Franchising

Definition: A continuing relationship in which a franchisor provides a licensed privilege to the franchisee to do business and offers assistance in organizing, training, merchandising, marketing and managing in return for a monetary consideration. Franchising is a form of business by which the owner (franchisor) of a product, service or method obtains distribution through affiliated dealers (franchisees).
If buying an existing business doesn't sound right for you but starting from scratch sounds a bit intimidating, you could be suited for franchise ownership. Just what is a franchise--and how do you know if you're cut out to be a franchisee? Essentially, a franchisee pays an initial fee and ongoing royalties to a franchisor; in return, the franchisee gains the use of a trademark, ongoing support from the franchisor, and the right to use the franchisor's system of doing business and sell its products or services.

In addition to a well-known brand name, buying a franchise offers many other advantages that aren't available to the entrepreneur starting a business from scratch. Perhaps the most significant is that you get a proven system of operation and training in how to use it. New franchisees can avoid a lot of the mistakes startup entrepreneurs typically make because the franchisor has already perfected daily operations through trial and error.

Reputable franchisors conduct market research before selling a new outlet, so you'll feel greater confidence that there's a demand for the product or service. The franchisor also provides you a clear picture of the competition and how to differentiate yourself from them.

Finally, franchisees enjoy the benefit of strength in numbers. You'll gain from economics of scale in buying materials, supplies and services, such as advertising, as well as in negotiating for locations and lease terms. By comparison, independent operators have to negotiate on their own, usually getting less favorable terms. Some suppliers won't deal with new businesses or will reject your business because your account isn't big enough.

Once you've decided a franchise is the right route for you, how do you choose the right one? With so many franchise systems to choose from, the options can be dizzying. Start by investigating various industries that interest you to find those with growth potential. Narrow the choices to a few industries you're most interested in, then analyze your geographic area to see if there's a market for that type of business. If so, contact all the franchise companies in those fields and ask them for information on their franchise opportunity. Any reputable company will be happy to send you information at no cost.

Of course, you shouldn't rely solely on these promotional materials to make your decision. You also need to do your own detective work. Start by visiting your library or going online to look up all the magazine and newspaper articles you can find about the company you're considering. Is the company depicted favorably? Does it seem to be well managed and growing?

Once you've decided on a certain franchise through your preliminary research, you need to find out if this opportunity is as good as it sounds. Your next step is to analyze it thoroughly to determine whether it's really worth buying.

Much of the information you'll need to gather in order to analyze a franchise will be acquired through the following:

  • Interviews with the franchisor
  • Interviews with existing franchisees
  • Examination of the franchise's Uniform Franchise Offering Circular (UFOC)
  • Examination of the franchise agreement
  • Examination of the franchise's audited financial statements
  • An earnings-claim statement or sample unit income (profit-and-loss) statement
  • Trade-area surveys
  • List of current franchisees
  • Newspaper or magazine articles about the franchise
  • A list of the franchisor's current assets and liabilities

Through this research, you want to find out the following:

  • If the franchisor--as well as the current franchisees--are profitable
  • How well-organized the franchise is
  • If it has national adaptability
  • Whether it has good public acceptance
  • What its unique selling proposition is
  • How good the financial controls of the business are
  • If the franchise is credible
  • What kind of exposure the franchise has received and the public's reaction to it
  • If the cash requirements are reasonable
  • What the integrity and commitment of the franchisor are
  • If the franchisor has a monitoring system
  • Which goods are proprietary and must be purchased from the franchisor
  • What the success ratio is in the industry

Don't be shy about asking for the required materials from the franchisor. After all, they'll be checking you out just as completely. If they aren't, that should sound a warning bell. Another warning sign is if the franchisor asks you to sign a disclaimer stating you haven't relied on any representations not contained in the written agreement. Such a requirement could indicate the franchisor doesn't want to be held responsible for claims made by its sales representatives.

See also "Uniform Franchise Offering Circular."

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