Understanding the Pros and Cons of Franchises
By: Wilmington Trust
Many prospective entrepreneurs are faced with a crucial choice - should they start a company from scratch or invest in a proven method of doing business by opening a franchise?
A franchise is essentially an individually owned business, operated under guidelines provided by another company known as the franchiser. Tapping the resources of an established organization can significantly reduce investment risk, but at a price. Franchisees must give up a great deal of independence and follow set rules and regulations. In addition, purchasing a franchise can often cost more than starting an independent business.
- Recipe for success. The franchise formula has already been proven to
work in the marketplace. A franchise also benefits from the greater efficiency
and profitability that results from uniform coordination.
- Access to financing. Franchisers will typically help entrepreneurs get
financing for franchises. Often, the franchiser itself will be the source of
financing. If entrepreneurs seek outside financing, lenders tend to be more
receptive because franchises are less risky businesses than unproven start-ups.
- Support. Franchisers provide training programs to help entrepreneurs
learn all aspects of running a franchise. They also offer assistance in choosing
a location, negotiating leases, setting up the business, and training personnel.
- Instant name recognition. Franchisers conduct advertising, often on
a national scale, for the benefit of their franchises. A well-known name gives
a new business a jump-start. In many cases, potential customers of a franchise
already know what products and services it provides.
- Cost savings. Because large companies buy goods in large quantities,
they can pass the savings on to their franchises.
- Lack of independence. Franchisees must give up significant control of
their businesses because the franchiser has the final word on how franchises
must operate. The franchiser may dictate which products and services can be offered, which signage and advertisements can be used, and which design and appearance standards must be followed. The company may also have rules regarding hours of operation, dress codes, and bookkeeping procedures.
- High costs. Franchisees have to pay an initial franchise fee, which
may range from several thousand to several hundred thousand dollars. Other initial
costs may include equipping the space, purchasing inventory, and buying insurance. Once the business is up and running, franchisees typically have to pay a percentage of the gross monthly sales, as well as annual royalties, to the franchiser. Some franchises must also contribute to a regional and national advertising fund.
- No guarantees of renewal. A franchise contract is for a limited time,
typically 15 to 20 years. At the expiration of the franchise agreement, the
franchiser is under no obligation to offer the same terms and conditions as
the original agreement or to renew it at all. The franchiser can also break the agreement if the franchisee fails to pay royalties or operate according to standards.
Aspiring business owners should consider the many advantages and disadvantages of operating a franchise before making the initial investment. In many respects, a franchise is an appealing option that provides a strong framework for success. However, for others who long to exercise their own business judgment, a franchise might not be the right opportunity.
Updated: January 1, 2013
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
© 2013 Wilmington Trust Corporation.