Franchising is based on a relationship between the brand owner and the local operator to skillfully and successfully extend one’s established business system (for a more detailed description of franchising, check out our post on Franchising Fundamentals).
Let’s first take a look at business ownership in general in terms of investment. We’ll later break this down into franchising as it compares to starting a business concept of your own.
Business Ownership: Risk and Reward
In any investment, there is some risk required upfront to achieve a reward later on. Even with less risky investments, such as bonds, you are sacrificing immediate access to funds to be able to reap the benefits at a later date.
Business ownership is no different in this regard. But here are a few ways in which owning a business stands out as an investment decision:
*While these skills are always helpful, franchising is an exception to this requirement
The exact risk, of course, will depend on the industry, location, and the skill set of the business owner (or strength of a franchisor’s business model and training program). Be sure to consider all of these factors before opening your own business.
Being a business owner gives you a better understanding of your stake in the investment than with stocks and bonds. You get to decide how to allocate profits, including how much to re-invest in the business. With hard work and a strategic approach, you can increase your business’s success and grow your profits.
“When you invest in a franchise or small business, you have complete control over your investment. Sometimes this isn’t a good thing for an investor, but if you are someone who is motivated, experienced, and has a plan for success, this can be a very good thing”Christopher Connor, Equities
Franchising vs. New Business
Franchising can be a great way to increase revenue and diversify your investments, just as it can be a great entry point for a prospective business owner. The proven business model, support services, and high potential for growth make franchising an intriguing investment opportunity for people of all backgrounds.
The estimated initial investment of starting a franchise can be found in item 7 of the Franchise Disclosure Document, or FDD. The FDD will be provided by the franchisor a minimum of 14 days prior to a Franchise Agreement contract being signed and is required by law. The Financial Performance Representation (FPR) is also disclosed in Item 19 of the FDD.
You will be able to review all of this information and get in touch with current franchisees prior to making a decision or signing any agreements. For more information on what you can expect to find in the FDD, check out our post on Everything You Need to Know About the FDD.
While it’s important to have a good understanding of the financials provided by the FDD, keep in mind that it is not a guarantee of your financial performance. The success of each individual franchise location is affected by the local market, how the business is operated, how marketing funds are allocated, the customer experience, and many other factors.
That being said, however, the FDD can give you a better understanding of your earning potential that you wouldn’t get when starting a business from scratch.
Average ROI for franchises are 25-50%, but this varies for each individual franchise. A projected ROI of about 20-25% is a good starting point. Franchises with diverse income streams (for example, membership and merchandise) also increase ROI.
Franchisees can benefit from reduced cost of supply chain services thanks to the franchisor’s reputation or relationship with certain suppliers.
Your franchisor likely has tried and true processes that have been proven effective, so it’s usually in your best interest to follow those systems rather than to try and do your own thing.
While financing is not typically provided by franchisors, it may be easier to receive financing in the form of an SBA loan for a franchise with a proven track record rather than for a start-up. Additionally, franchisors often offer assistance to help ease the process by providing necessary documentation on your behalf.
When you start a business from scratch, scalability can be a daunting task—both in terms of logistics and financials. If growth and expansion of your business are a part of your goals, franchising is the way to go.
The whole franchise model is built on the idea of scalability, and every detail has been perfected. Many franchisors also offer some financial benefits to multi-unit franchise owners, such as a reduced franchise fee.
Multi-unit owners can further save money on staffing by rotating their employees between locations when needed. Advertising costs can also be significantly lower per location if you own multiple units within the same geographic area. You can even start with multiple units right off the bat, provided you have sufficient capital.
Because franchising requires less innovation, trial and error, and process management than an independent start-up, many franchise owners find themselves investing in various franchise businesses to diversify their portfolio, cater to a wider range of demographics, and span multiple industries. While this approach may not be for everyone, it is something that is made a lot easier thanks to the franchise model.
With a strategic growth plan, there is always the option of later selling your franchise for a hefty profit.
“It’s good to keep in mind that in a well-performing franchise system, the exit value of a franchise may be higher than that found in an independent non-franchised business because the relationship with the franchisor’s marks increases the value of the business being sold”The Balance Small Business
Plan ahead and be prepared—consider exit strategies when purchasing a franchise even if you don’t anticipate selling. Your own personal circumstances could always change later on, and you’ll want to have options.
Risks of Franchising
The most obvious drawback to franchising is the fees.These typically include an initial franchise fee, ongoing royalty fees, and contributions to a marketing fund. For more details on specific breakdown of fees and royalties, see items 6 and 7 of the Franchise Disclosure Document. You must also renew the franchise agreement after the term expires (the length of the term varies depending on the specific franchise, but is typically 10 or 20 years).
Think of these fees as a tradeoff—you may be putting more into the investment, but the resources and support you receive in exchange will very likely create further opportunities for growth and profitability. Keep in mind that, even without franchise fees, an independent start-up can still prove to be more costly.
There are no guarantees in franchising, just as with any form of business ownership. The franchisor cannot guarantee your financial performance. The success of your business comes down to how you choose to operate it and apply the systems and procedures provided by the franchisor.
Continuing to invest additional money into your business will only improve your revenue stream, leading to higher and higher ROI. It’s always best to have an accountant to help you with financial management and planning. Have a long-term diversification strategy (investing in a separate retirement account, for example), or ensure your industry is resilient to economic downturn if you will be “all in.” With the proper preparation and due diligence, franchising can be a smart and rewarding investment for your future.