Should You Buy a Franchise? Key Pros, Cons and Questions to Ask

When you consider going into business for yourself, you have three basic choices: Start from scratch, buy an existing business, or look for opportunities to purchase a franchise.

A franchise gives you the licensed right to use a service mark, trademark or business concept. Each franchisee signs an agreement that governs how the business is operated. This ensures a uniform standard of quality within the system.

According to the Federal Trade Commission (FTC), a franchise exists when: 1) You get the right to operate under the franchisor's trademark, 2) the franchisor provides significant control or assistance, and 3) you pay a required fee.

Hundreds of thousands of franchise businesses exist in the United States, covering every conceivable industry, from such well-known brands as McDonald's to smaller local establishments. So, there's plenty of opportunities if you choose the franchise route. The challenge is to find one that's interesting and a good investment.

Be aware that the FTC requires franchisors to provide a Franchise Disclosure Document to franchisees. Under federal law, franchisors must provide you with this document at least 14 days before you sign or pay. (If the franchisor materially changes the agreement later, you must get the final agreement at least 7 days before signing.)

Buying a franchise obviously isn't a guarantee of success, but here are the main advantages:

• Uniformity. You can capitalize on a uniform business format and instant brand recognition, as well as tap training and ongoing support from the franchise company.
• Lower risk. This can be a plus for less-experienced entrepreneurs. While starting a business alone can expose you to a high risk of failure, a franchise can buffer that risk somewhat because the franchise may come with a package that eliminates the guesswork often associated with starting a business.
• Proven track record. Franchising typically includes an existing product or service, a proven market method, equipment, inventory and support, such as hands-on business consulting and advice.
• Network power. Franchisees can gain brand recognition from national advertisement and promotion. In addition, there can be power buying opportunities when purchasing inventory, materials and supplies through a network, which can help keep prices down.
• Start-up cash. Some franchise companies provide financing plans.

Certainly, these advantages can work for you. But before making the leap, consider the potential disadvantages:

• Lack of power. Franchisees forfeit a certain measure of control over their day-to-day operations. If you have a strong entrepreneurial personality, you may have a problem handling the relationship if you start to feel you are more a manager than a boss.
• Financial risks. Franchises can cost a great deal to start and generally include ongoing royalty fees that you often must pay even if an outlet hasn't earned significant income. Moreover, the central franchiser may face financial problems or actually go under.
• The "caged syndrome." You are typically committed to a franchising agreement that runs for several years, which can lock you into rigid business practices, fees and operating rules.
• Potential for sharing bad karma. Not all publicity is positive. Unethical management or business practices by one franchisee affect the entire system. For example, hygiene and cleanliness issues at one fast food restaurant can hurt sales at the others in the chain even if they have spotless records.

Deciding to go full ahead with a franchise is a difficult and challenging task. Take a look at the Federal Trade Commission's booklet on franchising and then carefully discuss the issues with your professional advisors. As with any investment, the more you know, the better prepared you are to make a go of it.

Some Questions to Ask Before Buying Into a Franchise

1. How many franchises does the organization have? A large number of franchises might indicate a successful, well-established business model. If so, that's a good sign, but be careful your franchise won't be too close to another location of the same franchise.

2. How much is the franchise fee? A blue-chip national chain will likely cost significantly more than most others.

3. What are the royalty fees? They range from 4% to 12% of gross sales, depending on the sector and the brand. Check and think carefully about this percentage before investing.

4. How much help can you expect from the franchisor? Will they help with site selection, licensing and hiring?

5. Is the franchise legitimate? If you aren't certain, check with the Better Business Bureau or the Federal Trade Commission.