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If you dream of owning a business, but you're struggling with choosing a business idea, you may consider starting your own or purchasing an existing business for sale.
Or you might consider starting a company by jumping into a chain business by buying a franchise.
Some people think franchises are the way to go because they're an established brand. But you shouldn’t jump to the conclusion that franchise ownership is the best business decision for you.
It's essential for potential franchise owners to understand the pros and cons of the franchise business model to understand if owning one is a smart way for you to make money.
In this article, we discuss how a franchise works, how and what franchise owners earn, the benefits and drawbacks of buying a license to operate under a brand, who might and might not enjoy a franchise business, and the importance of due diligence before making a financial investment.
What's a Franchise and How Does a Franchise Work?
A franchisee (entrepreneur) purchases a franchise (type of license/permit) allowing them access to the franchisor's (established company) business resources, such as their name, business models, systems, and trademarks.
Franchisees pay a franchisor a variety of franchise fees depending on the business and licenses.
These generally include start up costs, annual fees, and possibly a training fee, and commissions or ongoing royalty payments on profits.
With over 3,000 different franchises available in the United States ranging in cost from tens of thousands to millions, and almost 800,000 individual franchises in existence – it's clear people are making money with owning a franchise.
But don’t believe too quickly the statistics you’ll find on the internet claiming 90% of franchises succeed compared to only 15% of small businesses.
Whether you consider retail, food service, personal or children’s services, or a business-to-business franchise – buying a franchise right for you, for the right price, in the right physical location, and running it well, matters most.
But complications may arise, and it may be a lot more work than it seems to make your franchise successful. Becoming an overnight sensation, even with a prosperous chain business, isn’t a reality.
Just like being an entrepreneur takes a particular personality and skill set, a successful franchisee has to understand their strengths and areas for growth. And how they align with owning a licensed business.
How Do Franchise Owners Make Money
As a franchisee, you are an independent business owner. You will pay yourself an income based on the revenue and expenses of your business. In other words, your wages are dependent on the profitability of your business.
You're in charge of managing your company's financials and balance sheet – or at least overseeing them if you hire that function out. So, you can pay yourself as little of or as much of a salary as your profits allow.
What your profit ends up being is a factor of the incoming revenue minus all the overhead costs, royalty fees, other franchise expenses, and any taxes associated with running your business.
While becoming a franchise business owner can give you a head start on the entrepreneurial side of things, being an entrepreneur is challenging.
Your income is not guaranteed. Yet owning your own successful business provides opportunities for income growth you may not find as an employee.
If you require a set monthly salary or specific annual income, a franchise or any other business opportunity may not meet your needs since business profits are anything but guaranteed.
When you have additional income sources or substantial assets to carry you for a lengthy period until your franchise is successful, the income from your entrepreneurial efforts can grow as your business grows.
A survey by Franchise Business Review found that:
“37 percent of food franchise owners earn less than $50,000 per year, and just 16 percent – the “top performers” – earn more than $200,000 per year. The average annual income reported by all food and beverage operators that we surveyed is $120,000 for businesses open at least two years. Not bad, until you factor in the long hours and high initial investment that come with many food businesses. The good news is that our top food franchises report average earnings 15 to 20 percent higher than their competitors.”
They do note that profits and average income varies by sector and that median income may provide more helpful information.
“the median annual income is around $70,000, and if we include startup franchisees (those in business for less than two years) the median falls to around $50,000. Only 34 percent of all food franchise owners earned more than $100,000 last year – and many earned much less.”
Let's now take a look at the potential good and bad of entering the franchise industry.
Benefits of Buying a Franchise
There are benefits to buying a business already recognized as a successfully established brand. But you might not realize all of the other positives in buying a licensed business.
Here's a list of six ways franchises might help you succeed in business.
1. You’ll be off to a good start.
Starting a new business is hard, and don’t believe anyone who disagrees.
Choose a well-known franchise, with a proven business model, and your business will receive recognition right away.
Your customers have likely been to a company owned outlet or other successful franchise locations and know what to expect. And customers spending money is what you need to be successful and earn an income.
2. The foundation of your business is built for you.
Whether you call it a framework, the groundwork, or a playbook – part of buying a franchise business means you’ll likely follow a prescribed business plan.
You’ll know exactly what products or services you’ll be selling. Plus you'll receive an operations manual. You may also be provided training on running the business too.
If it’s a turnkey business, you will have all of the equipment and supplies you need to get off to a great start as well.
3. The size of the franchise may help you cut costs.
You may save money on supplies, equipment, and training if they are not already included in your licensing fees.
When the franchise is large enough, they can purchase in bulk and pass on savings to individual franchisees.
They may offer training program opportunities for not just management, but for staff too. This can be incredibly helpful for a new business owner who hasn't managed employees before.
4. The franchise will also do the legwork on legal matters and marketing.
Tasks like determining contracts and marketing for your products and services will be done for you.
These won’t become one more thing on your “to do” list.
The franchisor’s goal is to have creative campaigns and marketing materials bringing in customers, so they also reap the benefit in terms of fees from franchisees.
5. The franchise has the staff to do research and follow trends.
As a business owner, you’ll be busy running your business and the employees who work for you. Or you'll be managing your management team.
As a franchise owner, you don’t have to take extra time to follow trends in your industry.
You also won't need to dig deep into company data to determine if advertising campaigns are effective.
As time goes on, franchises make adjustments and may overhaul significant parts of the business. You’ll simply be updated as to new products, services, policies, protocols, and more.
6. You have the potential to make a lot of money.
Since some of the tasks you’d have to do on your own as an entrepreneur are taken care of by the franchise, you can focus on people.
