The Benefits and Responsibilities of Franchise Ownership
A franchise typically enables you, the investor or "franchisee," to operate a
business. By paying a franchise fee, which may cost several 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. For example, the franchisor
may help you find a location for your outlet; provide initial training and an operating
manual; and advise you on management, marketing, or personnel. Some franchisors offer
ongoing support such as monthly newsletters, a toll free 800 telephone number for
technical assistance, and periodic workshops or seminars.
While buying a franchise may reduce your investment risk by enabling you to associate
with an established company, it can be costly. You also may be required to relinquish
significant control over your business, while taking on contractual obligations with the franchisor.
- The Cost
- In exchange for obtaining the right to use the franchisor's name and its assistance, you
may pay some or all of the following fees.
- initial franchise fee and other expenses. Your initial franchise fee, which may
be non-refundable, may cost several thousand to several hundred thousand dollars. You may
also incur significant costs to rent, build, and equip an outlet and to 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
usually are 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.
- 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 to your menu popular items 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 pre-approved 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 also may require you to purchase supplies
only from an approved supplier, even if you can buy similar goods elsewhere at a lower
- restrictions 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
Before Selecting a Franchise System
Before investing in a particular franchise system, carefully consider how much money
you have to invest, your abilities, and your goals. The following checklist may help you
make your decision.
- Your Investment
- How much money do you have to invest?
- How much money can you afford to lose?
- Will you purchase the franchise by yourself or with partners?
- Will you need financing and, if so, where can you obtain it?
- Do you have a favorable credit rating?
- Do you have savings or additional income to live on while starting your franchise?
- Your Abilities
- Does the franchise require technical experience or relevant education, such as auto
repair, home and office decorating, or tax preparation?
- What skills do you have? Do you have computer, bookkeeping, or other technical skills?
- What specialized knowledge or talents can you bring to a business?
- Have you ever owned or managed a business?
- Your Goals
- What are your goals?
- Do you require a specific level of annual income?
- Are you interested in pursuing a particular field?
- Are you interested in retail sales or performing a service?
- How many hours are you willing to work?
- Do you want to operate the business yourself or hire a manager?
- Will franchise ownership be your primary source of income or will it supplement your
- Would you be happy operating the business for the next 20 years?
- Would you like to own several outlets or only one?
Shopping at a Franchise Exposition
Attending a franchise exposition allows you to view and compare a variety of franchise
possibilities. Keep in mind that exhibitors at the exposition primarily want to sell their
franchise systems. Be cautious of salespersons who are interested in selling a franchise
that you are not interested in.
Before you attend, research what type of franchise best suits your investment
limitations, experience, and goals. When you attend, comparison shop for the opportunity
that best suits your needs and ask questions.
- Know How Much You Can Invest
- An exhibitor may tell you how much you can afford to invest or that you can't afford to
pass up this opportunity. Before beginning to explore investment options, consider the
amount you feel comfortable investing and the maximum amount you can afford.
- Know What Type of Business is Right for You
- An exhibitor may attempt to convince you that an opportunity is perfect for you. Only
you can make that determination. Consider the industry that interests you before selecting
a specific franchise system. Ask yourself the following questions:
- Have you considered working in that industry before?
- Can you see yourself engaged in that line of work for the next twenty years?
- Do you have the necessary background or skills?
- If the industry does not appeal to you or you are not suited to work in that industry,
do not allow an exhibitor to convince you otherwise. Spend your time focusing on those
industries that offer a more realistic opportunity.
- Comparison Shop
- Visit several franchise exhibitors engaged in the type of industry that appeals to you.
Listen to the exhibitors' presentations and discussions with other interested consumers.
Get answers to the following questions:
- How long has the franchisor been in business?
- How many franchised outlets currently exist? Where are
- How much is the initial franchise fee and any additional start-up costs? Are there any
continuing royalty payments? How much?
- What management, technical, and ongoing assistance does the franchisor offer?
- What controls does the franchisor impose?
Exhibitors may offer you prizes, free samples, or free dinners if you attend a
promotional meeting later that day or over the next week to discuss the franchise in
greater detail. Do not feel compelled to attend. Rather, consider these meetings as one
way to acquire more information and to ask additional questions. Be prepared to walk away
from any promotion if the franchise does not suit your needs.
- Get Substantiation for Any Earnings Representations
- Some franchisors may tell you how much you can earn if you invest in their franchise
system or how current franchisees in their system are performing. Be careful. The FTC
requires that franchisors who make such claims provide you with written substantiation.
