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8 Things To Look Out for When Evaluating Franchise Opportunities

October 07, 2022
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Many of us are looking for a way to build a solid financial future for ourselves and our families. Buying a franchise is one way to do it. You get an established brand with a built-in customer base, plus you have the franchisor's support, knowledge, and resources at your disposal.

On the surface, it seems like a no-lose situation.

Person at Laptop Pointing at Franchise Agreement, Exercising Their Due Diligence Before Buying a Franchise
Remember, regardless of what the franchisor tells you about how successful you can be, always do your research and talk to previous or current franchisees of the business you're considering.

There's no harm in doing your due diligence and taking a holistic view in learning more about the opportunity from multiple angles.

With that said, even though All USA Franchises is well-versed in everything franchising, we still have to add a disclaimer that our blogs are not to be taken as legal advice. You should still get recommendations from an expert franchise lawyer, or advisor specializing in franchising.

They'll help you navigate the legal jargon inside franchise documents in plain English and can answer any questions before you sign the contract's dotted line.

The truth is, owning a franchise can be a great opportunity. Just know, however, that buying a franchise is a big undertaking and a life-changing decision with no guarantee of success. If you accept that fact going in, the risk could be worth the reward.

So, to help you make a more informed decision, we've highlighted eight things to look out for when evaluating franchise opportunities.

#1 Franchise Viability

A business model that thrives under any condition is something you want for long-term growth and dependability. You should also consider the industry and the type of franchise you want to buy as well. Yet, many factors determine a franchise's viability.

Does the franchisor offer products or services that meet the demands of consumers?

Clock Next to Money Symbolizing How Investing in a Sustainable Business Equals Long-Term Growth
Because a franchise that provides "wants" versus "needs" or one that ignores market trends may have difficulty generating revenues if the economy isn't doing so well or there's a lack of consumer demand.

A franchise that has stood the test of time and is still thriving is a good indicator of its viability. Likewise, franchises selling a product or service to a broad customer base that can bring repeat business is much more sustainable than those selling products with limited one-time uses.

Roof repair, for example, is a practical franchise opportunity in the home services industry. Consumers need roof repair services year-round, regardless of the economy or other market conditions.

People Looking at Computer, Analyzing Franchise Consumer Market Charts Seeking Opportunities Providing Consumers With Needs Versus Wants
On the other hand, seasonal franchises are not viable 365-days a year; think of Spirit Halloween stores as an example. You'll need to either make enough during the selling season to sustain yourself the rest of the year or have other sources of income you can rely on.

Researching a franchise's history tells you a lot about its profitability. Has the franchise shown consistent growth through the years, or does it seem to ebb and flow with changing trends and economic conditions?

Brand recognition is also a great indicator of franchise viability. Brands that people think of immediately and trust when they want a product or service are often reliable opportunities. The catch is that those reliable big-name brand franchises aren't cheap.

The bottom line, look for franchisors that have demonstrated consistent growth over time by doing your research to find out if a franchise is successful.

#2 The Upfront and Hidden Costs of Franchising

You should know the full cost of purchasing a franchise upfront and get an idea of the projected expenses of operating the business daily. The franchise agreement should outline everything you get with the initial purchase. Evaluate if what you're getting is worth the startup costs.

Money Puzzle Missing Center Piece Revealing the Word Fees; Always Consider A Franchise's Unexpected Costs
Here are some potential costs you should review before buying a franchise.
  • Royalty fees - They are typically monthly recurring payments made by you to the franchisor. These fees grant you the right to use a franchisor's brand and its trademarked products or services. Sometimes, they help pay for marketing and the overall costs to support the franchise system.

    The average royalty fee ranges between 5%–6% of gross revenue or volume but can vary from franchise to franchise. Learn how the royalty fees are calculated and how often you pay them.

    Some franchises don't require royalty fees but find other ways to get the income to support the business model. Ask what the royalty fee specifically covers and if they help offset your costs in other areas.

  • Advertising fees – Most franchisors require you to help pay for marketing and advertising costs. These can be included in the royalty fee or paid separately. You may also want to do local advertising to reach more customers in your area. Just know that the franchisor won't be responsible for these costs and will have to approve any marketing collateral or initiative you plan on running.

    "How much are advertising fees, how are they paid, and how often?" are a few questions to ask, but it doesn't hurt to dive deeper into them.

  • Product and service vendors – For many franchises, there are obvious products you need to use specifically. McDonald's, for instance, requires you to buy their food products. But what about the products and services that aren't as obvious but are needed to run the business? Examples include cleaning supplies, printer ink, paper, and administrative software to manage business operations and finances, etc.

    Some franchisors make additional money from franchisees by requiring them to purchase, rent, or use products and/or services from third-party vendors or suppliers. While these costs are expected, you won't be able to look for better prices if you want to shop around. You'll be tied to the vendors' and suppliers' prices designated by the franchisor. If you aren't paying royalty fees, this may be one way a franchisor brings in the money to help support the franchise system.

