FAQs

A franchise (or franchising) is a method of distributing products or services involving a franchisor, who establishes the brand’s trademark or trade name and a business system, and a franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor’s name and system. Technically, the contract binding the two parties is the “franchise,” but that term more commonly refers to the actual business that the franchisee operates. The practice of creating and distributing the brand and franchise system is most often referred to as franchising.

There are two different types of franchising relationships. Business Format Franchising is the type most identifiable. In a business format franchise, the franchisor provides to the franchisee not just its trade name, products and services, but an entire system for operating the business. The franchisee generally receives site selection and development support, operating manuals, training, brand standards, quality control, a marketing strategy and business advisory support from the franchisor. While less identified with franchising, traditional or product distribution franchising is larger in total sales than business format franchising. Examples of traditional or product distribution franchising can be found in the bottling, gasoline, automotive and other manufacturing industries.

A franchisor is a business or corporation that licenses the right to operate in its name and sell its products or services using the franchise’s branding, assets, and intellectual property. The advantage to becoming a franchisor is that franchising allows a business to expand its locations and size more quickly and more successfully by relying on franchisees to use their local market knowledge to grow the business.

A franchisee licenses the right to do business under a franchisor’s brand using the franchisor’s operational processes. Franchisees receive access to the franchisor’s proprietary knowledge, systems and support, while being held responsible for maintaining the same brand and quality standards as the franchisor. The advantage to becoming a franchisee is that the costs of opening a franchise are often lower compared to starting a company from the ground up, and the franchisee inherits the proven, established business model and brand as opposed to starting a new one.

In exchange for a franchise, the franchisee usually pays the franchisor an initial start-up fee and annual royalty fees or licensing fees depending on the language in the franchise agreement in order to use the franchisor’s proprietary business knowledge, intellectual property, processes, and branding, allowing the franchisee to sell a product or service with the franchisor’s business name.

The FTC Franchise Rule is a federal regulation which requires franchisors to prepare an extensive disclosure document and give a copy of this document to any prospective franchise purchaser. The disclosure document typically used to comply with the Rule is called a Franchise Disclosure Document (FDD), which replaced the prior Uniform Franchise Offering Circular, or UFOC, in 2008.

The Franchise Disclosure Document contains categories of information about the franchise’s operations such as required fees, basic investment, bankruptcy and litigation history of the company, how long the franchise will be in effect, a financial statement of the franchisor, and earnings claims.

To learn more, the International Franchise Association has provided a helpful guide to understanding the most important items in a franchisor disclosure document.

The best franchises are those with proven franchise business models and strong support systems that provide high-quality products or services that stand out from competitors. You can learn about the details of a franchise by researching its process to become a franchisee, reading its franchise agreement, speaking to current franchisees, and examining a franchise’s performance data in order to make an informed franchise business decision.

Franchising your business can not only strengthen your company’s brand recognition and reach, but it can also help secure its future. Franchising provides franchise business owners with an established product or service, which may already enjoy widespread brand-name recognition. Below are some helpful articles and presentations to get started!

Elements of Successful Franchising
Expanding a Business by Franchising
Multi-Unit Franchising: The Key to Rapid System Growth

Like starting any business, buying a franchise involves risk. Although most franchisees are satisfied and successful, some do suffer financial losses. That’s why you must be particularly wary of any company that “guarantees” profit or certain success. If you hear a claim about a company that sounds too good to be true, it probably is. Investigation of all earnings claims made by a franchisor is especially important. Regardless of earnings claims, you must recognize that your success can come only through hard work. Success or failure ultimately depends on you.

To help mitigate the risks of buying a franchise, studies show that successful franchisees:

• conduct their own marketing research
• use their own financial and legal advisors
• develop thorough marketing and business plans
• have prior work experience in the industry

Be sure to ask these questions before purchasing a franchise.

The sooner the better. It is usually a good idea to start figuring out how you will be funding your business venture as early in the process as you can. Some funding options take time and you don’t want to miss out on an opportunity. One of the most important aspects of opening a franchise is funding. Funding options come in all shapes and sizes. Based on your timeline, risk tolerance, credit history, and more, the best option for you might be a single solution, or a combination of several options.

Franchise Funding 101

Brought to you by Benetrends Financial – A Strategic Funding Partner of the IFA

One of the most important aspects of opening a franchise is funding. But just as franchises come in all shapes and sizes, so do the options for funding them. Based on your timeline, risk tolerance, credit history, and more, the best option for you might be a single solution, or a combination of several options.

Intro to Funding

• Using your Retirement Funds to Buy a Franchise (also called Rollover as Business Startups, ROBS, or 401(k)/IRA Rollover Funding): This method allows you to use your 401(k), IRA, 403(b), or other qualified retirement account to buy a franchise – with no penalties, upfront taxes, or debt. It can also be used as the capital injection required for SBA loans.
• SBA Loans (Small Business Administration): There are a variety of loan programs available through the SBA including specific ones for veterans, disaster recovery, etc. The primary one for small business owners is the 7(a) program, which is more generally focused on helping small businesses start and grow.
• ​Conventional Loans: Conventional loans can be provided by bank and non-bank lenders, but are not guaranteed by the SBA or other government entity. Any small business or franchise can apply; however, they are not typically available for new businesses. Approval depends largely on the overall credit risk of the business.
• Securities Backed Line of Credit: A line of credit backed by securities held in an investment portfolio. This type of loan is similar in concept to a home equity loan, but rather than the loan being backed by the equity in your home, it is backed by the securities held in your investment portfolio.
• Home Equity Loans: Although becoming less common, some entrepreneurs still rely on their biggest asset for cash – the equity in their homes – to finance a franchise or business purchase.
• Equipment Leasing:  Finance up to 100% of the value of equipment you need to start or run a business including: computers, office furniture, company vehicles, machines or special service equipment. This option may include a buyout for $1 at the end of the lease.

