The franchise businesses in the US have contributed a whopping $827 billion in economic output in 2022 and represent 3% of US GDP in 2023. If the idea of entrepreneurship seems exciting to you you must consider stepping into the world of franchise business. A recognizable brand, marketing and training support, and a proven business model are just a few of the perks that come with franchising.
Having said that, like any other business franchising has its own fair share of risks. Before you take the leap it is important for you as a franchisee to closely evaluate the franchise opportunity you are evaluating to invest in. Let’s find out why.
The franchising landscape is vast and continuously evolving. Current data indicates that there are over 3000 active franchisors operating in the United States alone. Every year, an average of 300 new brands adopt the franchising model, expanding the pool of opportunities for potential franchisees. However, this choice comes with a lot of complexities.
Location plays a pivotal role in the success of any brick-and-mortar franchise. When it comes to selecting the site for your business, it involves more than an area with high footfall. Several other factors can impact the success of your business such as:
For example: If you run a quick-service restaurant that has a bank nearby, it could get your location more visibility.
If you’re still not sure about site selection, you should seek advice from the franchisor or pay a visit to other franchises from the same franchise system to know how they're operating.
Understanding the financial health of the franchise business you’re planning to invest in can save you from potential pitfalls that may arise in the future. The best way to do this is by thoroughly reviewing the Franchise Disclosure Document (FDD) which gives invaluable information about the franchise business’ financial status, including income statements and balance sheets.
It's a good idea to hire an accountant or legal advisor to review the franchisor’s financial statements, audit reports, operating margins, revenue trends, and net income. This will help you gain a better understanding of whether the franchise’s fiscal performance aligns with your financial objectives.
For example, let’s say you’re considering investing in a popular burger chain franchise that’s been in the industry for a few years and is well known. At first glance, it might seem like an attractive investment. However, when you review Item 19 of the FDD, you notice that their income statements for the past three years show stagnant revenues, diminishing returns, and increasing debts. These financial indicators suggest that the franchisor may be struggling and there could be significant risks associated with the investment.
While you might be already familiar with the initial franchise fee, there are several other costs that you’ll be required to pay. These may include:
These additional costs, if not taken into account at the outset, can come as an unwelcome surprise, potentially thinning your budget or leading to financial strain. For brands like Subway, the initial franchise fee typically ranges from $10,000 to $15,000. But when it comes to its total investment which includes construction, equipment leasing costs, and a plethora of miscellaneous expenses the final investment is to the tune of $116,200 to $262,850.
The sustainability of your franchise business relies heavily on renewal rights, an often overlooked aspect of the franchise agreement. Some franchises allow no or only a few renewals upon termination. For example, McDonald’s has the initial traditional franchise term of 20 years and franchisees are given no rights to extend or renew the agreement after it ends. This is why it's vital that you thoroughly examine the renewal section under Item 17 in the franchise agreement. It’ll give you an in-depth comprehension of your rights to renewal, terms and conditions, renewal fees (if any), and any potential changes to the agreement upon renewal.
Disputes and disagreements can occur in the world of franchising and understanding how those disputes are handled can save you headaches down the road.
Typically, mediation is the first step where a neutral third party helps the franchisor and franchisee amicably resolve the issue. If this doesn’t work, arbitration might be the next step where an impartial panel of arbitrators makes a decision. In some cases, if a dispute isn’t resolved, it may escalate to litigation, a court-based procedure. Therefore, to avoid potential frustrations in the long run, you must understand the dispute resolution process for the franchise brand explained in the FDD.
Franchisors include clauses in their agreement that provide franchisees the option to transfer their business ownership to another party. This can be particularly beneficial in scenarios like passing on the business to family members. Hence, before you seal the deal and sign the franchise agreement, it’s of utmost importance to delve into the franchisor’s policy pertaining to business acquisition and ownership transfer stated in Item 14 of the franchise disclosure document. By scrutinizing the stipulations around selling and transferring your franchise, you’ll be able to effectively plan a strategic exit without any potential consequences such as penalties.
Becoming a franchisee is a long–term commitment with a minimum lock-in period of 10 years for most brands. Always do your research, and consider seeking professional advice from financial advisors or legal experts specializing in franchising. The more you understand the nuances of your potential franchise, the higher your chances of success.
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