By International Franchise Association
Many people dream of being an entrepreneur. By purchasing a home-based franchise, you can often sell goods and services that have instant name recognition and, depending on the franchise, you may be able to obtain training and ongoing support. But be cautious.Like any investment, purchasing a franchise is not a guarantee of success.
Before making an investment, you need to evaluate whether owning a franchise is right for you. The following information, provided by the Federal Trade Commission, will help you understand your obligations as a franchise owner, how to shop for franchise opportunities, and how to ask the right questions before you invest.
What Are the Advantages?
A franchise typically enables you, the investor or “franchisee,” to operate a business. By paying a franchise fee, which may cost several thousand dollars, you are given a format or system developed by the company (“franchisor”), the right to use the franchisor’s name for a limited time, and assistance. For example, a franchisor may provide initial training and an operating manual, in addition to advice on management, marketing, or personnel issues. Some franchisors offer ongoing support such as monthly newsletters, a toll-free telephone number for technical assistance, and periodic workshops or seminars.
What Are the Drawbacks?
While buying a franchise may reduce your investment risk by enabling you to associate with an established company, it can be costly. You also may be required to relinquish significant control over your business, while taking on contractual obligations with the franchisor. Below is an outline of several components of a typical franchise system. Consider each one carefully.
The Total Cost
In exchange for obtaining the right to use the franchisor’s name and its assistance, you may pay some or all of the following fees:
* Initial Franchise Fee and Other Expenses. Your initial franchise fee, which may be non-refundable, may cost several thousand to several hundred thousand dollars. You may also incur significant costs to rent, build, and equip an outlet (i.e., your home office or mobile unit) and to purchase initial inventory. Other costs include operating licenses and insurance. You also may be required to pay a “grand opening” fee to the franchisor to promote your new outlet.
* Continuing Royalty Payments. You may have to pay the franchisor royalties based on a percentage of your weekly or monthly gross income. You often must pay royalties even if your outlet has not earned significant income during that time. In addition, royalties usually are paid for the right to use the franchisor’s name. So even if the franchisor fails to provide promised support services, you still may have to pay royalties for the duration of your franchise agreement.
* Advertising Fees. You may have to pay into an advertising fund. Some portion of the advertising fees may go for national advertising or to attract new franchise owners, but not to target your particular outlet.
Controls
To ensure uniformity, franchisors typically control how franchisees conduct business. These controls may significantly restrict your ability to exercise your own business judgment. The following are typical examples of such controls:
* Site Approval. Many franchisors pre-approve sites for outlets. This may increase the likelihood that your outlet will attract customers. The franchisor, however, may not approve your site. This is less important or not an issue for most home-based franchises, that will provide an on-site service to clients.
* Design or Appearance Standards. Franchisors may impose design or appearance standards to ensure customers receive the same quality of goods and services from each outlet. Complying with these standards may increase your costs.
* Restrictions on Goods and Services Offered for Sale. Franchisors may restrict the goods and services offered for sale. For example, as a home-based automobile transmission repair franchise owner, you might not be able to perform other types of automotive work, such as brake or electrical system repairs.
* Restrictions on Methods of Operation. Franchisors may require you to operate in a particular manner; during certain hours; use only pre-approved signs, employee uniforms, and advertisements; or abide by certain accounting or bookkeeping procedures. These restrictions may impede you from operating your business as you deem best. The franchisor also may require you to purchase supplies only from an approved supplier, even if you can buy similar goods elsewhere at a lower cost.
* Restrictions of Sales Area. Franchisors may limit your business to a specific territory. While these territorial restrictions may ensure that other franchisees will not compete with you for the same customers, they could impede your ability to open additional outlets or move to a more profitable location.
Terminations and Renewal
You can lose the right to your franchise if you breach the franchise contract. In addition, the franchise contract is for a limited time; there is no guarantee that you will be able to renew it.
* Franchise Terminations. A franchisor can end your franchise agreement if, for example, you fail to pay royalties or abide by performance standards and sales restrictions. If your franchise is terminated, you may lose your investment.
* Renewals. Franchise agreements typically run for 15 to 20 years. After that time, the franchisor may decline to renew your contract. Also be aware that renewals need not provide the original terms and conditions. The franchisor may raise the royalty payments, or impose new design standards and sales restrictions. Your previous territory may be reduced, possibly resulting in more competition from company-owned outlets or other franchisees.
Do You Have What It Takes?
Before investing in a particular franchise system, carefully consider how much money you have to invest, your abilities, and your goals. The following checklist may help you make your decision related to a franchise:
* Your Investment. How much money do you have to invest?
* Your Abilities. What specialized knowledge or talents can you bring to a business?
* Your Goals. Would you be happy operating the business for the next 20 years?
Which Home-Based Franchises Make the Best Investments?
Like any other investment, purchasing a franchise is a risk. When selecting a franchise, carefully consider a number of factors, such as the demand for the products or services, likely competition, the franchisor’s background, and the level of support you will receive.
