Advantages and Disadvantages of Buying a Franchise

The Pros of Buying a Franchise

Reduced Risk

Franchising does not guarantee success, but a good franchise should help reduce the chances of failure.

A Proven System

With a tried and tested operating system, the franchisee loses the obstacles and gains the opportunities. A franchisee should receive a completely proven system that includes initial training, opening assistance, accounting systems, established suppliers, manuals and use of the trademarks. The all important "learning curve" helps prevent the franchisee from repeating previous mistakes and provides information on inventory levels, store design, competition, pricing structure and operational data drawn from the entire system.

Easier Access to Financing and Reduced Cash Requirements

Financial institutions prefer to lend to established franchised systems because of their higher success rate. The consumer awareness created by national or regional name recognition can reduce the costs of grand-opening promotional activity and advertising start-up. As well, the purchasing power of the franchisor can reduce the franchisee's initial outlay for equipment and supplies.

Purchasing Power

Collective purchasing power on products, supplies, extended health and insurance benefits, equipment and advertising can easily offset any ongoing royalties paid by the franchisee.

Site Selection Assistance

Franchisors can provide expert site selection assistance based on their operating experience and demographic knowledge. Landlords and developers prefer to deal with someone who has an established track record. This enables franchisees, as part of an established franchise system to obtain locations in major malls and other developments that otherwise would not be available to them as an independent operator.

Advertising Clout

Most independent businesses cannot afford the services of advertising and promotional experts. Consequently, their advertising is often poorly conceived and inconsistent. They also cannot afford to invest in the level of advertising required to maintain a commanding presence in the marketplace. In a franchise system, the advertising cost is spread over many units enabling the franchisor to achieve economies of scale. This also allows the franchisee to create well-conceived promotional campaigns and place the advertising in the most effective medium.

Building Equity

Because of the national or regional name recognition, and territorial exclusivity, a franchised business should sell faster and for a higher value than an independent business. A buyer is often motivated to buy the franchised business for the same reasons as the original franchisee and may perceive a higher value associated with a recognized name and system.

Stress Reduction

The ability to operate more effectively and efficiently can relieve many pressures of business. Systems that control job scheduling, cash flow and inventory levels allow the franchisee to run the business instead of the business running them.

The Cons of Buying a Franchise

Loss of Independence

The loss of independence can be viewed negatively by some franchisees. Although most franchisees invest in a franchise because they want the guidance of the franchisor, the moment they enter the franchise system they want to make changes. Unless you are capable of working within a system and can accept a certain amount of regimentation, you should think long and hard before entering into a franchise relationship. One of the greatest strengths of franchising is consistency amongst units, and with consistency must come compliance.

Franchisor's Failure to Perform

Some franchisors don't deliver what they promise for a couple of reasons. A common reason for failure is the franchisor's shortage of available capital, which can be caused by:

  1. The franchisor's unrealistic franchise sales projections;
  2. The franchisor underestimating the expenses associated with the development of the franchise system;
  3. The franchisor's failure to meet franchise sales projections, or
  4. High franchisee attrition.

Alternatively, it could be that the franchisor is just not capable of providing the support and assistance, or does not possess the ability to operate a franchise organization.

Misunderstanding the Franchise Agreement

Confusion over the interpretation of certain aspects of the franchise agreement can result in a problem with either the franchisor or the franchisee. A potential franchisee has probably never encountered a document anywhere near similar to a franchise agreement. A franchise agreement requires careful explanation and scrutiny, and failure to do so will inevitably result in a conflict that may end up in the courts.

Misrepresentation by the Franchisor

Misrepresentation by the franchisor can be intentional or unintentional. Projections of income and expense can be provided to the franchisee in good faith, but may turn out to be inappropriate for the location because of the franchisor's inexperience or unfamiliarity with the area's demographics. Conversely, the figures may be total fabrications simply to get the franchisee to sign on the dotted line and hand over the initial franchise fee.

Caveat Emptor (let the buyer beware), applies to franchising as it does to any consumer purchase or investment; however, consumers are often their own worst enemy, choosing to ignore cautionary advice and warning signals, and basing their investment decision on emotion without balancing it with logic.

Payment of Fees

The franchisee typically pays an initial fee for being granted the franchise, using the system, and receiving initial training. Typically, single-unit franchise fees are in the range of $25,000 to $35,000. The initial fee is paid only once during the term of the agreement; however, franchisors may charge a nominal renewal fee at the commencement of each new term of the agreement. The typical term for a franchise agreement is 5 or 10 years but may vary to coincide with the terms of a lease. Franchisors sometimes charge a site selection fee of $5,000 or more, in addition to the initial fee, which offsets their costs of site selection and lease negotiation.

In addition to the initial fee, some form of ongoing royalty is paid by the franchisee to the franchisor. In most instances, the royalty is based on a percentage of the Franchisee's gross sales, which vary from1% to10%, or even higher, with a median range of 3% to 6%; however, units with high sales volumes often pay 1% or 2% less.

Franchisees are also required to contribute to a national or regional advertising fund, which is in addition to any requirement that the franchisee invests a minimum amount on local advertising.