What is a franchise?
Franchising is a business agreement and distribution method that is based on a central franchisor licensing its brand, business model and any associated proprietary information to multiple other business owners, known as franchisees. The franchisees pay a startup fee and an ongoing portion of their business revenue to you, the franchisor who first came up with the idea, branding, imagery, design, products and sales model of the business. Franchisees benefit from having support from the franchisor and using an already-proven business model, while franchisors benefit from having others distribute their products and spread brand awareness in new markets.
Benefits of starting your own franchise
Starting a franchise comes with many business opportunities that can elevate your company’s success and provide you with supplemental income. Some people start their company with the intent of franchising after proving their concept, while others see franchising as a logical channel for growth:
Access to capital
One of the most challenging aspects of expanding a business is gathering the necessary capital to invest in the company’s growth. Opening a new storefront comes with a range of costs that you may not be prepared to pay on your own. When you enter into a franchise agreement with a franchisee, they are generally responsible for providing their startup funds or securing financing themselves. You enjoy the benefits of growing your company without having to worry about financing the large startup costs. In finance, this is known as using “OPM” or “other people’s money” to fuel your business success.
Because franchisees pay franchise fees to you and front their own startup fees, you have a significantly reduced financial responsibility than if you decided to open additional store locations by yourself. If a franchise location succeeds, you can benefit from their high profits. But if a franchise location is unsuccessful and fails to make money, you won’t be liable for losses. Most of the risks involved in being a franchisee are related to preserving your brand and ensuring that franchise locations meet your quality expectations, allowing you to focus on the big picture of your brand instead of worrying about financials.
When franchisees sign up to license your business model, they make a significant investment between franchise fees, merchandise, location and advertising. Although they are selling your products and ideas, they are the ones who are financially liable for their business success. As owner-managers, each individual franchisee is highly motivated for turning their location into a success. They are likely to commit long-term to the franchise because of their financial investment, spending time building a strong team and managing operations to improve quality and efficiency.
Passive revenue streams
While managing all of your franchisees does take some effort, your status as a franchisor means that you have the opportunity to earn passive income through fees and franchisee contributions that you can then reinvest into your company. As your franchise grows, you’ll have diverse sources of revenue from multiple owner-managers, so even if one location is unsuccessful you will still have a stream of royalties.
If you have a great idea, it’s only a matter of time before competitors start appearing and fighting for market share. Small businesses may struggle to grow large enough to defend their customer base on their own. Operating as a franchise allows your business to grow quickly across many different markets, spreading brand awareness and gaining market share with a minimal investment.
As a franchisor, your growth potential has very few limits. You can grow into new geographical markets without having to do research and seek out new markets yourself. You may be able to spread internationally and create support networks for your franchisees that enables them to expand and run multiple locations in their city. As long as you can sell your business as a successful investment opportunity to interested franchisors, you can keep opening new locations.
Economy of scale
By ordering inventory and other supplies in bulk, you can get a significant discount compared to buying small amounts of goods. If you have a large network of franchisees distributing your inventory, you can join forces to purchase in bulk and benefit from economy of scale without actually having to sell every piece of inventory yourself. As the number of franchisees increases, you can continue to grow your savings by producing larger quantities of product or equipment.
Ultimately, being a franchisor involves delegating business operations to other owner-managers who supervise the business activities at their location. Highly-motivated managers can hire staff, coordinate orders and market their location with very limited guidance. After you develop the initial orientation and support tools for your franchise, you can benefit from well-managed locations without actually having to supervise employees.
How to know if you’re ready to franchise your business
Although running a franchise is a great way for some businesses to expand and generate more profit, not all businesses are optimal for franchising. Starting a successful franchise operation requires you to carefully plan out your business model, standardize operations, manage legal agreements and create a compelling pitch for potential owner-managers. Before you commit to turning your business into a franchise opportunity, determine your chances of success by asking yourself a few key questions:
1. Are you profitable?
Before you can start asking others to expand your business, you should first ensure that your business plan works. People like the franchise business model because it allows them to start a business using a proven concept. If your business isn’t financially successful, you will not have the credibility to attract potential franchisees. You should be able to provide data that indicates consumer interest in the business and the ability to create a consistent and sustainable income stream for the franchisee.
2. Do you have a brand?
One of the hallmarks of a successful franchise is strong branding and customer recognition. People are likely to be more interested in signing a franchise agreement if they know that they will be selling branded products that consumers are already familiar with. Strong branding through packaging, signage, social advertising and a compelling mission statement can be extremely helpful in selling franchise locations and driving business to new locations.
3. Can your business be replicated?
Think about what makes your business special and determine whether or not you can reproduce your success at another location. If your business relies on your unique talents and dedication to thrive or only succeeds in a highly niche market, it may not be ideal as a franchise. An ideal franchise should be simple, teachable and appeal to customers in a range of markets. If you feel confident that you could teach another person your business model and generate success, you may be ready to start designing a franchise model.
4. Do you enjoy strategizing?
Even though franchising requires less hands-on work, successful franchisors still invest their time into creating a strong business plan, training their team of owner-operators, providing a return for franchisees and developing strategies for growth and development. You’ll need to generate leads for franchise sales, create training and support infrastructure and maintain relationships with franchisees to ensure that you can both continue to enjoy profits from your company’s business model and products.
What are the legal requirements to become a franchisor?
Before embarking on your franchising business, you should register your trademarks and patents to protect your franchise’s brand. This helps ensure you have the right to license the various parts of your business. You should also establish your franchising business a new legal entity by filing as an LLC or a corporation.