  • Adequate staff – The costs associated with maintaining and training adequate staff are expected. According to the U.S Bureau of Labor Statistics, salaries and wages accounted for between 60%–70% of employer costs as of June 2022.

    If you're not hiring independent contractors, you can expect to add employee benefits to these costs, along with any specialized training needed. Also included in these costs are insurance, retirement plans, paid leave, required payroll taxes for W-2 employees, etc.

  • Working capital – Some franchisors require you to have a set amount of working capital on hand as a condition for purchasing the franchise. Even a franchise advertised as turnkey will need money to keep it running until it becomes profitable. The Small Business Administration (SBA) recommends you have enough to cover business and living expenses for 1-2 years. This is the average time it takes to know if you're profiting or not.

  • Legal and accounting fees – We mentioned having a lawyer to guide you through the process of buying a franchise, reviewing the documents involved, etc. However, you'll need an accountant or CPA to set up how the franchise's expenses are broken down and set up a system to organize the finances of the business.

    You should set some money (at least $5,000+) to help pay for the expenses of hiring both a franchise lawyer and an accountant.

#3 Franchise Restrictions

Many people are attracted to the idea of owning a franchise because they want to have more control over their financial futures and enjoy being "the boss." Owning a franchise does allow you to run your own business, but it doesn't mean you have complete control over how it operates.

Most franchisors require you to adhere to a minimal set of guidelines to ensure the brand's integrity. Being aware of those restrictions before signing a franchise agreement can save you from regret down the line.

Non-Compete Document on Table With Glasses and Pen; These Clauses May Limit Future Business Expansion Plans
  • Non-compete clause – Some franchise agreements include a non-compete clause, which prevents you from opening another business that the franchisor considers competitive.

    For example, if you already own a house-cleaning franchise. Let's say you decide to expand into the pool cleaning business. A non-compete clause might prevent you from opening that business because it's a similar venture that involves cleaning products and services. This could stop you from expanding into any type of "competing" business determined by the franchisor, even if they don't offer the exact service/product directly but indirectly.

    It's good to know if there is a non-compete clause and how the franchisor defines what a competing business is. Find out your options if you feel you're being unfairly restricted from opening up another franchise.

#4 Location Approval

The franchisor typically has a say in location approval. Before you sign a franchise agreement, be sure you are comfortable with the location of the franchise. There are several things to think about before making that decision.
  • Protected territories – Ever seen a Subway on one block and then another just a few hundred blocks away from it?

    Subway is haunted by a fundamental flaw of cannibalizing its franchisees' sales. Having too many of the same franchises near one another creates competition among owners. Look for an opportunity that offers "protected territories."

  • This means the franchisor won't open another franchise within a specified number of miles of your location. A good rule of thumb is to always check to see how close the nearest franchise is.
    Business Labeled Store on a Map Surrounded by Location Pins; Typically Franchisors Have Final Location Approval

  • Property leasing and license fees – You'll be responsible for property leasing and all business licensing for your franchise. In many cases, the franchisor has already contracted the property, and the commercial landlord will lease it to you.

    The costs of renting the space for your future franchise should make sense to you and the franchisor. A good franchisor would work with you on negotiating the rent with the landlord of your franchise location. The costs of rent should reflect what other businesses pay for renting/owning commercial real estate property.

  • Location statistics – Where you're located has an impact on the success of your business. It wouldn't make sense to pay a premium price in rent for your franchise to exist in a mall if your target market doesn't intend to shop for what you're offering; think about your ideal customer and where they are more likely to shop. If your profit margin doesn't justify your rent, then you're in the wrong location.

    Here are some questions to ask yourself: Is the location rural or urban, is there a demand for your product in the area, and are there businesses nearby that can help or hinder success? You want your franchise near companies where you see the most foot traffic. Study where your nearby competitors are on a map and evaluate how far your future franchise location will be from them.

    Find out about traffic, crime statistics, and how accessible your business is from nearby roads or main streets. Take a day to talk to other store owners to survey how active business is in the area. Is business consistent, are there highs and lows throughout the week, and which times of the day are the busiest in a certain location?

    These are a few questions to ask, but a starting point to learning more about where your future location and how conducive it is to running a successful business.

#5 Guaranteed Claims of Success

At the end of the day, franchisors want to sell you a franchise. One of the ways they do this is by telling you how much money you could potentially make.

Sometimes they show you examples of the best-case scenarios from a select group of franchisees who are doing well under ideal circumstances. While the franchisor isn't being dishonest, they aren't giving you the full picture.

You can't determine how successful you'll be with your franchise before you start operating, and neither can the franchisor. Many factors determine the profitability of a business, some of which we've already talked about.

