Franchised businesses are becoming more popular. Some 12,510 new franchise establishments have opened up in 2014 so far, adding up to a growth rate of 1.7%, beating 2013's 1.4% growth rate.
A number of factors contribute to the increasingly fertile franchise environment. An overall strengthening economy, spurred by higher consumer confidence, income and spending, is one. And on the political front, a recent U.S. House of Representatives bill defining full-time employees as those working a 40-hour (or more) work week counters an earlier Affordable Care Act provision defining full-time employees as those working at least 30 hours a week. The higher benchmark means it will be easier for employers to avoid paying for their employee's health insurance.
For entrepreneurs intrigued by the prospect of owning cash-generating, brick-and-mortar establishments, but hesitant to create businesses from scratch, a franchise may be the perfect solution. (For more, see: Is Buying a Franchise Wise?)
Simply defined, a franchise is a model where the original business owner (franchiser) licenses his brand to a new owner (franchisee), and provides marketing, merchandising and organizational expertise, in exchange for monetary consideration. And unlike business owners who build from the ground up, franchisees may immediately plug into a proven system of operational success. Not only does this let them bypass rookie mistakes, but it also gives them access to an economy of scale. While independent operators fly solo in negotiating supply costs, lease terms and advertising expenses, franchisees can rely on the franchiser to bake these terms into their deals. The more franchisers ease their franchisees’ journeys and help them tilt towards profitability, the more money they ultimately pocket.
Dollars From Donuts
Those who take the franchise plunge face a wide-open frontier of businesses. The most popular franchises are eating establishments. Some 37% of all franchises are fast food chains, such as McDonald’s Corp. (MCD), Hardee's and Church's Chicken. Full-service, or “table” chains, such as Denny’s Corp. (DENN) and Pizza Hut [a subsidiary of YUM! Brands, Inc. (YUM)] account for 13% of all franchise elements. Lodging, electronics, automotive, retail foods, personal grooming and commercial and residential real estate concerns each claim a single-digit percentage market-share of the franchise space.
Prospective franchisees can start the selection process by perfunctorily narrowing the field down to only those businesses that inherently interest them. This short list should precede a robust geographic analysis of the area to make sure there’s regional demand for the business types in question. (For more, see: 6 Franchises That Are Cheap To Start.)
Buyer Beware: Do Your Due Diligence
With the type of business settled, prospective franchisees should then conduct exhaustive due diligence on a company’s financials. Any reputable franchiser with nothing to hide will freely disclose such information. But franchisees mustn’t rely solely on a company’s proprietary materials. It’s equally important to interview existing franchisees and examine the franchise's Franchise Disclosure Document (FDD) to determine if the chain has national adaptability. It’s likewise critical to make sure franchisers have strong conflict resolution mechanisms in place, since even the healthiest franchisee/franchiser partnerships are bound to have rocky moments. Therefore franchisees should ask franchisers to provide anecdotal examples of disagreements and how they were handled. While it’s natural for franchisers to highlight success stories, the denial of any hiccups should be a red flag.
Expect the due diligence tables to turn, as franchisers worth their salt will conduct deep-dive research into you, just as you investigate them. The most successful businesses are those where franchisers are selective about who they accept into the family, and their failure to do their own homework signals carelessness, and indicates that they aren’t worth partnering with. (For more, see: Share The Wealth With Franchises.)
Know Your Costs
The costs of becoming a franchisee depend on each business agreement. The Initial Franchise Fee, which can range from several thousand dollars to a few hundred grand, typically covers the cost of leasing or building a structure, purchasing equipment and buying inventory. New franchisees must often buy insurance and operating licenses, and some franchisers impose “grand opening” fees, which they use to tout new outlets. Franchisees may also have to pay royalty payments to franchisers, based on a percentage of weekly or monthly gross income. (For more, see: Top 7 Franchise Dangers.)
There are varying controls franchisers may visit upon franchisees, in an effort to maintain brand uniformity across all outlets. These measures can be stringent. For example: a franchiser may reject a chosen site for an establishment if they believe the area isn’t well-trafficked enough, or if it could create competition for the same customer base with other franchisees. Franchisers can also curtail a franchisees future ability to relocate. They may also dictate layout and design considerations, and require routine renovations to be paid for by the franchisee. Franchisers may even govern the very goods and services franchisees can sell. For example, they may detail the precise menu items restaurateurs may offer. Franchisers may forbid a muffler shop from performing oil changes, for example. Franchisers may even control a franchisee’s hours of operations. It's therefore up to each potential franchisee to determine the levels of oversight tolerable to them and to enter deals accordingly.
(For more, see: Most Expensive Franchise Fees.)
The Bottom Line
The franchise model has a unique set of pros and cons for entrepreneurs looking to hang their own shingle on a business that has built-in brand recognition. But for those that take the time to properly evaluate the type of business that best suits them, and rigorously research a franchiser’s story, the franchise approach may hold the key to success. (For more, see: 5 Hot Franchises Right Now.)