Funding Strategies

• FIRST-TIME FRANCHISE OWNER: Taking into account the franchise fee, royalty fees, working capital and other possible costs needed to start a franchise business, most potential franchisees find they don’t have the cash resources to purchase a franchise upfront. If you find yourself in this position as well, don’t be surprised if you run into a few financing challenges. Many lenders are typically more hesitant to approve loans if you don’t have experience or a solid track record as a business owner. Having said that, it’s not impossible, and luck favors those who are prepared.
• MULTI-UNIT OPERATORS: The most important thing to know if you want to become a multi-unit operator is that how your first unit is funded affects your ability to fund future units. So, if you are arranging financing for the first unit without considering how it is going to affect your ability to get additional financing, you may find yourself without any options to fund additional units. Since many larger franchises require a 3-unit commitment, the most common scenario is a “three-pack” over a 2-3 year window.

Among the points IFA recommends for investigation are:

• The type of experience required in the franchised business.
• The hours and personal commitment necessary to run the business.
• The track record of the franchisor, and the business experience of its officers and directors.
• How other franchisees in the same system are doing.
• How much it will cost to get into the franchise.
• How much you’re going to pay for the continuing right to operate the business.
• If there are any products or services you must buy from the franchisor and how and by whom they are supplied.
• The terms and conditions under which the franchise relationship can be terminated or renewed, and how many franchisees have left the system during the past few years.
• The financial condition of the franchisor and its system.

Financial statements represent the financial track record of your franchise and tell you how well positioned your franchisor will be for the future. They are provided for you in the Franchise Disclosure Document (FDD) and contain important information about the franchisor’s financial status and strength.

The two most important franchisor financial statements franchisees need to review are the Balance Sheet and Income Statement.

The Balance Sheet

A balance sheet is a snapshot summary of how much a company is worth on any given day. It reports the financial condition (solvency) of the franchisor.

Balance sheet categories include:

• Assets – what a company owns: current, fixed, and intangible assets.
• Liabilities – what a company owes: current and long-term debt.
• Stockholders’ equity – the company’s net worth; it is the money the company has taken in from the sale of stock plus any accumulated profits:

Stockholder’s Equity = Assets – Liabilities = Net Worth

Things you want to see on a franchisor’s balance sheet:

• Increasing assets
• Increasing stockholders’ equity
• More cash than debt
• Amount of current debt < (less than) 1/2 of the total assets
• Amount of current debt < 1/3 of the stockholders’ equity

The Income Statement

An income statement reports a company’s profit or loss. It shows a company’s income, expense and net income – also known as the “bottom line” or earnings.

Other names for an income statement include:

• Profit and loss statements
• Statement of income
• Statement of operation
• Statement of earnings
• Results of operations
• Statement of consolidated income

Income statement categories include:

• Revenues
• Costs and expenses: cost of sales, selling, general administrative, interest expenses
• Income before taxes
• Provision before taxes
• Net income (earnings)
• Net income (earnings) per share

Things you want to see on a franchisor’s statement:

• increasing profit
• more revenue derived from royalties and system income than from selling franchises
• increasing revenue trends, usually > 15%
• increasing net income trends, usually > 15%
• a profitable franchisor!

What you should know about these financial statements:

• The financial statements should be audited financial statements.
• The statements should contain three years of financial data (unless the franchisor has less than 3 years of operating history).
• You should take these to an accountant experienced in franchising for evaluation.

Before purchasing a franchise, we recommend carefully considering the items in the eight categories below that will be critical to your success:

COSTS

• How much money will this franchise cost before it becomes profitable?
• Can I afford to buy this franchise?
• Can I make enough money to make the investment worth my time and energy?

DEMAND

• Is there enough demand in your area for the franchisor’s products or services?
• Is the demand year-long or seasonal?
• Will the demand grow in the future?
• Does the product or service generate repeat business?

BRAND NAME

• How well known is the franchise name?
• Does it have a reputation for quality?
• Have any consumers filed complaints with the local Better Business Bureau?

EXPERIENCE

•  Has the franchisor been in business long enough to have established the type of business strength you are seeking?

YOUR ABILITIES

• Do you have the technical skills or experience to manage the franchise?
• Do you have the business skills to manage the franchise?

COMPETITION

• How much competition do you have, including other franchisees?
• Are the competing companies/franchises well established?
• Do they offer the same products and services at the same or lower prices?

Is there a specialty or niche you can capture?

TRAINING AND SUPPORT

• What kind and how much training and support does the franchisor provide?
• Do existing franchisees find this level of training and support adequate?

EXPANSION PLANS

• Is the franchisor planning to grow at a rate that is sustainable?

Franchise royalty fees are recurring fees paid by the franchisee to the franchisor in order to continue using the business name, branding, and more. Royalty fees might be paid regularly or by revenue, depending on the guidelines set in the franchise agreement.