The most important thing to do is research every opportunity and obtain a Franchise Disclosure Document (FDD). This gives you what you need to know about the franchise you want to buy, including financials and other important information.

Person With Magnifying Glass Examining Franchise Disclosure Document Carefully Looking at Items 7, 9, and 20
The Federal Trade Commission states: "…you must receive the document at least 14 days before you are asked to sign any contract or pay any money to the franchisor or an affiliate of the franchisor. You have the right to ask for — and get — a copy of the FDD once the franchisor has received your application and agreed to consider it…"

There are 22 disclosure items in an FDD. The SBA recommends you pay attention to three of them in particular:
  1. Estimated Initial Investment

  2. Franchisee Obligations

  3. Outlets and Franchisee Information

The third point is important because it gives you what you need to contact other franchisees. Asking others about their experiences can reveal a lot about the franchise you're considering. You'll typically get truthful answers and transparent real-world advice without the sales pitch.

In addition to speaking with other franchise owners, look for concerning behavior on the part of the franchisor. These behaviors include high-pressure sales tactics, refusing to provide the required documentation (or stalling), and evading questions.

Your franchise representative should answer all questions clearly and concisely. They should also be able to justify every fee associated with your franchise purchase.

#6 Renewal Terms

You might assume buying a franchise means you own it for life, but most franchisors require you to renew your franchise agreement after a specified term. The length of the term varies from one franchise to the next.

Hands Holding Clock Saying Time To Renew; Always Review Franchise Agreement's Renewal Terms Before Signing
Ask if there are additional fees when renewing your franchise, how long the renewal term is, and if there are any factors that could prevent renewal. Also ask if you can choose not to renew without penalty.

#7 Franchise Termination

A franchisor has the right to terminate the franchise agreement for many reasons. This can be anything from failure to pay royalty fees to engaging in behavior that the franchisor feels could potentially damage the brand's reputation and value.

Franchise Agreement Stamped Terminated With Pen and Stamper on It; Review What the Grounds Are for Termination
Ask about specific grounds for franchise termination; you never know if the franchisor could fail its franchisees but will inject legal clauses in the franchise agreement to protect themselves (e.g., Subway).

"Do you have any recourse if your franchise agreement is terminated without cause, and do you lose your investment?" these are some of the many questions you'd want to ask.

Because you never want to face yourself in a situation where a franchisor sets you up to fail. For example, military veterans and others filed a lawsuit with the FTC, suing the Burgerim food franchise over false promises and misleading documents, which sold franchisees the "dream of success."

#8 Franchisor/Franchisee Relationship

The relationship between the franchisor and franchisee plays a big role in your success. Some factors that can affect your ability of owning a franchise include how the franchisor treats its franchisees.

Two People Sitting Together Discussing Strategy; Seek Franchisors Treating You Like a Partner, Not a Number
As a franchise owner, you want to feel as if you are a partner, not just an employee. Also, does the franchisor engage in, or support, outside activities that don't align with your beliefs? It isn't necessarily a dealbreaker if they do, but it could cause issues that make your working relationship difficult.

Ask other franchise owners how their relationship is with the franchisor. Some questions include: "Do they listen to comments and suggestions, are they as invested in your success as you are, and how open are the lines of communication between both parties?

Bonus Round: Training and Support

Knowledge of the business you're about to embark on is necessary for a foundation that will help you make it work. Franchise training should be in-depth enough to give you all that you need to operate your business.

A good franchisor will give you well-rounded training like you've been in the business for years, even if you're new to the industry that franchise is in.

"What does the initial training entail? Is additional training available, and how much does it cost?" are great questions. Most franchisors provide initial training and support with the startup costs, then offer additional training for a fee.

Workshop Meeting With People Gathered At Table; Ensure the Franchise Opportunity Provides Adequate Training and Support
Additional training can be optional, but it can be a great way for new franchisees to expand their knowledge and sharpen their skills.

This is just a snapshot of everything you'll need to do to evaluate the franchise opportunity and behind-the-scenes research before investing.

They say if you want a tattoo, think about it for a year. Buying a franchise isn't the same as getting ink on your skin, but it's permanent in some ways.

And just like getting tattoos removed, wanting out of a franchise early on, has its financial "pains" or repercussions—but it can be a regrettable experience if it didn't pan out the way you expected it to be.

But if you've seriously considered owning a franchise for quite some time, there's one place we know where you can find an opportunity.

Are You Ready for a Franchise?

Are you ready to own a franchise business you could rely on? Buying a franchise is a great place to start once you do your research. Don't be afraid to ask questions. The more you know, the better prepared you'll be, and the more likely you'll find one that fits your needs.

All USA Franchises gives you access to tons of franchise opportunities, helpful blog articles, and advice that can help you find a franchise that works for you.

Start your franchise search today!

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