This is explained in more detail in the section "Investigating Franchise
Offers." Make sure you ask for and obtain written substantiation for any income
projections, or income or profit claims. If the franchisor does not have the required
substantiation, or refuses to provide it to you, consider its claims to be suspect.
- Take Notes
- It may be difficult to remember each franchise exhibit. Bring a pad and pen to take
notes. Get promotional literature that you can review. Take the exhibitors' business cards
so you can contact them later with any additional questions.
- Avoid High Pressure Sales Tactics
- You may be told that the franchisor's offering is limited, that there is only one
territory left, or that this is a one-time reduced franchise sales price. Do not feel
pressured to make any commitment. Legitimate franchisors expect you to comparison shop and
to investigate their offering. A good deal today should be available tomorrow.
- Study the Franchisor's Offering
- Do not sign any contract or make any payment until you have the opportunity to
investigate the franchisor's offering thoroughly. As will be explained further in the next
section, the FTC's Franchise Rule requires the franchisor to provide you with a disclosure
document containing important information about the franchise system. Study the disclosure
document. Take time to speak with current and former franchisees about their experiences.
Because investing in a franchise can entail a significant investment, you should have an
attorney review the disclosure document and franchise contract and have an accountant
review the company's financial disclosures.
Investigating Franchise Offerings
Before investing in any franchise system, be sure to get a copy of the franchisor's
disclosure document. Sometimes this document is called a Franchise Offering Circular.
Under the FTC's Franchise Rule, you must receive the document at least 10 business days
before you are asked to sign any contract or pay any money to the franchisor. You should
read the entire disclosure document. Make sure you understand all of the provisions. The
following outline will help you to understand key provisions of typical disclosure
documents. It also will help you ask questions about the disclosures. Get a clarification
or answer to your concerns before you invest.
- Business Background
- The disclosure document identifies the executives of the franchise system and describes
their prior experience. Consider not only their general business background, but their
experience in managing a franchise system. Also consider how long they have been with the
company. Investing with an inexperienced franchisor may be riskier than investing with an
- Litigation History
- The disclosure document helps you assess the background of the franchisor and its
executives by requiring the disclosure of prior litigation. The disclosure document tells
you if the franchisor, or any of its executive officers, has been convicted of felonies
involving, for example, fraud, any violation of franchise law or unfair or deceptive
practices law, or are subject to any state or federal injunctions involving similar
misconduct. It also will tell you if the franchisor, or any of its executives, has been
held liable or settled a civil action involving the franchise relationship. A number of
claims against the franchisor may indicate that it has not performed according to its
agreements, or, at the very least, that franchisees have been dissatisfied with the
franchisor's performance. Be aware that some franchisors may try to conceal an executive's
litigation history by removing the individual's name from their disclosure documents.
- The disclosure document tells you if the franchisor or any of its executives have
recently been involved in a bankruptcy. This will help you to assess the franchisor's
financial stability and general business acumen and predict if the company is financially
capable of delivering promised support services.
- The disclosure document tells you the costs involved to start one of the company's
franchises. It will describe any initial deposit or franchise fee, which may be
non-refundable, and costs for initial inventory, signs, equipment, leases, or rentals. Be
aware that there may be other undisclosed costs. The following checklist will help you ask
about potential costs to you as a franchisee.
- Continuing royalty payments.
- Advertising payments, both to local and national advertising funds.
- Grand opening or other initial business promotions.
- Business or operating licenses.
- Product or service supply costs.
- Real estate and leasehold improvements.
- Discretionary equipment such as a computer system or business alarm system.
- Legal fees.
- Financial and accounting advice.
- Compliance with local ordinances, such as zoning, waste removal, and fire and other
- Health insurance.
- Employee salaries and benefits.
It may take several months or longer to get your business started. Consider in your
total cost estimate operating expenses for the first year and personal living expenses for
up to two years. Compare your estimates with what other franchisees have paid and with
competing franchise systems. Perhaps you can get a better deal with another franchisor. An
accountant can help you to evaluate this information.
- Your franchisor may restrict how you operate your outlet. The disclosure document tells
you if the franchisor limits:
- The supplier of goods from whom you may purchase.
- The goods or services you may offer for sale.
- The customers to whom you can offer goods or services.
- The territory in which you can sell goods or services.