Training your employees and teaching and modeling your expectations is critical to your success.
The better your employees perform, the happier customers will be. Happy customers spend more money and will cause you much less grief than unhappy ones!
Drawbacks of the Franchise Option
Even with all of the pros of purchasing a franchise, there are indeed some negatives you need to consider.
Lots of paying customers aren’t always a guarantee you’ll have a profitable franchise – even with a top-rated franchise parent company.
1. Plenty of things can go wrong.
Even though it sounds like buying a franchise is not an overly complicated way to get started in a business, success isn’t a guarantee.
As an owner, you have a tremendous amount of work and responsibility for running your business.
If you can’t handle it or if you won’t hire a skilled manager, your success may be very short-lived.
2. If you want to be creative or make changes, forget it.
One of the biggest complaints about franchises is how little flexibility there is with anything.
From the uniforms, color schemes, and decorations, to the hours your business can be open, to prices, and location – the franchise may direct every part of the business.
Your business “playbook” and marketing plan may have little room for interpretation and adjustments even if you clearly see problems with parts of the existing franchise model.
3. They’re expensive.
You have upfront costs to purchase the franchise and initial start-up fees, along with profit-sharing to the franchise each month.
Expect annual royalty fees once you're in the franchise system as well. And you may even have to reapply years down the road to keep your franchise and sometimes they won’t approve it!
There are also plenty of other startup costs beyond the initial franchise fee to getting your business going which may include:
- establishing your legal business structure
- purchasing commercial real estate
- making leasehold improvements
- securing business insurance
- obtaining legal and accounting services
- hiring janitorial and waste removal services
- buying equipment and supplies
You may need a significant amount of legal and tax advice before you even begin the purchase process or sign the franchise contract with the parent franchise company.
While there are several low-cost franchises you can start (in the tens of thousands of dollars), you could see your combined initial costs exceed a hundred thousand dollars.
A food franchise for example could cost multiply six figures (or seven!) when you factor in the building and equipment on top of the upfront cost for the franchise and any other fees the franchisor passes on.
4. There can still be competition.
If you’ve been in bigger cities, you have probably seen franchise stores a few blocks from each other (in addition to all of the competitors selling the same/similar products and services.)
And while there may be plenty of customers, having stores close together may cut into profits.
It’s important to understand what the territory rules are, if any, for new business licensees.
5. The support might disappear after you are up and running.
The franchisor may put a lot of effort into your business as you get started. But the support may quickly fade – or you may have to pay for support as time goes on.
Be sure you understand the agreement about ongoing training and if it's provided. What the support looks like should be clearly explained in a contract.
Some franchisors may not renew a franchise agreement if there are problems like weak sales.
6. If it’s a new and popular franchise, it may not last long.
Being popular is one thing but having staying power is another.
If you choose to buy a franchise business related to the latest fads because it’s where you’ll “make a killing” quickly, think again.
The cheaper and the newer the franchise is, the more problems you may have.
It’s not to say all new or inexpensive franchises are poor investments.
But you’ve probably questioned how a franchise business or two in your area could make a go of it, and within a year their doors were closed.
Who Might a Franchise be Best for?
After reading through the pro’s and con’s, buying a franchise might make sense if:
- You're brand new to running a business from scratch
- Want structure and support
- Don’t want to create business plans, policies, protocols, or do tasks like marketing
If you are content with taking direction from the franchisor on everything, this model may work well for you.
Who Might Want to Avoid Franchises?
Many franchise owners do best working directly in their franchise and overseeing employees and operations.
Unless you have an excellent team in place, depending on others to run your business regularly could cause problems – just like in any business you start or take over.
Those looking to start creative businesses or those who want to continue making changes and improvements to products and services should avoid franchises.
Don’t assume you’ll have a say in how advertising dollars are spent. Or be able to “tweak things” with a licensed business.
You need to consider that most franchise companies will tell you how to operate, when to operate, and where to operate your business.
Doing Your Due Diligence Matters
Prospective franchisees need to watch out for slick advertising from a franchise broker, promises of easy money with little effort, or fast approval of a franchise loan.
Before you even consider purchasing a franchise, read and learn from as many sources as you can. Research various types of franchises. If you are still interested, determine the type of business you want and look at options.
When you find a particular franchise, do as much homework as you can on it – even if you have to hire experts to help.
Look for complaints with the Better Business Bureau (BBB) and your state's regulatory agencies about the parent company.
If there are franchise units for this business anywhere locally, try to find time to meet with a current franchisee.
You should also have an experienced franchise attorney or franchise consultant review all of the franchise disclosure documents and assist you with understanding any other legal information related to the franchise.
Make sure you understand all the costs from the initial investment and franchise fee to the advertising fees and royalty payments before investing any money.
Speaking with other franchise owners can help you understand any hidden costs and the most common type of ongoing costs involved with running their individual franchise units.
All this takes time and energy when you really just want to jump in and start your business. Realize research and patience pay off in a big way for potential franchisees.
You can avoid many problems by getting clear with where you stand in the franchise agreement from the very beginning.
Buying a Franchise to Make Money?
Buying a franchise is like buying any other business. There are rewards and challenges to being an entrepreneur.
It's essential you do your due diligence and thoroughly investigate the franchise opportunity and the track record and failure rate of its franchisees before making an upfront investment.
If you believe the franchise model fits your business goals and personality, you can make money by choosing the right franchise and managing it (or having it managed) properly.
For most, it is not a passive way to improve their financial health or get wealthy. But many find it to be a worthwhile way to make money and be successful in business.