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Many people dream of being an entrepreneur. By purchasing a franchise,
you can often sell goods and services that have instant name recognition
as well as obtain training and ongoing support to help you succeed.
However; like any investment, purchasing a franchise is not a guarantee
of success.
A franchise typically enables you, the investor (franchisee), to operate
a business. By paying a franchise fee, which may anywhere from several
thousand dollars to more than a hundred 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.
While buying a franchise may reduce your investment risk by enabling you
to associate with an established company, it can be costly. You may also
be required to relinquish significant control over your business while
taking on contractual obligations with the franchisor.
One of the biggest mistakes you can make is to hurry into business, so
it's important to understand your reasons for going into business, and
determine if owning a business is right for you. See our Is Franchising
for Me? page for some helpful ways to evaluate whether a franchise
concept is suitable for you. If it is, then you must perform a host of
tasks to evaluate the particular opportunity being considered. The
information and guidelines in this website will hopefully help you.
What is Franchising?
A franchise is a legal and commercial relationship between the owner of
a trademark, service mark, trade name, or advertising symbol and an
individual or group wishing to use that identification in a business.
The franchise governs the method of conducting business between the two
parties. Generally, a franchisee sells goods or services supplied by the
franchisor or that meet the franchisor's quality standards.
Franchising is based on mutual trust between the franchisor and
franchisee. The franchisor is expected to provide the business expertise
(marketing plans, management guidance, financing assistance, site
location, training, etc.) that otherwise would not be available to the
franchisee. The franchisee brings the entrepreneurial spirit and drive
necessary to make the franchise a success.
There are primarily two forms of franchising:
Product/trade name franchising
Business format franchising
In the simplest form, a franchisor owns the right to the name or
trademark and sells that right to a franchisee. This is known as
product/trade name franchising. The more complex form, business format
franchising, involves a broader ongoing relationship between the two
parties. Business format franchises often provide a full range of
services, including site selection, training, product supply, marketing
plans, and even assistance in obtaining financing.
Remember that the franchisor wants to control standards so that the
trademark maintains its value. Thus you will be subject to many controls
on what you can do. McDonalds is not going to allow you to sell tacos or
hotdogs or anything else they do not approve. Franchisors want their
products to be uniform and the marketing power of that is that when I go
into McDonalds in Gary Indiana, I will get the same product as I do in
San Francisco. Thus, franchisees surrender a lot of freedom when
entering into a franchise. Another consideration is that a franchisees
fortunes are tied to the integrity of the brand name. Remember the e-
coli scare with Jack in the Box some years ago you can be certain that
many franchisees were affected by that.
The Cost of Franchising
In exchange for obtaining the right to use the franchisor's name and
assistance, you may pay some or all of the following fees:
Initial franchise fee and other expenses. Your initial
franchise fee, which may be nonrefundable, may cost several
thousand to several hundred thousand dollars. You may also
incur significant costs to rent, build, and equip an outlet
and 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 are usually 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 Exercised by the Franchisor
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 the site you want.
Design or appearance standards. Franchisors may impose design or
appearance standards to ensure customers receive the same quality of
goods and services in each outlet. Some franchisors require periodic
renovations or seasonal design changes. 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
restaurant franchise owner, you may not be able to add popular items to
your menu or delete items that are unpopular. Similarly, as an
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 method of operation. Franchisors may require you to
operate in a particular manner. The franchisor might require you to
operate during certain hours, use only preapproved signs, employee
uniforms, and advertisements, or abide by certain accounting or
bookkeeping procedures. These restrictions may impede you from operating
your outlet as you deem best. The franchisor may also require you to
purchase supplies only from an approved supplier, even if you can buy
similar goods elsewhere at a lower cost.
Restriction 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.
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Franchise Disclosure Laws
Franchising is regulated by law to a certain extent. Certain disclosures
must be made that will give you some information about the people who
run the franchise, bankruptcy, lawsuits, number of units operating,
number terminated, identities of other franchisees, and the financial
condition of the franchisor. However, it is up to you to evaluate the
information.
Pay particular attention to the disclosed litigation if there are
many lawsuits filed that is a big red flag. Also look at franchise
turnover if high another red flag. Call existing franchisees ask
them how they are doing, is it worth the investment, would they buy this
franchise again?
Franchise Relationship Laws
Although California has a franchise relations act it deals mostly
with rights on non-renewal and/or termination. For the most part, the
rights of the parties will be established by the franchise contract
alone. Encroachment is a good example. You would not think it would be
fair for a franchisor to sell another franchise that could be put in a
mile down the road. But unless the Franchise agreement prohibits it
that is usually permissible. That is one reason why we recommend all
prospective franchisees get a lawyer to review it.
Franchise Agreements
The agreements themselves are generally long, they are written by
lawyers, and are often difficult to understand. Given that this may be
one of the most important transactions you will ever make, you need to
understand it well. There are a number of provisions to consider.
Royalty and ad fund payments are the big ones. Territory is another one
Another one of particular importance is what happens in the case of a
dispute. Many provide for arbitration, which is different form court
you have to pay the judge to hear your case and there are no rights to
an appeal. In some states, franchisors are entitled to lost future
profits if you terminate the agreement or are terminated with cause.
That is, the franchisor can ask you to pay the profits it would have
made if you had still been in business but you will have no business or
income from which to pay such profits!
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