Many people dream of being an entrepreneur. By purchasing a franchise,
you often can sell goods and services that have instant name recognition
and can obtain training and ongoing support to help you succeed. But be
cautious. Like any investment, purchasing a franchise is not a guarantee
THE BENEFITS AND RESPONSIBILITIES OF FRANCHISE OWNERSHIP
The information below is intended to help you understand your obligations
as a franchise owner, how to shop for franchise opportunities, and how to
ask the right questions before you invest.
A franchise typically enables you, the investor or "franchisee," to
operate a business. By paying a franchise fee, which may cost several
thousand dollars, you are given a format or system developed by the
company ("franchisor"), the right to use the franchisor's name for a
limited time, and assistance. For example, the franchisor may help you
find a location for your outlet; provide initial training and an operating
manual; and advise you on management, marketing, or personnel. Some
franchisors offer ongoing support such as monthly newsletters, a toll free
800 telephone number for technical assistance, and periodic workshops or
While buying a franchise may reduce your investment risk by enabling you
to associate with an established company, it can be costly. You also may
be required to relinquish significant control over your business, while
taking on contractual obligations with the franchisor.
Below is an outline of several components of a typical franchise system.
Consider each carefully.
* The Cost
In exchange for obtaining the right to use the franchisor's name and its
assistance, you may pay some or all of the following fees.
-- initial franchise fee and other expenses. Your initial franchise fee,
which may be non-refundable, may cost several thousand to several hundred
thousand dollars. You may also incur significant costs to rent, build, and
equip an outlet and to purchase initial inventory. Other costs include
operating licenses and insurance. You also may be required to pay a "grand
opening" fee to the franchisor to promote your new outlet.
-- continuing royalty payments. You may have to pay the franchisor
royalties based on a percentage of your weekly or monthly gross income.
You often must pay royalties even if your outlet has not earned
significant income during that time. In addition, royalties usually are
paid for the right to use the franchisor's name. So even if the franchisor
fails to provide promised support services, you still may have to pay
royalties for the duration of your franchise agreement.
-- advertising fees. You may have to pay into an advertising fund. Some
portion of the advertising fees may go for national advertising or to
attract new franchise owners, but not to target your particular outlet.
To ensure uniformity, franchisors typically control how franchisees
conduct business. These controls may significantly restrict your ability
to exercise your own business judgment. The following are typical examples
of such controls.
-- site approval. Many franchisors pre-approve sites for outlets. This
may increase the likelihood that your outlet will attract customers. The
franchisor, however, may not approve the site you want.
-- design or appearance standards. Franchisors may impose design or
appearance standards to ensure customers receive the same quality of goods
and services in each outlet. Some franchisors require periodic renovations
or seasonal design changes. Complying with these standards may increase
-- restrictions on goods and services offered for sale. Franchisors may
restrict the goods and services offered for sale. For example, as a
restaurant franchise owner, you may not be able to add to your menu
popular items or delete items that are unpopular. Similarly, as an
automobile transmission repair franchise owner, you might not be able to
perform other types of automotive work, such as brake or electrical system
-- restrictions on method of operation. Franchisors may require you to
operate in a particular manner. The franchisor might require you to
operate during certain hours, use only pre-approved signs, employee
uniforms, and advertisements, or abide by certain accounting or
bookkeeping procedures. These restrictions may impede you from operating
your outlet as you deem best. The franchisor also may require you to
purchase supplies only from an approved supplier, even if you can buy
similar goods elsewhere at a lower cost.
-- restrictions of sales area. Franchisors may limit your business to a
specific territory. While these territorial restrictions may ensure that
other franchisees will not compete with you for the same customers, they
could impede your ability to open additional outlets or move to a more
* Terminations and Renewal
You can lose the right to your franchise if you breach the franchise
contract. In addition, the franchise contract is for a limited time; there
is no guarantee that you will be able to renew it.
-- franchise terminations. A franchisor can end your franchise agreement
if, for example, you fail to pay royalties or abide by performance
standards and sales restrictions. If your franchise is terminated, you may
lose your investment.
-- renewals. Franchise agreements typically run for 15 to 20 years. After
that time, the franchisor may decline to renew your contract. Also be
aware that renewals need not provide the original terms and conditions.
The franchisor may raise the royalty payments, or impose new design
standards and sales restrictions. Your previous territory may be reduced,
possibly resulting in more competition from company-owned outlets or other
BEFORE SELECTING A FRANCHISE SYSTEM
Before investing in a particular franchise system, carefully consider how
much money you have to invest, your abilities, and your goals. The
following checklist may help you make your decision.
* Your Investment
-- How much money do you have to invest?
