Franchises are an attractive business type for entrepreneurs. This is because entrepreneurs get to be part of an already existing brand, and use the institutional knowledge that that franchise has accumulated, to build their business. Although many of the elements of building a successful franchise business are the same as those of building an independent small business, there are some notable differences. So here’s a guide on what you need to know to start a franchise. 

What is a Franchise?

A franchise is a business that has a license from a franchisor to use some or all of its intellectual property, processes, expertise, business model, brand, and rights to sell franchisor branded products and services. The franchisee pays fees to the franchisor and agrees to work within a specified framework stated in a franchise agreement.

Any business structure can be a franchisee. The most popular business structures are sole proprietorship, C corporation, S corporation, and partnership. Limited liability companies (LLC) are permitted under state law. Each business structure carries its own tax and legal implications, so it’s important to consult with an attorney before choosing a business structure. LLCs are particularly adaptable for the needs of an entrepreneur running a small business. You can learn more about LLCs here.

What are the Main Capital Outlays for Becoming  Franchisee?

The main capital outlays of becoming a franchisee are the following:

  • License Fee: to purchase the franchise license, you will typically need between $20,000 and $50,000.
  • Minimum Liquid Assets: if you are a services business, you will ordinarily need to have between $50,000 and $60,000 in liquid assets (cash and cash equivalents), or between $75,000 and $100,000 if your business is facilities-based.
  • Royalties: You will have to pay the franchisor between 4% and 12% of your franchise’s profits.
  • Other expenses: You will also have traditional expenses such as securing a location, and wages for staff.

Check the Failure Rate

In a world where competitors are a click away, being able to differentiate your business from the rest has never been more important. Brand recognition is vital. The typical customer prefers to choose products and services from brands that they know. They just don’t have time to navigate through all the options out there. People are creatures of habit. 

Franchisees tap into human nature. Rather than trying to get a customer to try out something new, you approach customers as something familiar, a brand that they know and trust. It’s not just about brands. Startups fail at an astonishing rate: 90% fail, and just 40% ever turn a profit. Failure is due to a number of failures in business processes, such as cash flow problems (83% of startups). Franchises allow entrepreneurs to tilt the scales in their favor by leveraging the institutional memory and expertise of the franchisor. For instance, franchisors usually have an ob-boarding period where they teach their new franchisee their best practices for successfully running their franchise. By helping franchisees, the best franchisors are able to ensure a low failure rate. This isn’t a guarantee of success, but it does mean you are more likely to succeed. For instance, the top 100 franchises in America have a failure rate of under 2%

So what you want to do is check the failure rate of the franchise you are thinking of working with. This is a good indication of the quality of what you are signing up for. The lower the failure rate, the better it is for you. The franchise failure rate depends on the industry as well as the franchisor. In other words, some industries just have high failure rates because they are so tough, while others are easier to succeed in. You want it easy. This research will be part of your business plan and will help to articulate the business case, or lack therefore, of building this franchise business. 

You can see this and other details on franchises on sites such as Franchise Direct. You want to see what the typical fees are for the industry, the liquid assets required, the royalty, marketing and other fees you will have to pay, and desired monthly or yearly revenues. 

Using industry averages, you can determine whether a particular franchise has an attractive financial package. It may be worth it to pay over the industry average if you are getting a superior relationship, but you can only assess this if you look at industry trends. 

Your odds of success will increase if your location is somewhere where you won’t face a lot of competition. You want customers to be hungry for a product or service, and to have no choice but to come to you. If visiting you is just an option, then the more options there are, the less likely you are to create and keep a customer. 

Create the Skeleton of the Business

A business is, at its heart, a network of contracts. You will need to sign a franchise license agreement with the franchisee. This is a standard contract that all franchisees have to sign. This sets out the expectations of the franchisor, and each party’s rights and obligations. You will be expected to live up to the agreement, otherwise, you will lose your license. The business structure that signs the agreement is the business structure that will operate the franchise. 

In order to secure your franchise, you should already have a location because, normally, a franchise license agreement is location-specific. 

Before signing the franchise license agreement, you need to be clear as to how you are going to go from concept to profitability. Just because a franchise has a low failure rate doesn’t mean you can’t be one of the few that fail. You have to have a clear business plan that has conservative growth projections and clearly shows how you will run the company to achieve your stated goals. 

With some franchisees, you will receive help building your business plan and making it more realistic, so after signing the agreement, you will be able to refine it further to include the things you learn as part of the onboarding process. You may find that your pre-franchise ideas were unrealistic and that with consultation with the franchise, you developed more realistic goals. That’s why it’s so vital to look at the quality of onboarding that a franchisor gives.