Starting a Business

What to consider before opening a franchise

Before you make the investment, follow these steps to help you select the right opportunity.

Published: August 02, 2019

Buying a franchise may offer prospective business owners an attractive balance of independently managing day-to-day operations while receiving support from an established company or well-known corporate brand.

Statistics show franchises typically have a much lower rate of failure than other independent businesses. As the owner of a franchise location, you may benefit from the franchisor’s help and guidance, collective buying power, brand recognition, and profitability.

Though franchising is a tested and enticing route, success is not guaranteed. Opening a franchise often means conforming to the rules and guidelines of the franchisor, facing ongoing costs, and entering a competitive market.

Before investing in a franchise, consider these important factors.

Assess your finances

To open a franchise, you’ll need to invest upfront when you pay the franchisor a one-time franchise fee. Most franchise fees are between $20,000 and $50,000, and buying into a well-known franchise can be pricey. For example, the franchise fee for McDonalds or Taco Bell is about $45,000.

From there, you’ll be responsible for paying monthly royalty fees – typically 4 to 12 percent of your gross sales revenue – for the right to use the franchise name and other resources. You may also face monthly marketing fees based on your revenue, but these are typically lower than royalty fees.

In addition to accounting for these fees, you will want to estimate how much you may need for inventory and working capital to operate the business in the early stages. Depending on the franchise, you might also face a build-out cost, determined by the franchisor, to cover furniture, fixtures, equipment, and signage.

The cost of opening a franchise varies. The total estimated investment to open a Wendy’s franchise, for example, is $2 to $2.5 million, while costs to open a Subway location fall between $120,000 and $260,000. Be sure to conduct franchise-specific research and evaluate your financial capabilities honestly.

If you plan to apply for a bank loan or line of credit to run your franchise, a lender will review your credit profile and typically ask for detailed information, including gross annual revenues and tax returns, among other things.

Evaluate your experience

There are franchising opportunities in just about every industry, so there’s room to be selective. Ask yourself whether you would enjoy spending your days running a particular type of business. For example, if you’re interested in opening a retail store, you should feel comfortable interacting regularly with customers and managing employees. Other kinds of franchises may require more technical expertise.

Start by considering broad categories of businesses that appeal to you, and then research specific opportunities within those sectors. Attending industry events and trade shows also can help you gain insight and narrow down your options.

Do your research

Once you are seriously considering a franchise, review the Franchise Disclosure Document (FDD) the Federal Trade Commission requires companies to provide. The FDD includes:

  • A history of the business
  • Information about its executives
  • Relevant litigation and bankruptcy disclosures
  • Initial and ongoing fees and investments
  • Audited financial statements

This document also explains franchisee obligations. You may wish to analyze the FDD with the help of your accountant or business advisor. If you choose to consult with a franchise attorney, budget for $1,500 to $5,000 in consulting fees.

Further, be sure to research the track record of individual franchise locations, especially those in your area. Find out how many branches of the franchise have recently opened or closed in your region. Ask about the success rate and the average number of years a franchisee typically stays with the business.

In addition, evaluate the franchise in relationship to its larger industry. Find out how much competition is already in your market — and whether there are significant competitors who have not yet entered the space but might do so in the near future. Does your potential franchise have a unique position that will allow you to compete?

Complete your due diligence

Before making a major investment in a franchise, speak with those who have gone before you. Make appointments to meet current and former franchise owners in your area.

What do they wish they had known when they were just starting out? Learn about the challenges they faced, how they overcame them, and which factors contributed to their success. This is the time to get specific about financials: ask franchise owners about contracts, leases, inventory, and cash flow. If you can, speak with former franchise owners who shut down their operation and try to assess which factors led to the business closing.

With so many franchising options, it’s important to choose a business that matches your experience, skills, and aspirations. Assessing your personal interests and goals may help you decide which business route to take.

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