-- How much money can you afford to lose?
-- Will you purchase the franchise by yourself or with partners?
-- Will you need financing and, if so, where can you obtain it?
-- Do you have a favorable credit rating?
-- Do you have savings or additional income to live on while starting
* Your Abilities
-- Does the franchise require technical experience or relevant education,
such as auto repair, home and office decorating, or tax preparation?
-- What skills do you have? Do you have computer, bookkeeping, or other
-- What specialized knowledge or talents can you bring to a business?
-- Have you ever owned or managed a business?
* Your Goals
-- What are your goals?
-- Do you require a specific level of annual income?
-- Are you interested in pursuing a particular field?
-- Are you interested in retail sales or performing a service?
-- How many hours are you willing to work?
-- Do you want to operate the business yourself or hire a manager?
-- Will franchise ownership be your primary source of income or will it
supplement your current income?
-- Would you be happy operating the business for the next 20 years?
-- Would you like to own several outlets or only one?
Selecting a Franchise
Like any other investment, purchasing a franchise is a risk. When
selecting a franchise, carefully consider a number of factors, such as the
demand for the products or services, likely competition, the franchisor's
background, and the level of support you will receive.
Is there a demand for the franchisor's products or services in your
community? Is the demand seasonal? For example, lawn and garden care or
swimming pool maintenance may be profitable only in the spring or summer.
Is there likely to be a continuing demand for the products or services in
the future? Is the demand likely to be temporary, such as selling a fad
food item? Does the product or service generate repeat business?
What is the level of competition, nationally and in your community? How
many franchised and company-owned outlets does the franchisor have in your
area? How many competing companies sell the same or similar products or
services? Are these competing companies well established, with wide name
recognition in your community? Do they offer the same goods and services
at the same or lower price?
* Your Ability to Operate the Business
Sometimes, franchise systems fail. Will you be able to operate your
outlet even if the franchisor goes out of business? Will you need the
franchisor's ongoing training, advertising, or other assistance to
succeed? Will you have access to the same or other suppliers? Could you
conduct the business alone if you must lay off personnel to cut costs?
* Name Recognition
A primary reason for purchasing a franchise is the right to associate
with the company's name. The more widely recognized the name, the more
likely it will draw customers who know its products or services.
Therefore, before purchasing a franchise, consider:
-- The company's name and how widely recognized it is.
-- If it has a registered trademark.
-- How long the franchisor has been in operation.
-- If the company has a reputation for quality products or services.
-- If consumers have filed complaints against the franchise with the
Better Business Bureau or a local consumer protection agency.
* Training and Support Servcies
Another reason for purchasing a franchise is to obtain support from the
franchisor. What training and ongoing support does the franchisor provide?
How does their training compare with the training for typical workers in
the industry? Could you compete with others who have more formal training?
What backgrounds do the current franchise owners have? Do they have prior
technical backgrounds or special training that helps them succeed? Do you
have a similar background?
* Franchisor's Experience
Many franchisors operate well-established companies with years of
experience both in selling goods or services and in managing a franchise
system. Some franchisors started by operating their own business. There is
no guarantee, however, that a successful entrepreneur can successfully
manage a franchise system.
Carefully consider how long the franchisor has managed a franchise
system. Do you feel comfortable with the franchisor's expertise? If
franchisors have little experience in managing a chain of franchises,
their promises of guidance, training, and other support may be unreliable.
A growing franchise system increases the franchisor's name recognition
and may enable you to attract customers. Growth alone does not ensure
successful franchisees; a company that grows too quickly may not be able
to support its franchisees with all the promised support services. Make
sure the franchisor has sufficient financial assets and staff to support
Shopping at a Franchise Exposition
Attending a franchise exposition allows you to view and compare a variety
of franchise possibilities. Keep in mind that exhibitors at the exposition
primarily want to sell their franchise systems. Be cautious of
salespersons who are interested in selling a franchise that you are not
Before you attend, research what type of franchise best suits your
investment limitations, experience, and goals. When you attend, comparison
shop for the opportunity that best suits your needs and ask questions.
Know How Much You Can Invest
An exhibitor may tell you how much you can afford to invest or that you
can't afford to pass up this opportunity. Before beginning to explore
investment options, consider the amount you feel comfortable investing and
the maximum amount you can afford.
Know What Type of Business is Right for You
An exhibitor may attempt to convince you that an opportunity is perfect
for you. Only you can make that determination. Consider the industry that
interests you before selecting a specific franchise system. Ask yourself
the following questions:
* Have you considered working in that industry before?
* Can you see yourself engaged in that line of work for the next twenty
* Do you have the necessary background or skills?
