10 Things You Need to Know Before Buying Into a Franchise

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buying into a franchiseOwning a franchise allows you to go into business for yourself, but not by yourself. A franchise owner operates by selling an established product or service which often has significant brand recognition (think McDonald’s or Orange Theory). A franchise includes not only a product, service, and trademark but also the complete method to conduct the business itself such as the marketing plan and operations manuals. Running a franchise increases your chances of business success because you are leveraging a proven business model and benefitting from an existing customer base, which would take years to develop with your own original idea. However, people often make the mistake of thinking franchises are just a ‘business in a box.’ People also falsely believe that franchises have a smaller failure rate than other businesses, and that is not true. Like all businesses, 60 percent of franchises will be out of business in year two.

Therefore, if you’re thinking of buying into a franchise, you need to prepare yourself. While these types of businesses provide you with everything you need to get started plus training for you and your team, they are not necessarily easy to run. You need significant cash reserves to get started, especially with a food franchise. For example, did you know that often you must have 2 million in liquidity to even apply to become a franchisee of a major food franchise such as McDonalds or Qdoba Grill? Also, many franchisees are required to contribute a designated amount to advertising each month, but they have no control over how those dollars are spent.

10 Things to Need to Know First Before Buying into a Franchise

Potential pitfalls aside, buying into a franchise can be a good way to own your own business (and enjoy all of the perks that come with it!), as long as you do it in a smart and calculated way. This list has several important things to think about before buying into a franchise.

1. Do Your Homework

Educate yourself. You need to know about the industry and the business you want to buy into. Interview the franchisor aggressively. They will typically only introduce you to people who will help them sell you a business license. Ask questions about their pre-opening support, franchise license boundaries, site selection, design, construction, financing, training, and a grand-opening program.

2. Assess Your Work Style & Strength

How do you feel about doing the same tasks all the time? Do you like people? How about business-to-business sales? If you hate sales, you will have trouble running any business. If you hate people, you’ll need a partner to handle that side of the business. Be honest with yourself about your strengths and weaknesses. Pick three people you trust and ask them to tell you about your strengths & weaknesses. It’s best to buy a business where you have some experience. Don’t buy a restaurant franchise because you like to eat. Buy a restaurant because you have experience in food service and management.

3. Investigate the Fees

In addition to the initial franchise fee, franchisees must pay ongoing royalties and advertising fees. Then there’s often opening day expenses when headquarters may require you to give away free stuff and do special promotions. Franchisees must be careful to balance requirement/restrictions with their own ability to run a business. A system-wide scandal can make your franchise perform poorly: think Chipotle and the lettuce scandal, or the Starbucks manager who called the cops to arrest two black male patrons which caused protests across the country. If the franchisor runs into a problem, that could easily cause problems for your individual franchise too. The term (duration) of a franchise agreement is usually limited, and the franchisee may have little or no say about the terms of a termination.

4. Get Your Money Straight

Getting a franchise up and running can involve hefty sums of cash, including the buy-in fee and the cost of equipment, location and fit-up construction for retail businesses, and up-front marketing costs. You’ll need at least the first year of operating capital before the business catches on, not to mention funds to live on while you are building the business. Even well-known brands like Dunkin need time to catch on in a new location.

5. Read the FDD Disclosure Statement Carefully

The Franchise Disclosure Document, FDD, is the document which provides information about the franchisor and franchise system to the franchisee requirements. No franchisee is completely independent. Franchisees are required to operate their businesses according to the procedures and restrictions set forth in the franchisee agreement. These restrictions usually include which products or services can be offered, pricing, and geographic territory. This agreement also makes requirements on how much working capital the franchisee needs to have available. The FDD is the most serious disadvantage to becoming a franchisee as you have no control over who else can buy a franchise in your area, nor can you deviate from requirements or products.

6. Use a Franchise Attorney

Not every business lawyer can negotiate a franchise agreement—you need a specialist. The FDD or franchise license agreement is a contract that describes the relationship between the franchisor and franchisee, including the use of trademarks, fees, support, and control. It’s the legal, written contract between the franchisor and franchisee that tells each party what each is supposed to do.

7. Beware of Franchise Consultants

Most franchise consultants are paid salespeople for the franchise owners. Consultants will put on a hard sell to get you signed to a franchise deal as quickly as possible. Why?  They get a commission on the initial franchise fee. Ask them to make their financial arrangements clear, up front, so that you don’t get lied too.

8. Work for a Franchise

Learn by doing. Before starting a business or buying a franchise, I suggest working for one. Once you become an employee, you can see how things really work, and how much support is really provided by the franchisor. It’s like being an undercover boss, and it could give you valuable information. You should work at least 6 months to get a real impression of how things work.

9. Hire Professional Help

I already mentioned getting a franchise attorney, but you also need an accountant to help you run the numbers. You’ll need a breakeven analysis so that you really understand what your cash outlay will be monthly. A seasoned insurance agent will be beneficial too. Your entire professional team should review the franchise agreement before it’s signed.

10. Talk to Other Franchisees

You should reach out to other franchise owners to get their story and see what the real story is about the pros and cons. One of the most important questions to ask them is how much support they receive from headquarters.  You also want to ask them if they would buy into the business again based on what they know now. Aim to speak to at least 10 franchisees because many small business owners are prideful and won’t want to admit that they struggled financially.

Depending on the franchise you choose, you could be investing between $150,000 and $1 million before the business even opens. Do yourself a favor: try to find any disgruntled franchisees online before you sign your franchise agreement. You need to know if there’s any discord out there about your franchisor. Take advantage of the training, national and regional advertising, operating procedures, operational assistance, ongoing supervision, and management support, and access to bulk purchasing. Another helpful resource to check out before buying into a franchise is the International Franchising Association’s Franchising 101 guide.

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