How to Buy a Franchise
Laura Roden’s career in financial services has covered the spectrum from investment management, brokerage, banking and corporate finance to teaching finance and entrepreneurship at the college and graduate school levels. She earned both her undergraduate and MBA degrees from Harvard University, and holds Series 7, 63 and 65 FINRA licenses. She has been a featured speaker on finance topics at the Milken Global Conference, the New York Society of Security Analysts, the Inc 500 conference and the Angel Capital Association as well as many other venues.
Janet Schaaf is a freelance writer, editor and proofreader who considers reader advocacy to be her calling. After taking a few roads less traveled, Janet completed a bachelor’s degree in English Literature from the University of Missouri-Kansas City, with English Department Honors. She has been correcting grammar and checking facts since she could string a sentence together. For the past three years, Janet has focused on making personal finance topics understandable and relatable. Loan terms and credit card agreements can look overwhelming, but understanding what you’re agreeing to is paramount in grasping the impact debt can have on your life.
Buying a franchise can be quicker than creating a business from scratch, but it comes with a high initial investment as well as ongoing fees and restrictions. Understanding how to buy a franchise will help you decide if franchise ownership is right for you.
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What you should know about buying a franchise
Buying a franchise is a popular way to own a business: There are over 100,000 businesses operating as franchises, according to a LendingTree analysis of U.S. Census Bureau data. When you enter into an agreement to buy a franchise, you as the franchisee pay a company — called the franchisor — for the right to use the franchisor’s brand name, management expertise and other assets or services.
Benefits of owning a franchise business can include an immediately recognizable brand name to attract customers, availability of training for yourself and employees, guidance in the location and structure of facilities, access to supplier relationships and referrals to lenders to help with financing.
Drawbacks to buying a franchise
In exchange for these benefits, you’ll pay the franchisor an upfront fee as well as ongoing franchise fees. The fees can vary widely from one franchisor to another. The Federal Trade Commission (FTC) requires franchisors to provide you with a copy of the Franchise Disclosure Document, 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.
In addition to paying fees, you’ll be asked to give up some control over the business, such as choosing which products you sell, how you advertise, where you purchase supplies and whether you can sell the franchise. Many franchisors also require you to meet minimum net worth and liquidity requirements, which can create a barrier to entry for many entrepreneurs.
How to buy a franchise in 5 steps
1. Pick a franchise business you want to buy.
Thousands of franchise opportunities are listed in the SBA’s Franchise Directory. Narrow your search based on:
- Industry: Starting a business is a huge time commitment, so choose a franchise in a field you’re passionate about and will enjoy working in for many years. And if you already have experience in that field you’re more likely to be approved by franchisors and get a business loan.
- Brand name: A key part of a franchise’s value is a brand name that attracts customers. Think about whether the franchise name is truly compelling to consumers and untainted by any negative associations.
- Initial investment: You’ll need money for both the franchise fee and startup expenses like equipment, rent, inventory and franchise tax. Calculate how much upfront outlay you can afford and choose an opportunity that fits your budget.
- Read the Franchise Disclosure Document (FDD): The FDD details 23 items 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.
2. Decide on a location.
Your decision about where to locate should consider customer experience, competitive environment and cost. Is the location convenient and attractive to customers? How dense is the competition from rival businesses? Is suitable space available to rent or purchase? How does this impact your upfront costs and time to launch?
3. 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 that you can borrow from according to your current needs, up to a preset credit limit, similar to a credit card.
- Equipment financing: Equipment loans are a type of loan that allows you to purchase machinery or equipment needed to operate your business, 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 makes 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 franchise: Some banks may offer loans specifically tailored for funding franchises.
4. Review and sign your franchise agreement.
The franchise agreement is a legally binding contract; review it carefully. It governs how your franchise can be terminated or renewed, among other important terms.
5. Attend corporate training and prepare for your grand opening.
Franchisors usually require you to attend training sessions which may be several weeks long. Taking advantage of this opportunity will help you prepare for a successful grand opening.
Pros and cons of buying a franchise
| Pros | Cons |
|---|---|
Recognizable brand. Operating expertise. Available financing. | Limited control. Added expense. No permanent ownership. |
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 — it’s easiest for someone who already has substantial net worth and good credit. It also comes with operating restrictions and risk of losing 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 like 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 is often challenging.
- Starting a new business: you won’t inherit someone else’s worries, and you can design a business tailored to your own 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.
Often the key question is not how to buy a franchise, but whether buying a franchise is a good fit for your own entrepreneurial goals.