If the industry does not appeal to you or you are not suited to work in
that industry, do not allow an exhibitor to convince you otherwise. Spend
your time focusing on those industries that offer a more realistic
Visit several franchise exhibitors engaged in the type of industry that
appeals to you. Listen to the exhibitors' presentations and discussions
with other interested consumers. Get answers to the following questions:
* How long has the franchisor been in business?
* How many franchised outlets currently exist? Where are they located?
* How much is the initial franchise fee and any additional start-up
costs? Are there any continuing royalty payments? How much?
* What management, technical, and ongoing assistance does the franchisor
* What controls does the franchisor impose?
Exhibitors may offer you prizes, free samples, or free dinners if you
attend a promotional meeting later that day or over the next week to
discuss the franchise in greater detail. Do not feel compelled to attend.
Rather, consider these meetings as one way to acquire more information and
to ask additional questions. Be prepared to walk away from any promotion
if the franchise does not suit your needs.
Get Substantiation for Any Earnings Representations
Some franchisors may tell you how much you can earn if you invest in
their franchise system or how current franchisees in their system are
performing. Be careful. The FTC requires that franchisors who make such
claims provide you with written substantiation. This is explained in more
detail in the section "Investigating Franchise Offers." Make sure you ask
for and obtain written substantiation for any income projections, or
income or profit claims. If the franchisor does not have the required
substantiation, or refuses to provide it to you, consider its claims to be
It may be difficult to remember each franchise exhibit. Bring a pad and
pen to take notes. Get promotional literature that you can review. Take
the exhibitors' business cards so you can contact them later with any
Avoid High Pressure Sales Tactics
You may be told that the franchisor's offering is limited, that there is
only one territory left, or that this is a one-time reduced franchise
sales price. Do not feel pressured to make any commitment. Legitimate
franchisors expect you to comparison shop and to investigate their
offering. A good deal today should be available tomorrow.
Study the Franchisor's Offering
Do not sign any contract or make any payment until you have the
opportunity to investigate the franchisor's offering thoroughly. As will
be explained further in the next section, the FTC's Franchise Rule
requires the franchisor to provide you with a disclosure document
containing important information about the franchise system. Study the
disclosure document. Take time to speak with current and former
franchisees about their experiences. Because investing in a franchise can
entail a significant investment, you should have an attorney review the
disclosure document and franchise contract and have an accountant review
the company's financial disclosures.
INVESTIGATING FRANCHISE OFFERINGS
Before investing in any franchise system, be sure to get a copy of the
franchisor's disclosure document. Sometimes this document is called a
Franchise Offering Circular. Under the FTC's Franchise Rule, you must
receive the document at least 10 business days before you are asked to
sign any contract or pay any money to the franchisor. You should read the
entire disclosure document. Make sure you understand all of the
provisions. The following outline will help you to understand key
provisions of typical disclosure documents. It also will help you ask
questions about the disclosures. Get a clarification or answer to your
concerns before you invest.
* Business Background
The disclosure document identifies the executives of the franchise system
and describes their prior experience. Consider not only their general
business background, but their experience in managing a franchise system.
Also consider how long they have been with the company. Investing with an
inexperienced franchisor may be riskier than investing with an experienced
* Litigation History
The disclosure document helps you assess the background of the franchisor
and its executives by requiring the disclosure of prior litigation. The
disclosure document tells you if the franchisor, or any of its executive
officers, has been convicted of felonies involving, for example, fraud,
any violation of franchise law or unfair or deceptive practices law, or
are subject to any state or federal injunctions involving similar
misconduct. It also will tell you if the franchisor, or any of its
executives, has been held liable or settled a civil action involving the
franchise relationship. A number of claims against the franchisor may
indicate that it has not performed according to its agreements, or, at the
very least, that franchisees have been dissatisfied with the franchisor's
performance. Be aware that some franchisors may try to conceal an
executive's litigation history by removing the individual's name from
their disclosure documents.
The disclosure document tells you if the franchisor or any of its
executives have recently been involved in a bankruptcy. This will help you
to assess the franchisor's financial stability and general business acumen
and predict if the company is financially capable of delivering promised
The disclosure document tells you the costs involved to start one of the
company's franchises. It will describe any initial deposit or franchise
fee, which may be non-refundable, and costs for initial inventory, signs,
equipment, leases, or rentals. Be aware that there may be other
undisclosed costs. The following checklist will help you ask about
potential costs to you as a franchisee.
-- Continuing royalty payments.
-- Advertising payments, both to local and national advertising funds.
-- Grand opening or other initial business promotions.
-- Business or operating licenses.
-- Product or service supply costs.
