Franchise Basics
From Franchise 500 (https://www.franchise500.com/article/36328)

Introduction

With a franchise agreement you are licensing your business's trademarks to someone else to use as branding for their own separate business. The franchise agreement would spell out in detail the requirements that the other party must comply with in order to keep using the trademarks. The other party is required to pay specified compensation in one form or another.

The Pros

The greatest strength of franchising is its ability to bring independent retailers together using a single trademark and business concept. The benefits of this affiliation are many: brand awareness, uniformity in meeting customer expectations, the power of pooled advertising and the efficiencies of group purchasing.

For the individual owner, there are several advantages to franchising. The ever-present risk of business failure is reduced when the business program has already proved to be successful in the marketplace; the use of an established trademark saves the business owner the cost of creating and advertising a name that customers will recognize; and the advantages of group advertising and purchasing make operations more profitable. In addition, ongoing training creates an instant operational expertise that would otherwise need to be acquired through trial and error. Also, with franchising, expansion seems to come more naturally. Operating a successful franchise may quickly lead to building a second and then a third business, and so on. Fortunes have been built this way.

The Benefits

• Reduction of risk
• Turnkey operation
• Standardized products and systems
• Standardized financial and accounting systems
• Collective buying power
• Supervision and consulting readily available
• National and local advertising programs
• Point-of-sale advertising
• Uniform packaging
• Ongoing research and development
• Financial assistance
• Site selection guidance
• Operations manual provided
• Sales and marketing assistance

The Cons

Franchising, however, is not for everyone. Fiercely independent entrepreneurial types (you know who you are) may chafe under the strict operational requirements and specifications of a franchised business. If things have to be done your way, you may want to head in another direction.

Also know that some franchise systems are better than others. A weak franchise program will not train you well to handle the challenges of the business, will not do a good job of assisting you when problems arise, and will not make the best use of your advertising dollars.

The Downside

• Loss of control
• A binding contract
• The franchisor's problems are also your problems

If you're considering buying a franchise, don't let wild expectations influence your decision. While franchising is designed to put people into business who have never owned a business before, the excitement of ownership can create an impulse to move forward without proper planning. If you rush headlong into buying a franchise expecting to boost your current working salary, but the earnings don't allow you to pull out more than half your former salary, you will be one unhappy camper. Work with a good CPA to prepare a cash-flow projection for the business before you take the plunge. Know how long it will take to break even and turn a profit, as well as the amount of salary you'll realistically be able to pay yourself.

Associated Costs

In terms of capital investment, your franchise fee will be determined by the profitability of the business. Most companies have a scale when it comes to franchise fees. They can have varying ranges, anywhere from $2,000 to $100,000+, depending on the size of the system. In addition to this front-end franchise fee--the one-time charge that a franchisor assesses you for the privilege of using the business concept, attending their training program, and learning the entire business-there will also be an ongoing royalty fee, typically ranging from 2 to 10 percent, or a monthly figure. Some of the other costs associated with a franchise include:

Facility/Location

In some cases, you may also have to buy land or a building, or you may have to rent a building. If you rent a building, you'll be responsible for not only the monthly lease but for the one-time security deposit as well. In addition, you'll have to pay for leasehold improvements. In some cases, the owner of the building will put these in and factor them into your rental, probably charging you a small additional fee. The franchisor might provide you with an allowance for leasehold improvements that runs in the neighborhood of $10,000 to $35,000 for your average franchise. Most franchisors will tell you what their estimated leasehold improvements will be.

Equipment

Different types of businesses will need various pieces of equipment. There are generally long-term payments available for most equipment purchases. Fortunately, most banks will provide loans for equipment because it also serves as collateral.

Signs

Outside signage can be very expensive for the small-business owner. Most franchisors have developed a sign package that the franchisee is obligated to purchase.

Opening Inventory

This will usually consist of at least a two-week supply, unless you're in a business that requires a much more complicated inventory. Most franchisors will tell you what their opening inventory requirements are.

Working Capital

For rent, you may be required to deposit first and last months' payments as well as a security fee. You'll also have to pay a deposit to the electric, gas and telephone companies (who will want deposits prior to giving you service). You'll need some working capital and money in the cash drawer to make change. You'll need money to pay your employees. You'll need money just to operate until there's a cash flow. If you're buying a franchise that relies on charge accounts, you're going to have to allow yourself some additional capital before the bills are paid by the customers and returned to you.

Advertising Fees

There is usually a fee for advertising on a regional or national basis. Most larger franchisors require their franchisees to pay a certain amount into a national fund used to advance the concept. The upside is the benefits are quite substantial in terms of the visibility you get with the type of advertising that most franchisors do.

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