Understand that restrictions such as these may significantly limit your ability to
exercise your own business judgment in operating your outlet.
- The disclosure document tells you the conditions under which the franchisor may
terminate your franchise and your obligations to the franchisor after termination. It also
tells you the conditions under which you can renew, sell, or assign your franchise to
- Training and Other Assistance
- The disclosure document will explain the franchisor's training and assistance program.
Make sure you understand the level of training offered. The following checklist will help
you ask the right questions.
The level of training you need depends on your own business experience and knowledge of
the franchisor's goods and services. Keep in mind that a primary reason for investing in
the franchise, as opposed to starting your own business, is training and assistance. If
you have doubts that the training might be insufficient to handle day-to-day business
operations, consider another franchise opportunity more suited to your background.
- You often must contribute a percentage of your income to an advertising fund even if you
disagree with how these funds are used. The disclosure document provides information on
advertising costs. The following checklist will help you assess whether the franchisor's
advertising will benefit you.
- How much of the advertising fund is spent on administrative costs?
- Are there other expenses paid from the advertising fund?
- Do franchisees have any control over how the advertising dollars are spent?
- What advertising promotions has the company already engaged in?
- What advertising developments are expected in the near future?
- How much of the fund is spent on national advertising?
- How much of the fund is spent on advertising in your area?
- How much of the fund is spent on selling more franchises?
- Do all franchisees contribute equally to the advertising fund?
- Do you need the franchisor's consent to conduct your own advertising?
- Are there rebates or advertising contribution discounts if you conduct your own
- Does the franchisor receive any commissions or rebates when it places advertisements? Do
franchisees benefit from such commissions or rebates, or does the franchisor profit from
- Current and Former Franchisees
- The disclosure document provides important information about current and former
franchisees. Determine how many franchises are currently operating. A large number of
franchisees in your area may mean increased competition. Pay attention to the number of
terminated franchisees. A large number of terminated, cancelled, or non-renewed franchises
may indicate problems. Be aware that some companies may try to conceal the number of
failed franchisees by repurchasing failed outlets and then listing them as company-owned
If you buy an existing outlet, ask the franchisor how many owners operated
that outlet and over what period of time. A number of different owners over a short period
of time may indicate that the location is not a profitable one, or that the franchisor has
not supported that outlet with promised services.
The disclosure document gives you the names and addresses of current franchisees and
franchisees who have left the system within the last year. Speaking with current and
former franchisees is probably the most reliable way to verify the franchisor's claims.
Visit or phone as many of the current and former franchisees as possible. Ask them about
their experiences. See for yourself the volume and type of business being done.
The following checklist will help you ask current and former franchisees such questions
- How long has the franchisee operated the franchise?
- Where is the franchise located?
- What was their total investment?
- Were there any hidden or unexpected costs?
- How long did it take them to cover operating costs and earn a reasonable income?
- Are they satisfied with the cost, delivery, and quality of the goods or services sold?
- What were their backgrounds prior to becoming a franchisee?
- Was the franchisor's training adequate?
- What ongoing assistance does the franchisor provide?
- Are they satisfied with the franchisor's advertising program?
- Does the franchisor fullfill its contractual obligations?
- Would the franchisee invest in another outlet?
- Would the franchisee recommend the investment to someone with your goals, income
requirements, and background?
Be aware that some franchisors may give you a separate reference list of selected
franchisees to contact. Be careful. Those on the list may be individuals who are paid by
the franchisor to give a good opinion of the company.
- Earnings Potential
- You may want to know how much money you can make if you invest in a particular franchise
system. Be careful. Earnings projections can be misleading. Insist upon written
substantiation for any earnings projections or suggestions about your potential income or
Franchisors are not required to make earnings claims, but if they do, the FTC's
Franchise Rule requires franchisors to have a reasonable basis for these claims and to
provide you with a document that substantiates them. This substantiation includes the
bases and assumptions upon which these claims are made. Make sure you get and review the
earnings claims document. Consider the following in reviewing any earnings claims.
- Sample Size. A franchisor may claim that franchisees in its system earned, for
example, $50,000 last year. This claim may be deceptive, however, if only a few
franchisees earned that income and it does not represent the typical earnings of
franchisees. Ask how many franchisees were included in the number.
- Average Incomes. A franchisor may claim that the franchisees in its system earn
an average income of, for example, $75,000 a year. Average figures like this tell you very
little about how each individual franchisee performs. Remember, a few, very successful
franchisees can inflate the average. An average figure may make the overall franchise
system look more successful than it actually is.
