How to Open a Franchise
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The franchise business model consists of an existing business or brand (called the franchisor) that licenses the use of its name, trademarks, products, or services to another business, group, or individual (called the franchisee). The franchise model allows the franchisor to expand its brand without needing to operate a new location, and the franchisee gains the benefit of starting out with a business that already has a familiar name and a solid reputation.
Steps to Opening a Franchise
Explore the Costs of Opening a Franchise
Since most people interested in starting a franchise are really interested in becoming franchisees, this guide focuses on the franchisee’s role in the franchise business model. Before you take the plunge, it’s best to explore the costs, benefits, and risks involved in becoming a franchisee, and then familiarize yourself with the general steps required to form your business and enter into a franchise agreement.
The upside of becoming of franchisee is that you’ll have a well defined business format and tested system at your disposal. The downside is that you won’t be able to run your business in just any way you want, and you may not always be able to control your costs. The section below is a overview of the types of costs and contractual obligations you’ll likely encounter if you become a franchisee.
The Initial Franchise Fee
Whatever franchise system you choose, you can expect to pay an initial franchise fee. The initial fee varies from franchise to franchise, so you’ll need to do some research. Subway, for example, has an initial franchise fee of $15,000, Anytime Fitness’s initial fee is $37,500, and the initial fee for McDonald’s is currently $45,000. You can figure out the initial franchise fee for pretty much any company by doing a simple internet search.
Too expensive? Learn how to start your own business.
Other Franchise Expenses
Your initial franchise fee, however, won’t cover everything you’ll need to get started. You’ll need to prepare for additional costs, such as building or renting a location, purchasing equipment and inventory, and purchasing insurance and business licenses. Some franchisors also require occasional renovations and other updates that could increase your business’s costs down the road.
Franchise Royalties / Monthly Payments
In most cases, you’ll pay ongoing royalties to the franchisor for the right to use the company’s name and sell its products or services. The royalty payments usually amount to a percentage of your business’s gross income, though some franchisors charge a flat monthly fee. If you fail to make these payments, the franchisor might terminate your franchise agreement.
More generally, the franchisor might dictate your location, restrict your sales territory, require you to do business with specific suppliers, and dictate your building’s design, hours of operation, and employee uniforms (as the case may be).
Your company, in other words, won’t have the freedom of a completely independent business to decide where and when to cut costs, what products it wants to sell and not sell, and what services it wants to provide. The trade-off is that you’ll have access to the franchisor’s years of experience and typically a host of tools designed to help you start and maintain your business.
Choose a Franchise
To get started, you’ll need to identify a franchise system that interests you and that fits your skills and experience, but the thousands of options out there can make this decision difficult. One reliable approach is to define your expectations and limitations in advance of considering specific franchises. Ask yourself how much money you’re willing to invest, if you intend to manage the outlet yourself, if you’re interested in a specific type of business over others, if you intend to own several outlets or just one, and just how much control over your business you’re willing to share with the franchisor. Once you work out answers to these and similar questions, you can then match the franchise system to your expectations and not the other way around.
Fortunately, there are several helpful franchise directories available online, including the website for the International Franchise Association (IFA) and WorldFranchising.com. These and similar websites can help you learn more about the available franchise systems, their initial fees, and their royalties (among other details). You can also attend one of the many annual franchise expositions in the United States and question company representatives face to face.
Submit the Franchise Application
Once you have selected a potential franchise system, you’ll need to contact the franchisor and express your interest. This usually involves submitting an online application through the franchisor’s website that includes questions about your net worth, work and management experience, employment history, educational background, and desired locations. If the franchisor is interested in you based on the online application, you’ll typically receive additional emails and answer additional questions on the way to actually speaking on the phone with a sales representative.
Be patient. The application and this parade of emails is really a screening process building toward the all-important personal contact between you and a sales representative. You can learn a lot about the franchisor based on its website, the character of the emails you receive, and the behavior of the sales representative on the phone. If at any point you get the impression that the franchisor isn’t the kind of business you want to be involved with for the long haul, contact other potential brands instead.
Study the Franchise Disclosure Document (FDD)
After you submit your application, and if both you and the franchisor are still interested in doing business, you can expect to receive a Franchise Disclosure Document (FDD) from the company. If the company doesn’t send it more or less automatically, be sure to request it. You have a right to receive a copy of the company’s FDD after the franchisor receives your application and shows its interest, and you shouldn’t make any decisions—or pay fees of any kind—until you and an attorney have reviewed the franchisor’s FDD.
The Franchise Disclosure Document contains 23 parts covering a wide range of items. In general, the FDD will lay out the franchisor’s business experience, litigation history, bankruptcy history (if any), and the main costs associated with investing in the franchise system. You’ll learn about any deposits, fees, royalty percentages, and other costs you’ll be expected to pay, and you’ll learn about the franchisor’s restrictions on the way you do business.
Form Your Business
Once you have examined the Franchise Disclosure Document and otherwise investigated the franchisor—and if, at this point, you’re still interested!—you’re almost prepared to sign a franchise agreement and get your business started. Before you sign anything, however, you might think about how you want to structure your business.
Franchisees have the usually business formation options available to them. You can operate as a sole proprietor, a partnership, a limited liability company (LLC), or a corporation. If you decide to be a sole proprietor, there will be no legal separation between you and your business, which is why you might consider formalizing your business with the state as either an LLC or corporation. Keep in mind that, even if the franchisor is an LLC or a corporation, that doesn’t mean your business is an LLC or corporation. Your business’s legal structure is something you establish on your own.
You can form an LLC or start a corporation by filing a formation document with your state’s business formation agency (usually the secretary of state’s office) and paying the state’s filing fees. If you decide to go this route, make sure to form your corporation or LLC with the state before signing your franchise agreement. Ultimately, you will want to sign the franchise agreement in the name of your LLC or corporation to preserve the business’s status as an entity distinct from you.
Sign the Franchise Agreement
So you’ve selected and researched your franchisor, examined your franchisor’s FDD, possibly even formalized your business by filing with the state, and decided to move forward and become a franchisee. If you’ve reached this stage, your next and final step—at least in the process of becoming a franchisee—is to sign the franchise agreement.
Typically, there shouldn’t be any surprises in the franchise agreement, particularly if you closely examined the Franchise Disclosure Document, but you and your lawyer should closely examine the document anyway to make sure it doesn’t contain any stipulations, fees, or policies you haven’t seen before.