Investor Words defines a franchise as, "a form of business organization in which a firm which already has a successful product or service (the franchisor) enters into a continuing contractual relationship with other businesses (franchisees) operating under the franchisor's trade name and usually with the franchisor's guidance, in exchange for a fee." Many entrepreneurs elect to buy into a franchise because it is an established and proven business. Moreover, the franchisee has the support of a large network.
At the core of a franchise is the operating or franchise agreement. Any investor wishing to enter into a franchise must consent to this agreement, which heavily favors the franchiser to protect the company's brand. Franchise states you should carefully review the Franchise Disclosure Document before committing to entering into the company, "read the FDD carefully since it will include a vast amount of information on the franchise such as: history of franchise and its key principals, financial statements, litigation, franchise openings/closings/terminations, franchisee contacts, franchise agreement, requirements, and more."
The advantages is a new franchisee can avoid costly mistakes as they have been made and corrected by the franchiser, and the franchisee is given a pre-written operating map that increases success rates. New franchisees are given support for their location, such as employee training manuals and operation manual. For instance, in the popular Subway franchise, the operation manual tells servers how much meat to put on a footlong sub and how to properly fold it.
However, the franchisee is ultimately responsible for staffing and training. Score puts the staffing process this way: "you [will be] required to hire people who will accept your style and be able to train other employees in that culture without your presence. Turnover of employees is expensive and time consuming."
According to NOLO, startup costs can be steep, "before opening your franchise, you may be required to pay a non-refundable initial franchise fee, anywhere from several thousand to several hundred thousand dollars." Many franchises offer "in-house" financing to new investors but these in-house products are often more costly than a small business loan; the benefit is a higher approval rate for borrowers.
The Small Business Administration has a directory of loan programs to aid in financing business ventures. Depending on the size of the franchise fee, you may qualify for a micro loan, which range up to $35,000. Micro loans carry 8 percent to 13 percent interest rates and require a personal guarantee as well as collateral (See Resources).
Many franchiser's do not offer specific earnings numbers to would-be franchisees. Rather, franchiser's supply investors with average sales numbers of other locations but do not typically include operating expenses, making it difficult to determine the level of profitability. However, investors can use the strength of the franchise's success to glean an idea of its profitability. For instance, Franchise Gator reports that in Houston, one of these most popular franchises is Wingstop, with 50 restaurant locations in the Houston area. A new investor should speak with current franchisees to ascertain the level of profitability.
An important consideration to new investors is how to exit the franchise should the need arise because of health issues or economic issues. Franchise agreements contain "no-kill" clauses that deter franchisees from exiting the franchise agreement even if the franchiser has not completely meet its obligations. Nolo cautions, "as a franchisee, you have little legal recourse if you're wronged by the franchiser. Most franchisers make franchisees sign agreements waiving their rights under federal and state law."
Under most franchise agreements, you can sell the franchise location to another party, transfer it to an existing franchisee or declare bankruptcy to break the franchise agreement.