There are two types of franchising: product or trade-name franchising and business-format franchising.
Product and trade-name franchises designate a territory for the sale of the product. The licensee pays for the privilege of representing a nationally recognized product, such as Coca-Cola or Lay’s Potato Chips.
Business-format franchises are more complex. This type of franchise is what most people envision when they think of a franchise. Basically, the franchisee must do business according to the format set forth by the franchisor. The franchisor decides how the business is run, as well as the signage, uniforms, pricing, and location. This type of franchise offers very little chance for originality, as the franchisor does not want the franchisee to present a different face to the public, which may cause confusion and loss of business. Examples include McDonald’s and Century 21 Realty.
Common characteristics of business format franchises include:
- Identity based on trade-name.
- Operating system or business format ready to be transferred to franchisees.
- A continuous financial relationship, usually a lump sum paid in advance, then ongoing royalties based on a percentage of gross revenue.
Risks and Rewards
First the risks. Franchising is not for everyone. Before you start a franchise make sure you’re willing to be part of a very disciplined system. You have to be comfortable with someone else dictating the hours you operate, what you sell, how you train your staff and in some cases, what you wear. Also, make sure you can handle long hours of hands-on labor.
Before you enter into a franchise agreement, do your homework and get a good lawyer and a trusted financial advisor.
According to a study by the Woodrow Wilson International Center for Scholars, the risk of early failure of new franchisees exceeds the failure rate of independent businesses. Before entering into a franchise agreement, you should be aware that franchisees generally have lower earnings than non-franchise businesses, due to franchise fees and royalties. In addition, franchisees are often required to buy supplies from the franchisor, and in some cases, the prices are higher than what you could pay on the open market. Market saturation also presents a problem for many franchisees.
Now the rewards. The franchisor offers a business plan, a concept with a proven track record and a management support system. They also have set the credibility for your business and a recognizable product or service. In addition, the franchisor offers you the value of their business, which include training, marketing and advertising.
When to Avoid Starting a Franchise
Many of the risks in franchising present their potential before you sign a franchise agreement. Here’s a list of red flags that may indicate considerable risk and little reward.
- Franchisors who tell you that you don’t need a lawyer or financial advisor to look at the franchise disclosure document.
- Franchisors who don’t give you the disclosure document at your first meeting.
- Franchisors who pressure you to sign before the 10 day waiting period.
- Franchisors who have thin management or a marginally successful prototype store.
- Franchisors who make verbal projections about how much you can earn but do not put any projections in writing.
- Franchisors who have no operations manual, or either a very short or very long training manual. (A long one could mean it is too difficult to train employees.)
- If you just don’t feel right about it. Trust your instincts.