- Gross Sales. Some franchisors provide figures for the gross sales revenues of
their franchisees. These figures, however, do not tell you anything about the franchisees'
actual costs or profits. An outlet with a high gross sales revenue on paper actually may
be losing money because of high overhead, rent, and other expenses.
- Net Profits. Franchisors often do not have data on net profits of their
franchisees. If you do receive net profit statements, ask whether they provide information
about company-owned outlets. Company-owned outlets might have lower costs because they can
buy equipment, inventory, and other items in larger quantities, or may own, rather than
lease their property.
- Geographic Relevance. Earnings may vary in different parts of the country. An
ice cream store franchise in a southern state, such as Florida, may expect to earn more
income than a similar franchise in a northern state, such as Minnesota. If you hear that a
franchisee earned a particular income, ask where that franchisee is located.
- Franchisee's Background. Keep in mind that franchisees have varying levels of
skills and educational backgrounds. Franchisees with advanced technical or business
backgrounds can succeed in instances where more typical franchisees cannot. The success of
some franchisees is no guarantee that you will be equally successful.
- Financial History
- The disclosure document provides you with important information about the company's
financial status, including audited financial statements. Be aware that investing in a
financially unstable franchisor is a significant risk; the company may go out of business
or into bankruptcy after you have invested your money.
Hire a lawyer or an accountant to
review the franchisor's financial statements. Do not attempt to extract this important
information from the disclosure document unless you have considerable background in these
matters. Your lawyer or accountant can help you understand the following.
- Does the franchisor have steady growth?
- Does the franchisor have a growth plan?
- Does the franchisor make most of its income from the sale of franchises or from
- Does the franchisor devote sufficient funds to support its franchise system?
Selecting a Franchise
Like any other investment, purchasing a franchise is a risk. When selecting a
franchise, carefully consider a number of factors, such as the demand for the products or
services, likely competition, the franchisor's background, and the level of support you
- Is there a demand for the franchisor's products or services in your community? Is the
demand seasonal? For example, lawn and garden care or swimming pool maintenance may be
profitable only in the spring or summer. Is there likely to be a continuing demand for the
products or services in the future? Is the demand likely to be temporary, such as selling
a fad food item? Does the product or service generate repeat business?
- What is the level of competition, nationally and in your community? How many franchised
and company-owned outlets does the franchisor have in your area? How many competing
companies sell the same or similar products or services? Are these competing companies
well established, with wide name recognition in your community? Do they offer the same
goods and services at the same or lower price?
- Your Ability to Operate the Business
- Sometimes, franchise systems fail. Will you be able to operate your outlet even if the
franchisor goes out of business? Will you need the franchisor's ongoing training,
advertising, or other assistance to succeed? Will you have access to the same or other
suppliers? Could you conduct the business alone if you must lay off personnel to cut
- Name Recognition
- A primary reason for purchasing a franchise is the right to associate with the company's
name. The more widely recognized the name, the more likely it will draw customers who know
its products or services. Therefore, before purchasing a franchise, consider:
- The company's name and how widely recognized it is. -- If it has a registered trademark.
- How long the franchisor has been in operation.
- If the company has a reputation for quality products or services.
- If consumers have filed complaints against the franchise with the Better Business Bureau
or a local consumer protection agency.
- Training and Support Services
- Another reason for purchasing a franchise is to obtain support from the franchisor. What
training and ongoing support does the franchisor provide? How does their training compare
with the training for typical workers in the industry? Could you compete with others who
have more formal training? What backgrounds do the current franchise owners have? Do they
have prior technical backgrounds or special training that helps them succeed? Do you have
a similar background?
- Franchisor's Experience
- Many franchisors operate well-established companies with years of experience both in
selling goods or services and in managing a franchise system. Some franchisors started by
operating their own business. There is no guarantee, however, that a successful
entrepreneur can successfully manage a franchise system.
Carefully consider how long the
franchisor has managed a franchise system. Do you feel comfortable with the franchisor's
expertise? If franchisors have little experience in managing a chain of franchises, their
promises of guidance, training, and other support may be unreliable.
- A growing franchise system increases the franchisor's name recognition and may enable
you to attract customers. Growth alone does not ensure successful franchisees; a company
that grows too quickly may not be able to support its franchisees with all the promised
support services. Make sure the franchisor has sufficient financial assets and staff to
support the franchisees.