an economic and expeditious manner.  Simply defined, a franchise is an opportunity that affords an individual the privilege to establish a company based upon previously developed concepts, processes, or ideas from another business entity.

Most experts recognize three basic types of franchises:

1. Business Concept: Business format franchises allow a franchisee to replicate a business concept under the franchisor name in order to merchandize and offer products and services.  (examples: McDonalds, UPS Stores, etc).
2. Distributorships: Distribution franchises are arrangements which provide the ability to market and sell other company’s  products.  (examples: Apple computers, Nike Shoes, etc)
3. Licensing: Brand name licensing provides the individual licensees the ability and right to utilize the parent company’s trademark in the operation of their own company.  (examples: NFL team logos, Elvis Presley photographs, etc)

There are thousands of franchises in the United States that span every conceivable industry and product.  For purposes of this article, we will be focusing on the ‘Business Concept’ franchise.

Definitions/Structure:

• Franchisor: The franchisor owns the overall rights and trademarks of the company and allows its franchisees to use these rights and trademarks in order to do business.
• Franchisee: The entrepreneur who acquires the right from the franchisor to use the company’s trademarks, sell proven and recognized products, or utilize an established business practice in a defined area or specific location.  The franchisee typically pays an initial fee in exchange for this right, in addition to a royalty that is typically paid on either a percentage of profits or as an annual expense.
• Franchise Consultant: Franchise Consultants provide an important service to individuals evaluating whether buying a franchise is the right path to take.  A competent consultant will help the individual understand the pros and cons of each opportunity including the fees involved.   Several of the more established franchise consultants will have a profiling and modeling process to assess the entrepreneur’s lifestyle and business goals whereby specific franchise recommendations can be made.
• Franchise Disclosure Document (FDD): The FDD will detail the contractual obligations, the royalty and fee schedule, geographic territory details, roles of the franchisee and franchisor, and any other legal terms related to the franchise.  In the United States, the FDD is governed by the Federal Trade Commission (FTC).  In addition to the federal regulations, 23 states have adopted their own requirements pertaining to the marketing and sales of franchises in addition to the distribution of the FDD.
• Franchise Agreement: The Franchise Agreement is the contract that details the responsibilities, obligations, and expectations of the franchisor and franchisee, in addition to the terms and conditions for the franchisee.  This is a legally binding contract and is signed by the entrepreneur when they have finalized the decision to acquire the franchise.
• Franchise Re-Sale: The alternative to buying a new franchise would be to acquire a franchise re-sale.  A franchise re-sale is essentially a franchise that has already been put into operation by another individual.  Typically, re-sales have a track record of verifiable earnings, management and staff already in place, and an established customer base.

There are considerable benefits to those individuals who pursue franchising as the path to small business ownership.  As with anything, there are drawbacks as well.  Detailed below is a summary of the advantages and disadvantages to acquiring a franchise.

Advantages:

•      Proven business model and product/service. Typically  a brand with market awareness

•       Marketing/Sales/Ops support

•       Quick start up

•       Training, professional guidance; Typically there exists a historical perspective

•       Continued consulting relationship

•       Access to other franchisees for help

•       Regulated by the FTC (Federal Trade Commission) = easy to evaluate franchise (FDD)

Disadvantages:

•       You have to follow the system to be successful – limited choices

•       Usually must meet mandated annual sales goals – not completely your own boss

•       You pay franchise fees and royalties in exchange for training and marketing support

•       Protected territories = operational boundaries

•       Binding contract

•       Franchisor’s problems are your problems

At any given time, there are many franchise re-sales available for purchase.  Acquiring an existing franchise in the secondary market is often the preferred path for many individuals.  A summary of the advantages and disadvantages of purchasing a franchise re-sale are as follows:

Advantages:

•     Existing cash flow & good will

•      Actual historical results

•      Attractive to funding/finance companies

•      Established location & customer base

•      Employees in place

•      Systems may be in place

•      Owner financing

Disadvantages:

•       Challenges in confirming actual cash flow

•       Business is over-valued (inflated by goodwill)

•       Hidden seller motives

•       Employee defection

•       Higher Debt Service

•       Poor training/support by the former owner (if part of the deal)

Acquiring a franchise that has a proven model of success can be one of the fastest and most economical methods to fulfilling the dream of owning a profitable business when compared to starting a business from scratch. There are thousands of franchises available and the research, investigation, and qualification process can be daunting, to say the least.

Leveraging a consultant with an established track record of success who possesses the tools, resources, core experience, and global network will help to demystify the complex variables associated with the due diligence process.  Assisting the entrepreneur to narrow the plethora of opportunities based upon individual lifestyle and financial requirements will enable the entrepreneur to smoothly travel the road to business ownership.

About the author
Michael Fekkes is a Certified Business Intermediary (CBI®) at ENLIGN Business Brokers

Tel. 910.691.2202 ● Email: mfekkes@enlign.com ● Web: www.enlign.com

Note from the Editor

Michael has a been a great contributor to this blog and I love Michael’s insights. There are times I agree with Michael and there are times I don’t.

What I like about Micheal in this article is he advises people to use a Franchise Consultant rather than go through the process alone. I think this is a very valuable tip for first timers. At times, there is a huge gap between what the franchisor says to what is actually the reality of the situation. You’ve got to be aware that there is a lot of sugar coating when it comes to franchise sales.

Personally, I am not a big fan of buying a franchise or even buying a franchise resale. Rather, I’d prefer to buy an existing business that is already profitable. Because when you buy an existing business you already have existing revenues and a proven system in place if the business is profitable. The upside is you can expand the business and you own the brand.

Whereas in a franchise you are building someone else’s brand NOT yours. To me a franchise is like buying yourself a job. Not to mention the upside is fairly limited. If you’d like to expand then you probably might need to buy an additional franchise in another region.

Having said all this, for some people and in certain situations a franchise might be the best option. All I am saying is evaluate other options like buying a business or starting a business from scratch before buying a franchise.

Regards,
Vinil Ramdev
Founder and Chief Editor, StartUpGrowthExpert.com

Image: Francesco Marino / FreeDigitalPhotos.net

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