Advantages and Disadvantages of Owning A Franchise

Buying A Franchise

A franchise is a business model where a franchisor grants a franchisee the right to use its trademark, brand, and operational systems within a prescribed territory for a set period of time (usually ten year terms). In exchange, the franchisee must follow the franchisor’s reporting obligations, business plan, and payment requirements including an initial franchise fee and ongoing royalties. Studies have shown that about 85% of new franchisees are still operational after five years compared to just 50% of new non-franchised businesses. The proven business model, built-in customer base, and established brand recognition associated with owning a franchise are powerful advantages for those seeking to own a successful business. Those looking to buy a business may choose to purchase an operating franchised business or a new franchised territory.

Power of Franchised Brand

The most important and powerful advantage of owning a franchise is being a part of a credible and trustworthy brand recognized and known by consumers. A recognized brand name with proven success in establishing a growing customer base is likely to be well worth the cost of franchise ownership. Moreover, national or regional marketing support provided by franchisors (reimbursed by franchisees via marketing fees) benefits franchisees from economies of scale in a way that independent businesses can not match. The marketing reinforces the power of the brand, which may grow further over time with the addition of new franchisees who help fund even more marketing. The exclusivity to solely conduct business on behalf of the franchise in protected territories helps ensure that each individual franchisee benefits from the brand.

Review Franchise Disclosure Document

The best way in which prospective franchisees may assess the value of a franchised brand is by closely reviewing the Franchise Disclosure Document (FDD). The FDD is a legally mandated document provided by franchisors to prospective franchisees that describes the franchisors’ fees and royalty requirements, past litigation, financial performance, business plan, and competitive advantages. The information provided by the FDD is an invaluable source of information to conduct due diligence on the franchisor and verify whether other franchisees have been successful in implementing the franchisor’s business model. In fact, prospective franchisees may even contact past and current franchisees and question them as to their experiences with the franchise. The FDD must be given to prospective franchisees at least 14 days prior to signing a franchise agreement with the franchisor.

Training and Purchasing Power

For prospective buyers unfamiliar with the industry in which the franchise operates, purchasing a franchise is an excellent way to receive professional training and subsequent guidance by experts with the experience and knowledge of operating the franchised business model. Owners of non-franchised business may also provide free training to buyers after the sale, but the level of formalized training and professional guidance provided by franchisors is often superior. Additionally, franchise owners benefit from lower bulk purchasing costs for inventory and equipment, which may significantly lower their start-up costs and ongoing supply expenses. Being a part of a large network of franchisees provides excellent negotiating power and leverage with suppliers and vendors. This increases the operating margins of franchisees and helps defray required royalty expenses.

Disadvantages of Franchises

  • The disadvantages of owning a franchise are the royalties, marketing fees, reporting requirements, operating restrictions, and contractual obligations imposed by the franchisor.
  • The franchisor’s control over the business also includes the power to control the franchisee’s right to re-sell the franchised business to another party.
  • For most prospective buyers of franchises, royalty fees payable to the franchisor (based on a percentage of sales) is often the biggest detriment to owning a franchise.
  • A franchisee may attempt to negotiate an exemption of royalties for sales below a minimum amount of annual revenue.
  • This allows a franchisee to avoid paying the franchisor a percentage of their sales even when they are losing money.
  • Marketing fees should result in added customer traffic from a national or regional marketing campaign highlighting the franchised brand.
  • If not, there should be a mechanism in which the franchise is entitled to verify how the marketing dollars are spent.
  • Restrictions on the operations of a franchisee include deciding where supplies or inventory is purchased, what items the franchisee are prohibited from selling, and how individual franchisees may advertise to the public.
  • This tends to disproportionately impact experienced operators familiar with the industry who want the freedom to run their business as they see fit.
  • For example, an experienced restauranteur considering the purchase of a franchise specializing in selling certain subs and sandwiches may desire to also sell related menu offerings.
  • In such a case, the franchise may prohibit selling such items, and may further conducts random checks on franchisees to ensure compliance.
  • Less experienced operators may not mind the restrictions and are happy to simply follow the franchisor’s proven model of success.

Dependence on Franchisor

Being dependent on the training, guidance, business plan, and brand of the franchisor may not be for everyone. Some buyers simply work better independently or already have knowledge and experience in the industry in which the franchise operates. Other buyers are comfortable following the requirements and paying the costs imposed by the franchisor since they trust the power of the franchisor’s brand and know-how in guiding their business. In either case, prospective buyers of franchises should closely examine the value of the franchisor’s brand by reviewing the FDD and speaking with other franchise owners. If the benefits of the franchisor’s brand outweigh the costs and requirements imposed by the franchisor, then purchasing a franchise may be a good idea for those seeking training and guidance when buying a business.

Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.