Franchising is a type of business arrangement that lies somewhere between buying a business and starting your own business. It involves an agreement between a Franchisor (Burger King, Subway, Mail Boxes etc,) and you, the individual business person, called the Franchisee.
The Franchisor offers their established corporate brand name, experience, expertise, training, support, and proven methodology to the Franchisee. In return, the Franchisee pays an upfront fee and continuing royalties.
I bring Franchising up in the Bootstrapping context as it almost completely solves the experience/know-how part of the limited resources equation. As to the cost part, many Franchises will be clearly out of most start-ups’ reach. However, the franchising industry is so big and diverse that many have a relatively low initial cost. Recently Entrepreneur magazine had an article on 80+ Franchises that required an initial cost of $25,000 or less. (Entrepreneur.com)
Franchising is a large business sector. There are over 300 types of business categories supporting over 18,000,000 employees and accounting for 3% of US gross domestic product (GDP). There are many and diverse categories of businesses available for Franchising. A partial list of the different franchise businesses is Automotive, Business Services, Children’s Products & Services, Education Financial Services, Food, Health Care, Home Improvement, Hotels & Motels, Maintenance, Personal Care, Pets, Recreation, Service & Tech businesses, and more every year.
Jeffrey Tannenbaum, the former Wall Street Journal’s expert on Franchising, described franchising as a mixed bag. He said, “For many people becoming a franchisee is the shortcut to prosperity, but for others, it is the shortcut to hell.”
Let’s look at the pros and cons of franchising.
- Allows you to be in your own business with a limited knowledge of the industry and of running a business. You get the advantage of the Franchisor’s proven track record of success, their training, their operating methods, their suppliers, their credibility, their ongoing support, etc.
- Some major risks of business failure are reduced.
- Quick start to get your business operational. Every facet of starting and running the business is provided to you. An entrepreneur, starting on his or her own, would take considerably longer to begin.
- Expansion: If you become successful, you can expand quite rapidly through the expertise and cooperation of the Franchisor. They are anxious to discover successful operators who have proven they have what it takes to grow. Sometimes the Franchisor will block your expansion plans, despite your proven success. If this happens, you can draw inspiration from Sam Walton, the founder of Wal-Mart. Sam’s initial entry to retailing was as a Franchisee for the Ben Franklin 5 & 10 Cent stores. He followed their formula and added his creativity and work ethic to become a leading franchisee. He started to expand in neighboring Arkansas towns. Early on, Sam spotted the advent of retail discount stores. He approached the Ben Franklin management to let him pioneer a discount store under their umbrella. They summarily dismissed him, and Wal-Mart was born. Little did the Ben Franklin management realize how profoundly they would affect retail history.
- Due Diligence: Franchising is a highly regulated business. By law, every potential Franchisee upon asking must be provided with a Franchise Disclosure Document from the Franchisor. This will give you details of the arrangement with Franchisees, financial strength of Franchisors, their list of existing Franchisees, and, in many cases, lists of past Franchisees. You want to know everything you can about your potential partner.
- Training is provided to you and to your employees. The learning curve of running a business is accelerated.
- In most cases Advertising and Marketing of the brand is provided. In some cases, you may be required to contribute to the costs of it.
- Territory: You are assigned an exclusive Franchise for a specified geographic area. No one else can use your brand in this defined area. This provision should be specifically spelled out in the contract.
- Lack of Control: You don’t have the independence of an owner of a business. The Franchisor requires you to strictly follow their rules and to use their systems. Changes require approval. You are also limited in where to buy your supplies, how to advertise, which products you can and cannot offer, volume goals, etc. The arrangement can be frustrating for a creative personality.
- Costs can be high, both the initial fee and ongoing royalties. However, costs are never to be considered in a vacuum. They need to be measured against the profits you create.
- Royalties are paid on volume and not on profits in most instances. This is usually not a great arrangement as one party can lose money while the other profits. Their interests are not aligned even though it is a partnership.
- Inequality: It is an unequal partnership. The Franchisor has much more power. If the Franchisor does not deliver on their support promises, you may not have much recourse, as most contracts favor the Franchisor. Also, you may not have the money to pursue your expensive legal options.
- Selling the company may be difficult. Let’s say you’ve been successful over the years in building the franchise and want to now retire or change your lifestyle. In an independent business, you are completely free to sell to anyone at any price you desire. This is not necessarily so for a Franchisee. Some contracts won’t allow you to sell, or you can only sell back to the Franchisor. This might not allow you to get a fair price. So, you should try to address this issue in your original contract.