This article was written by our friends at Fundera, a marketplace that lets you discover financial options you never knew you had.
Chances are if you’re interested in owning a business in your area of interest, there’s a franchise for that. There are franchises across 300 business categories, from restaurants to tax services to mosquito control.
The allure of franchising is obvious—you become a small business owner virtually overnight, bypassing some of the hardest parts of a new business. On the other hand, franchising limits your autonomy, and ties you to a brand whose national reputation you don’t have any control over. Plus, success is never guaranteed, even for a well-known franchise.
If you’re thinking about franchising, here are the main things you need to know to make an informed decision.
You’ll need to play by the franchise rules
The question at the heart of buying a franchise is whether you want to play by your own rules or are happy to play by someone else’s.
When you buy a franchise, you gain access to that company’s systems, brand recognition, and resources. But you’ll also need to stick to their standards, ask for permission to start a new location, and abide by any other contractual agreements—or face termination.
If your definition of entrepreneurship is “being the boss” and making executive decisions about how to work and where to work, franchising may not be for you. If you can work under the constraints of the franchise, and find a thrill in bringing that franchise’s products or services to new markets, keep reading.
You won’t be more or less likely to fail
There’s a myth about franchising success known as “The Stat,” which says that franchises have a success rate of over 90%—much higher than independent retail businesses.
The Stat, unfortunately, is completely unproven and can’t apply to every entrepreneur, franchise type, and city.
You won’t find one single stat to predict your future in franchising. A more helpful approach is to analyze how similar businesses have done in your city, and how similar businesses have done in that industry.
Review the franchise disclosure document
The franchise disclosure document, or FDD, provides a wealth of information about the franchise’s background, litigation history, initial and ongoing costs, restrictions, growth and turnover, financial statements, and more.
Get your hands on the FDD as soon as possible. Under FTC rules, you must receive the document “at least 14 days before you are asked to sign any contract or pay any money to the franchisor or an affiliate of the franchisor.” Your goal should be to obtain the FDD before you spend money investigating the franchise’s history.
The FDD will cover the basics—such as what resources you will receive from the franchisor and what fees you’ll owe them as a result—as well as answer important questions, including what percentage of the franchisee’s profits must go towards national advertising, or how much a franchisor devotes to franchisees to support its system. This information will help you figure out whether joining this franchise, in this market, is worth your investment.
You may need to secure financing
One of the biggest barriers to franchising is the high cost of entry. The initial franchise fee can run hundreds of thousands of dollars, and that’s before the costs for buying (or even renting) any necessary equipment and inventory, and obtaining business licenses and insurance. Then there are your royalty fees and regular ongoing expenses.
So you may want to investigate possible sources of financing before you move ahead on buying a franchise.
Your best financing options include:
● SBA loans: The Small Business Administration has loan programs that partially guarantee loans disbursed by SBA-approved lenders, which results in low interest rates and long repayment terms. Some SBA loans are specific for franchise funding—which means the franchise must be in the SBA-approved franchise directory.
● Franchisor financing: Franchisors will sometimes offer you loans, contributions on down payments, or reductions in certain fees.
● Short-term loans from alternative lenders: If you don’t qualify for an SBA loan or want something more immediate, a short-term loan from an alternative lender may have higher rates with less stringent qualifications, and can sometimes fund in as little as one business day.
● Lines of credit or credit cards: Business LOCs or business credit cards provide revolving credit—you only pay interest on what you’ve spent with your LOC or card, and you can draw on these credit lines over and over (as opposed to a term loan, which is finished once it’s paid off).
Each of these options has their own pros and cons, including the time it takes to get approved and differing spending limits—so start researching what you might be eligible for now.
Talk to a current franchise owner
A franchise owner in your chosen franchise is the only one who really understands the decision you’re about to make. They can tell you what’s working, what isn’t working, and what they would avoid if they could do it again.
Talk to financial and legal professionals
When it comes to buying a franchise, your two best friends might be your accountant and your lawyer.
Your accountant can help review the FDD and give context and meaning to the franchisor’s financial statements and assess earning projections. They’ll also be able to answer questions you can’t, such as what’s the financial track record of franchises in areas like yours?
Your lawyer can help you navigate the complexities of a franchising contract and advise you on whether the decision to invest your money and time in this particular franchise is wise. They can also help explore complaints about the franchisor to the Better Business Bureau or to the local government office of consumer affairs.
If you do buy a franchise, recognize you’ll always need to give final say over to the franchisor. Take the time to review the obligations of operating under that franchise’s banner to decide if working within those constraints is worth the payoff.