-- Real estate and leasehold improvements.
-- Discretionary equipment such as a computer system or business alarm
-- Legal fees.
-- Financial and accounting advice.
-- Compliance with local ordinances, such as zoning, waste removal, and
fire and other safety codes.
-- Health insurance.
-- Employee salaries and benefits.
It may take several months or longer to get your business started.
Consider in your total cost estimate operating expenses for the first year
and personal living expenses for up to two years. Compare your estimates
with what other franchisees have paid and with competing franchise
systems. Perhaps you can get a better deal with another franchisor. An
accountant can help you to evaluate this information.
Your franchisor may restrict how you operate your outlet. The disclosure
document tells you if the franchisor limits:
-- The supplier of goods from whom you may purchase.
-- The goods or services you may offer for sale.
-- The customers to whom you can offer goods or services.
-- The territory in which you can sell goods or services.
Understand that restrictions such as these may significantly limit your
ability to exercise your own business judgment in operating your outlet.
The disclosure document tells you the conditions under which the
franchisor may terminate your franchise and your obligations to the
franchisor after termination. It also tells you the conditions under which
you can renew, sell, or assign your franchise to other parties.
* Training and Other Assistance
The disclosure document will explain the franchisor's training and
assistance program. Make sure you understand the level of training
offered. The following checklist will help you ask the right questions.
-- How many employees are eligible for training?
-- Can new employees receive training and, if so, is there any additional
-- How long are the training sessions?
-- How much time is spent on technical training, business management
training, and marketing?
-- Who teaches the training courses and what are their qualifications?
-- What type of ongoing training does the company offer and at what cost?
-- Whom can you speak to if problems arise?
-- How many support personnel are assigned to your area?
-- How many franchisees will the support personnel service?
-- Will someone be available to come to your franchised outlet to provide
more individual assistance?
The level of training you need depends on your own business experience
and knowledge of the franchisor's goods and services. Keep in mind that a
primary reason for investing in the franchise, as opposed to starting your
own business, is training and assistance. If you have doubts that the
training might be insufficient to handle day-to-day business operations,
consider another franchise opportunity more suited to your background.
You often must contribute a percentage of your income to an advertising
fund even if you disagree with how these funds are used. The disclosure
document provides information on advertising costs. The following
checklist will help you assess whether the franchisor's advertising will
-- How much of the advertising fund is spent on administrative costs?
-- Are there other expenses paid from the advertising fund?
-- Do franchisees have any control over how the advertising dollars are
-- What advertising promotions has the company already engaged in?
-- What advertising developments are expected in the near future?
-- How much of the fund is spent on national advertising?
-- How much of the fund is spent on advertising in your area?
-- How much of the fund is spent on selling more franchises?
-- Do all franchisees contribute equally to the advertising fund?
-- Do you need the franchisor's consent to conduct your own advertising?
-- Are there rebates or advertising contribution discounts if you conduct
your own advertising?
-- Does the franchisor receive any commissions or rebates when it places
advertisements? Do franchisees benefit from such commissions or rebates,
or does the franchisor profit from them?
* Current and Former Franchisees
The disclosure document provides important information about current and
former franchisees. Determine how many franchises are currently operating.
A large number of franchisees in your area may mean increased competition.
Pay attention to the number of terminated franchisees. A large number of
terminated, cancelled, or non-renewed franchises may indicate problems. Be
aware that some companies may try to conceal the number of failed
franchisees by repurchasing failed outlets and then listing them as
If you buy an existing outlet, ask the franchisor how many owners
operated that outlet and over what period of time. A number of different
owners over a short period of time may indicate that the location is not a
profitable one, or that the franchisor has not supported that outlet with
The disclosure document gives you the names and addresses of current
franchisees and franchisees who have left the system within the last year.
Speaking with current and former franchisees is probably the most reliable
way to verify the franchisor's claims. Visit or phone as many of the
current and former franchisees as possible. Ask them about their
experiences. See for yourself the volume and type of business being done.
The following checklist will help you ask current and former franchisees
such questions as:
-- How long has the franchisee operated the franchise?
-- Where is the franchise located?
-- What was their total investment?
-- Were there any hidden or unexpected costs?
-- How long did it take them to cover operating costs and earn a
-- Are they satisfied with the cost, delivery, and quality of the goods
or services sold?
-- What were their backgrounds prior to becoming a franchisee?
-- Was the franchisor's training adequate?
-- What ongoing assistance does the franchisor provide?
-- Are they satisfied with the franchisor's advertising program?
-- Does the franchisor fullfill its contractual obligations?
-- Would the franchisee invest in another outlet?
-- Would the franchisee recommend the investment to someone with your
goals, income requirements, and background?