Because you are representing a business opportunity to a third party, the government has laws in place to ensure franchisees aren’t being taken advantage of. The federal government has a franchise law enforced by the Federal Trade Commission, and many states also have their own franchising rules. These laws set minimum expectations for the information franchisors have to provide to franchisees through a report known as the franchise disclosure document, or FDD.
Carefully review federal franchise law to determine the content and formatting of your FDD. Many businesses work with a franchise lawyer to prevent violations and protect themselves from lawsuits. The federal franchise rules requires the FDD to cover 23 subjects related to the terms of a franchise sale:
- Corporate information
- Management and business qualifications
- Litigation history
- Startup fees
- Additional fees
- Estimated startup investment
- Sourcing products and services
- Summary of franchisee legal obligations
- Financing details
- Support from franchisor and advertising requirements
- Other proprietary information
- Management obligations of franchisees
- Restrictions on offering products and services
- Renewal, termination and transfer
- Celebrity or influencer contracts
- Financial performance
- Current franchise outlets
- Financial reporting obligations
- Copies of contracts and agreements
- Receipt of FDD
Some states require franchisors to register their FDD before selling any franchises. Most franchise disclosure laws require the franchisor to provide the FDD at least two weeks before the franchisee signs the agreement, allowing them enough time to review and understand all of the information.
How to choose a pricing model
Fees are the way you make money as a franchisor. Your pricing model determines how much money franchisees will pay you initially and how much they need to pay to continue operating. Franchisors need to create a pricing model that balances profit with value for franchisees. If your franchising company charges too many fees, it may prevent franchisees from being successful and dissuade them from signing up or renewing their contract.
The two main parts of a franchise pricing model are the initial franchise fee, which can range from $20,000 to $50,000, and the ongoing royalty fee which generally ranges from 4% to 12% of the profit. Some franchisors choose to charge a flat monthly rate instead of a percentage. Other fees you might charge include:
- Area development fees
- Site location fees
- Software and equipment setup
- Promotional costs
- Initial inventory charge
- Relocation fee
- Administration fees
- Additional training fees
- Customer support service
- Payment processing fees
Tips for attracting franchisees
To have a successful franchise, you need to recruit competent owner-operators who are willing to invest in your business model to start their business. Just like franchisees research franchisors, you should vet applicants and consider their ability to contribute to your success and follow brand guidelines. Use these tips to seek out quality franchisees:
Optimize your website
Create a page on your website dedicated to explaining franchising opportunities at your company. Be clear about what you have the offer as a franchisor and what kind of experience you expect from applicants. Provide an easy-to-use contact form so that interested potential buyers can reach out to you directly.
Target key locations
Use location-based online and print ads to find potential franchisors that are local to areas you have already scouted. Direct advertising spreads local awareness of your brand and generates interest in the business opportunities you have to provide.
Engage your current franchisees
Your current franchisees are a valuable networking resource for informing others of the benefits of franchising. Provide incentives for current franchise owners to serve as brand ambassadors online or at industry events. Current franchisees attesting to positive company culture and lucrative business plan can be a convincing tool for attracting new leads.
Related: A guide to running a successful fitness franchise
Terms of a franchise agreement
The franchise agreement is the legal document that confirms the sale and purchase of a franchise outlet. The franchise agreement specifically outlines how a franchisee can use your proprietary information and what they owe in return. The franchise agreement includes operational guidelines that the franchisee must legally follow including training and site maintenance. It also specifies the length of the contract and when it goes into effect.
How to support your franchisees
If you want your franchise business to grow on a large scale, you should be involved in the development of new outlets. Like any business, your franchise’s policies and procedures will likely adapt over time to respond to changes in market trends. There are several ways to offer strategic support to each of your franchisees:
A common provision in a franchise agreement is that the franchisor will help the franchis ee select a location and secure real estate or a leasing agreement for their new outlet. Some franchisors assist in site development or assign territories to their franchisees based on market research.
Build confidence with face-time
If possible, meet with your franchisees face-to-face in their location to give them customized advice on making sales and running an efficient outlet. You can also consider hiring staff to help onboard new franchisees if you want to offer additional support beyond the initial orientation.
Once your franchising business is large enough, consider providing in-house financing for expanding current outlets or starting new ones. Offering low-interest loans to trustworthy franchisees can be mutually beneficial for both you and the franchisees.
Provide a developed operating manual
Your operating manual is one of the main things you have to offer in exchange for the franchise fee. It outlines all of the best practices associated with running a successful outlet and includes extensive business advice. Developing a detailed operating manual gives every franchisee a valuable resource that they can reference when managing the day-to-day procedures of the business.
Encourage professional development
After any initial training, give your franchisees opportunities for professional development to help them enhance their business skills and overcome challenges. Provide ongoing trainings whenever you debut a new product or update company branding to ensure your franchisees have the support they need to keep up with company-wide changes and adjust company workflows.
Put your franchisees in touch with one another to create a network of owner-managers that can provide support for one another and share business strategies. You can create a sense of community by celebrating successes as a group and encouraging group input on how to improve the franchise as a collective and work towards shared success.
Market your brand
Investing in marketing and advertising can grow sales across all of your company’s franchise outlets, increasing your royalties while contributing to your franchisee’s financial success. Developing brand awareness through video advertising, SEO optimization and your social media presence can build trust among your customer base and make them feel more comfortable purchasing from any of your franchise’s outlets.