Demand
Is there a demand for the franchisor’s products or services in your community? Is the demand seasonal? For example, lawn and garden care or swimming pool maintenance may be profitable only in the spring or summer. Is there likely to be a continuing demand for the products or services in the future? Is the demand likely to be temporary, such as selling a fad food item? Does the product or service generate repeat business?
Competition
What is the level of competition, nationally and in your community? How many franchised and company-owned outlets does the franchisor have in your area? How many competing companies sell the same or similar products or services? Are these competing companies well established, with wide name recognition in your community? Do they offer the same goods and services at the same or lower price?
Your Ability to Operate a Business
Sometimes, franchise systems fail. Will you be able to operate your outlet even if the franchisor goes out of business? Will you need the franchisor’s ongoing training, advertising, or other assistance to succeed? Will you have access to the same or other suppliers?
Name Recognition
A primary reason for purchasing a franchise is the right to associate with the company’s name. The more recognized the franchise name, the more likely it will draw customers who know its products or services. Therefore, before purchasing a franchise, consider:
* The company’s name and how widely recognized it is
* If it has a registered trademark
* How long the franchisor has been in operation
* If the company has a reputation for quality products or services
* If consumers have filed complaints against the franchise with the Better Business Bureau or a local consumer protection agency
Training and Support
Another reason for purchasing a franchise is to obtain support from the franchisor. What training and ongoing support does the franchisor provide? How does their training compare with the training for typical workers in the industry? Could you compete with others who have more formal training? What backgrounds do the current franchise owners have? Do they have prior technical backgrounds or special training that helps them succeed? Do you have a similar background?
Franchisor’s Experience
Many franchisors operate well-established companies with years of experience both in selling goods or services and in managing a franchise system. Some franchisors started by operating their own business. There is no guarantee, however, that a successful entrepreneur can successfully manage a franchise system. Carefully consider how long the franchisor has managed a franchise system. Do you feel comfortable with the franchisor’s expertise? If franchisors have little experience in managing a chain of franchises, their promises of guidance, training, and other support may be unreliable.
Growth
A growing franchise system increases the franchisor’s name recognition and may enable you to attract customers. Growth alone does not ensure successful franchisees; a company that grows too quickly may not be able to support its franchisees with all the promised support services. Make sure the franchisor has sufficient financial assets and staff to support the franchisees.
Earnings
Some franchisors may tell you how much you can earn if you invest in their franchise system or how current franchisees in their system are performing. Be careful. The FTC requires that franchisors that make such claims provide you with written substantiation. Make sure you ask for and obtain written substantiation for any income projections, or income or profit claims. If the franchisor does not have the required substantiation, or refuses to provide it to you, consider its claims to be suspect.
What Should You Investigate Before Signing a Contract?
Once you find a franchise opportunity that interests you, it’s time to conduct extensive research on the offering. Make sure you complete a thorough investigation on the franchise before signing any contract. You may want to consult with an attorney or business advisor during this step.
Before investing in any franchise system, be sure to get a copy of the franchisor’s disclosure document. Sometimes this document is called a Franchise Offering Circular. Under the FTC’s Franchise Rule, you must receive the document at least 10 business days before you are asked to sign any contract or pay any money to the franchisor. You should read the entire disclosure document. Make sure you understand all of the provisions. Seek clarification or answers to your concerns before you invest. Here are some areas to focus on:
Business Background
The disclosure document identifies the executives of the franchise system and describes their prior experience. Consider not only their general business background, but also their experience in managing a franchise system. Also consider how long they have been with the company. Investing with an inexperienced franchisor may be riskier than investing with an experienced one.
Litigation History
The disclosure document helps you assess the background of the franchisor and its executives by requiring the disclosure of prior litigation. The disclosure document tells you if the franchisor, or any of its executive officers, has been convicted of felonies involving, for example, fraud, any violation of franchise law or unfair or deceptive practices law, or are subject to any state or federal injunctions involving similar misconduct. It also will tell you if the franchisor, or any of its executives, has been held liable or settled a civil action involving a franchise relationship. A number of claims against the franchisor may indicate that it has not performed according to its agreements, or, at the very least, that franchisees have been dissatisfied with the franchisor’s performance.
How Do You Get Started?
After reviewing the essential paper work and signing on the dotted line, your real journey as a home-based franchise owner begins. Take advantage of the fact that you are now a privileged member of a large and established business organization. Absorb all of the knowledge you can from your peers and learn from their past mistakes and successes. Get all of the formal training you are eligible for and read all of your instruction manuals. Most importantly, have confidence in your abilities and take pride in building a successful home-based business you can call your own.
Reprinted with permission of the International Franchise Association, the world’s oldest and largest association representing the franchising industry, whose long-standing role is “building local businesses, one opportunity at a time.” Visit the Federal Trade Commission’s web site at www.ftc.gov or IFA’s web site at www.franchise.org.
