How to Buy a Franchise in 7 Steps
How to Buy a Franchise in 7 Steps
When you enter into an agreement to buy a franchise, you (the franchisee) pay a company (also known as the franchisor) for the right to use its brand name, management expertise and other assets or services.
Buying a franchise can be quicker than creating a business from scratch, but it comes with a high initial investment, ongoing fees and restrictions. Understanding how to buy a franchise will help you decide if franchise ownership is right for you.
1. Compare franchise options.
If you want to open a franchise, the first step is to research your options and choose a brand. You may already have a specific brand in mind, but before you commit, it’s important to do some research.
When comparing franchise opportunities, consider the following factors:
- Industry: Starting a business is a huge time commitment, so choose a franchise in a field you’re passionate about and that you’ll enjoy working in for many years. If you already have experience in that field, you may be more likely to be approved by franchisors and get a business loan.
- Location: What needs aren’t being fulfilled in your desired location? Is there demand for a certain product or service? What would the competition look like? Be sure to factor location into your decision, considering the types of franchises that might perform best.
- Brand name: A key part of a franchise’s value is a brand name and a good reputation that attracts customers. Think about whether the franchise name is compelling to consumers and ensure that it’s untainted by any negative associations.
To get started, you can browse thousands of franchise opportunities in the SBA’s Franchise Directory, which lists the franchise brands that are eligible for SBA financing.
2. Consider upfront and ongoing costs.
Next, consider how your business budget aligns with the initial investment required to open a franchise. You’ll need enough cash to cover the franchise fee and startup costs such as equipment, rent, inventory and a franchise tax. You’ll typically need to pay the initial franchise fee with your own money, but you’ll likely be able to pay other expenses with your first few months of revenue or from borrowed money.
Some franchises are more expensive to start than others. For example, the initial franchise fee for a Chick-fil-A franchise is $10,000, but Taco Bell franchise fees will cost between $25,000 and $45,000. You’ll also need to be prepared to pay ongoing royalty fees — these vary significantly between brands, but usually fall between 4% and 12% of your monthly revenue. Some franchisors publicly disclose these details on their website, but you may need to contact the company directly to learn more about expected costs.
To choose a franchise opportunity that fits your budget, consider how much you can afford to pay up front and over time. Don’t forget to consider the potential return on your investment by researching the profitability of different franchise brands.
3. Read the Franchise Disclosure Document.
Franchise brands disclose fees and other important details in an annual Franchise Disclosure Document (FDD). The Federal Trade Commission (FTC) requires franchisors to provide you with a copy of the FDD, which must disclose financial and other contractual terms to prospective franchisees, at least 14 days before you sign a franchise agreement or pay any money to a franchisor.
The FDD details 23 items that are essential to understand before making a legal commitment. Request the FDD from the franchisor so you’ll have the facts you need to create a budget and write a business plan.
4. Decide on a location.
As we mentioned previously, location is an important consideration when you’re opening a franchise. You might have a general idea of where you’d like to open your business — but before that can happen, you’ll need to find the right space. Many business owners rent a space to start, but buying commercial property is another option.
To select a location, consider the cost and accessibility of different spaces. While it might be appealing to rent a lower-cost space, a higher-cost location could be worthwhile if it’s in a more desirable part of town that will attract customers.
A commercial real estate agent or broker could be a big help in this search. They might have access to listings that aren’t readily available to the public, and they can help you assess the potential profitability of different locations.
5. Get franchise funding.
Most franchisors have minimum franchisee net worth and liquid asset requirements that can be substantial. Since the combined cost of franchise fees and startup expenses exceeds most entrepreneurs’ ready cash, it’s common to seek business loans.
These may include:
- Line of credit: A business line of credit is a revolving form of funding you can borrow from as needed up to a preset limit, similar to a credit card.
- Equipment financing: Equipment loans allow you to purchase machinery or equipment needed to operate your business, typically using the equipment as collateral to secure the loan.
- Commercial real estate loans: This type of loan is used to purchase business property.
- SBA loans for franchises: The U.S. Small Business Administration offers loans with favorable rates and terms to businesses that meet SBA criteria.
- Preferred lenders with the franchise: While few franchisors offer direct financing, many refer franchisees to “preferred lenders” that are familiar with their business model and may favorably consider lending to a new franchisee.
- Bank loans for franchises: Some banks may offer loans specifically tailored for funding franchises.
6. Review and sign your franchise agreement.
The franchise agreement is a legally binding contract, so you’ll need to review it carefully. This document includes details on your franchise fees, obligations and other important terms. It also governs how your franchise can be terminated or renewed in the future.
Because the contract is legally binding, you’ll want a professional’s eyes to review it as well. If you haven’t already enlisted the help of a lawyer who specializes in franchise law, this is the time to do so. If there are any discrepancies between what’s listed in the document and what you verbally discussed with the franchisor, your attorney can address them. They can also help you understand the terms disclosed in the agreement to make sure signing is in your best interest.
7. Attend corporate training and prepare for your grand opening.
Franchisors usually require you to attend training sessions, which may be several weeks long. In some cases, training might be available for your employees as well. Taking advantage of training opportunities will help you prepare for a successful grand opening.
Pros and cons of buying a franchise
Pros
- Proven business model. Many new businesses fail in their first few years, but with a franchise, you’re starting with a business model that’s already been proven successful in the market.
- Brand recognition. You don’t have to invent new products or convince consumers to want them — that’s already been done for you.
- Operating expertise. You and your employees can receive in-depth training to learn best practices and avoid common errors.
- Available financing. Some lenders are more willing to give loans to franchisees of strong brands, ase the business model is already well understood.
Cons
- Strict requirements. Many franchisors set minimum net worth and liquidity requirements, which can create a barrier to entry for many entrepreneurs.
- Limited control. There may be restrictions on what you sell, where you locate, what other businesses you operate and more.
- Added expense. Franchise fees cut into your profits, and franchisor-mandated facilities, supplies and advertising may be more expensive than other options you could choose.
- No permanent ownership. When a franchise agreement expires, the franchisor could change the terms or choose not to renew it.
Is buying a franchise the right business for you?
Franchising can be a tempting way to start a business fast without having to build it from scratch, but this convenience can be expensive. Starting a franchise is easiest for someone who already has substantial net worth and good credit. It also comes with operating restrictions and the risk of losing the value you’ve built if the agreement isn’t renewed.
Alternatives to buying a franchise
Buying a franchise isn’t the only option you have. Alternative paths to business ownership include:
- Buying an existing business that isn’t a franchise: It may come with assets including facilities, equipment, trained employees and a solid customer base, without the franchise fees and restrictions. But you’ll need to make sure you’re not acquiring any hidden problems, and negotiating a mutually agreeable price for a small business can be challenging.
- Starting a new business: You won’t inherit someone else’s worries, and you can design a business tailored to your vision. The risk is that you may run out of money before your products are built, your brand is known or you have enough paying customers to keep you afloat.
Ultimately, you’ll need to decide if buying a franchise is a good fit for your entrepreneurial goals or if another option might work best for you.
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