Be aware that some franchisors may give you a separate reference list of
selected franchisees to contact. Be careful. Those on the list may be
individuals who are paid by the franchisor to give a good opinion of the
* Earnings Potential
You may want to know how much money you can make if you invest in a
particular franchise system. Be careful. Earnings projections can be
misleading. Insist upon written substantiation for any earnings
projections or suggestions about your potential income or sales.
Franchisors are not required to make earnings claims, but if they do, the
FTC's Franchise Rule requires franchisors to have a reasonable basis for
these claims and to provide you with a document that substantiates them.
This substantiation includes the bases and assumptions upon which these
claims are made. Make sure you get and review the earnings claims
document. Consider the following in reviewing any earnings claims.
* Sample Size
A franchisor may claim that franchisees in its system earned, for
example, $50,000 last year. This claim may be deceptive, however, if only
a few franchisees earned that income and it does not represent the typical
earnings of franchisees. Ask how many franchisees were included in the
* Average Incomes
A franchisor may claim that the franchisees in its system earn an average
income of, for example, $75,000 a year. Average figures like this tell you
very little about how each individual franchisee performs. Remember, a
few, very successful franchisees can inflate the average. An average
figure may make the overall franchise system look more successful than it
* Gross Sales
Some franchisors provide figures for the gross sales revenues of their
franchisees. These figures, however, do not tell you anything about the
franchisees' actual costs or profits. An outlet with a high gross sales
revenue on paper actually may be losing money because of high overhead,
rent, and other expenses.
* Net Profits
Franchisors often do not have data on net profits of their franchisees.
If you do receive net profit statements, ask whether they provide
information about company-owned outlets. Company-owned outlets might have
lower costs because they can buy equipment, inventory, and other items in
larger quantities, or may own, rather than lease their property.
* Geographic Relevance
Earnings may vary in different parts of the country.
An ice cream store franchise in a southern state, such as Florida, may
expect to earn more income than a similar franchise in a northern state,
such as Minnesota. If you hear that a franchisee earned a particular
income, ask where that franchisee is located.
* Franchisee's Background
Keep in mind that franchisees have varying levels of skills and
educational backgrounds. Franchisees with advanced technical or business
backgrounds can succeed in instances where more typical franchisees
cannot. The success of some franchisees is no guarantee that you will be
* Financial History
The disclosure document provides you with important information about the
company's financial status, including audited financial statements. Be
aware that investing in a financially unstable franchisor is a significant
risk; the company may go out of business or into bankruptcy after you have
invested your money.
Hire a lawyer or an accountant to review the franchisor's financial
statements. Do not attempt to extract this important information from the
disclosure document unless you have considerable background in these
matters. Your lawyer or accountant can help you understand the following.
-- Does the franchisor have steady growth?
-- Does the franchisor have a growth plan?
-- Does the franchisor make most of its income from the sale of
franchises or from continuing royalties?
-- Does the franchisor devote sufficient funds to support its franchise
ADDITIONAL SOURCES OF INFORMATION
Before you invest in a franchise system, investigate the franchisor
thoroughly. In addition to reading the company's disclosure document and
speaking with current and former franchisees, you should speak with the
* Lawyer and Accountant
Investing in a franchise is costly. An accountant can help you understand
the company's financial statements, develop a business plan, and assess
any earnings projections and the assumptions upon which they are based.
An accountant can help you pick a franchise system that is best suited to
your investment resources and your goals.
Franchise contracts are usually long and complex. A contract problem that
arises after you have signed the contract may be impossible or very
expensive to fix. A lawyer will help you to understand your obligations
under the contract, so you will not be surprised later. Choose a lawyer
who is experienced in franchise matters. It is best to rely upon your own
lawyer or accountact, rather than those of the franchisor.
* Banks and Other Financial Institutions
These organizations may provide an unbiased view of the franchise
opportunity you are considering. Your banker should be able to get a Dun
and Bradstreet report or similar reports on the franchisor.
* Better Business Bureau
Check with the local Better Business Bureau (BBB) in the cities where the
franchisor has its headquarters. Ask if any consumers have complained
about the company's products, services, or personnel.
* Government Departments
Several states regulate the sale of franchises. Check with your state
Division of Securities or Office of Attorney General for more information
about your rights as a franchise owner in your state.
* Federal Trade Commission (FTC)
If you have questions or problems about franchises, write: Correspondence
Branch, Federal Trade Commission, Washington, DC 20580. While the FTC does
not resolve individual disputes, your comments help in its law enforcement
from material by the Federal Trade Commission and the North
American Securities Administrators Assn -- Dec. 1994
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