Ideas are a dime a dozen—nurturing and developing them to fruition is where the true value lies. Nearly everyone has thought up of great business concepts, but only a small fraction of those individuals have the drive and resources to act on them. The execution phase is where many a would-be entrepreneur loses steam. Launching a company from scratch is usually a lengthy, lonely process. Sure, you need a great idea to spark the process, but after that its takes untold amounts of grit and ingenuity (and not to mention money) to ultimately generate substantial profits.
There is an untold amount of hurdles that hopeful entrepreneurs face during the initial planning and conceptual phases of the business development lifecycle—and after they finally have the business up and running, there’s still a large amount of fine-tuning via trial and error that has to be done in order to optimize cash flow and ensure long-term sustainability.
That’s where the concept of franchising comes into play. Individuals invest capital into franchises to essentially cut out the colossal undertaking of generating a business from the ground-up. The key advantage is that you essentially are provided with a pre-built package of plans and guidance for initializing the business. On the other hand, many individuals are dissuaded from franchises due to the significantly prohibitive financial barrier of entry due to the considerable upfront costs associated with the majority of franchising endeavors.
A long-held belief in the corporate world is that franchise businesses generate jobs more efficiently than other forms of startup entities. The preferential media treatment of franchise ventures--fueled in large part to their historically-superior economic performance—has prompted many small business owners to explore franchising opportunities. Comprehending the benefits and drawbacks of pursuing the franchising route is essential in determining whether or not it is the optimal business move for you.
That’s why we’ve compiled the following overview of the main pros and cons of franchising to help you make an informed decision as to whether it is right for you.
Franchise What? Understanding the Basics
Before we get too far into the weeds about the pros and cons of franchising, it helps to first understand what they are and how they are structured. A franchise is a type of business that is owned and operated by an individual—called a “franchisee”—but that is branded and managed by a larger entity—called the “franchisor.” The majority of the name-brand retailers and restaurants that you interact with on a daily basis are franchises, from McDonalds to UPS, they are all structured as franchises.
Put simply, a franchise is a joint venture between the franchisor and franchisee. The franchisor created the business and sells the franchisee the right to use its name and concept. The franchisee purchases this right to sell the franchisor’s goods or services under a pre-existing model and trademark. It’s a tried-and-tested model that has a longstanding history in the United States. The model dates all the way back to the mid-1800’s when McCormick Harvesting Company and I.M. Singer Company formulated organizational, marketing and distribution systems that are credited with being the basis of the modern-day iteration of franchising. Currently, there are over 790,000 franchise establishments across the country, which generate approximately $500 billion annually to the GDP.
Franchises are premised on contractual agreements, which are complex and vary widely depending on the franchisor. Usually, a franchise contract entails three payment categories to the franchisor. First, the franchisee has to buy the franchise upfront. Next, the franchisor typically gets reimbursement for providing training, resources and consulting services. Additionally, the franchisor gets continual royalties based on a predetermined percentage of the franchisee’s profit margin.
Franchising Advantages
There are a number of reasons why franchises are an attractive option to existing and potential small business owners. Here are a few of the most commonly-cited ones:
- Vetted Concept: When you make an investment into a franchise, you are doing so with the peace of mind in knowing that the business has already proven successful. You have complete access to the financials and receive expert insight from peer franchisees who have invaluable experience profitably operating the identical business.
- Branding Power: Customers place trust in brands they are familiar with—meaning they are much more inclined to pay top-dollar for their favorite company’s product over the competition because they know what they are getting in terms of quality. Think about it: how many times have you opted for the famous “Golden Arches” of McDonalds over the local offerings that you have no idea what you are getting? Familiarity = Profitability.
- Corporate Partnership Kick-Backs: Franchisors routinely take care of all the negotiating related to forging strategic partnerships with other major organizations—and the trickle-down from these alliances flow directly to the franchisee who automatically become approved vendors or potentially receive major discounts on materials and equipment, or exclusive supply chains.
Franchising Disadvantages
While purchasing a franchise has its obvious benefits, just like any other business model, it has its potential drawbacks:
- High Upfront Costs: Per the Federal Trade Commission (FTC), in order to be deemed a franchise, the franchisor is required to impose an initial franchise fee. This cost affords the franchisee utilization of a business system and affiliated trademark for a certain period of time. This average fee is between $50,000 - $75,000, which can be prohibitive for some owners with limited liquidity.
- Royalty Payments: The majority of franchise royalties are derived from a percentage of the franchise’s revenue—usually ranging between 4% and 12%. Some franchisors also impose an additional marketing, advertising, software, merchant accounts and other fees that can cut into the franchisee’s profit margin.
- Limited Control: One of the main reasons why franchisees usually fail is that they refuse to adhere to the business model provided to them by the franchisor. If you simply cannot accept the fact that you will not have the option of changing a menu item at your franchised restaurant or develop your own branding campaign, then franchising might not be the ideal investment for you.
Don't forget to read the rest of this 3 part series:
- What to Look for When Evaluating a Franchise Opportunity - Part 2 of a 3 Part Series on Franchising in New York
- Exiting a Franchise: The Value of a Plan, Part 3 of a 3 Part Series on Franchising in New York
Francine E. Love is the Founder & Managing Attorney at LOVE LAW FIRM, PLLC which dedicates its practice to serving entrepreneurs, start-ups and small businesses. The opinions expressed are those of the author. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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