What Factors Should You Consider When Comparing Franchise Opportunities?

Buying a franchise is a complex and long-term investment; and, if you are like most first-time franchise buyers, it will be one of the biggest investments of your life. As a result, the decisions you make during the buying process are extremely important. And this starts with deciding which franchise opportunity you want to pursue.

There are lots of options. According to Franchising.com, there are more than 3,000 franchisors operating in the United States currently, and, “an average of 300 new brands start franchising each year.” Of course, not all of these options will be relevant to you. In fact, once you decide what type of franchise you want to own, you start looking into geographical availability, and you start getting a feel for which franchised brands resonate with you and which ones don’t — you may quickly find yourself trying to decide between just two or three franchise systems.

But, while narrowing down your options from 3,000-plus is easy, narrowing down your options from two or three to the final one is a different task altogether. All franchise systems are not alike; and, while franchisees are independent business owners, their success also depends heavily on their franchisors in a variety of different ways.

From the fees franchisors collect to how much they spend on advertising and how vigorously they protect their brands, many of the business decisions franchisors make have a direct impact on their franchisees’ businesses as well. As a result, if you don’t make an informed decision, you could very well find yourself struggling to make it as a franchisee.

With all of this in mind, when buying a franchise, how do you make an informed decision about which franchise opportunity to pursue? Here are seven factors to consider when you have narrowed down your options to two (or perhaps three to five) franchise opportunities:

1. Initial investment

The initial investment is the total amount of money you will need to establish your franchise and open for business. Initial investments vary widely between types of franchises. While opening a fitness center or restaurant could easily require an initial investment of a quarter-million dollars or more, you may be able to start a mobile franchise for somewhere in the range of $30,000 to $40,000.

How to compare initial investments

In order to compare initial investments, you can review Item 7 of each franchisor’s Franchise Disclosure Document (FDD). Depending on the franchises you are seeking to compare, you may also be able to find initial investment information online. When comparing franchisors’ Item 7 disclosures, there are a number of factors you will want to keep in mind, including:

• Franchisors’ Item 7 figures are estimates only, and you will need to independently assess your costs to open a franchise.
• Not all franchisors include the same costs in their Item 7 disclosures. When comparing initial investments, make note of line items that only appear in one franchisor’s FDD.
• A significant portion of the Item 7 initial investment estimate is the “Additional Funds” line item. This is an amount that is intended to cover your expenses during the opening phase before your franchise becomes profitable. You will need to read the footnotes to the Item 7 table in order to determine what period this line item covers.

2. Royalties and marketing fees

Once you open for business, you will need to pay royalty and marketing fees to your franchisor on an ongoing basis. Most franchisors calculate their royalties and marketing fees as a percentage of gross revenue and require franchisees to pay on a monthly basis. However, there are some exceptions, and you will need to carefully review Item 6 of the FDD in order to determine the ongoing fees associated with each franchise opportunity you are considering.

While there are some loose standards for royalties and marketing fees, franchisors are free to charge whatever they believe their franchisees will be willing to pay. Some franchisors charge minimum fees as well, which means that you must pay a certain dollar amount regardless of your franchise’s revenue for the month. In addition, some franchisors require their franchisees to pay “lost future royalties,” which means that if your franchise goes under, you must still pay what you would have owed had your franchise been successful.

3. Territory rights

Most franchises come with some sort of territory. What it means to be granted a territory as a franchisee depends on the specific terms of the franchise agreement. Some franchisors offer “exclusive” territories within which no other franchisees are permitted to sell their goods or services (although franchisors generally reserve the right to sell in their franchisees’ territories from company-owned locations). Others, however, simply restrict the geographic area in which franchisees can spend their marketing dollars.

In order to determine what type of territory a franchisor offers, you can review Item 12 of the FDD. However, it will be important to review the relevant terms of the franchise agreement as well, as the franchisor’s Item 12 summary may not fully describe the restrictions that apply to franchisees’ territorial rights.

4. Initial term and renewals

When you buy a franchise, your rights are not unlimited in duration. Your franchise agreement will specify an initial term, and it will provide a list of conditions that you will need to satisfy in order to renew your franchise agreement when the initial term expires.

As a franchisee, what you do not want to do is work on building your business for two or three years and just start to earn a decent living only to have your franchisor refuse to renew your franchise agreement.  At this point, you might not have even earned back your initial investment. As a result, it is generally better to have a longer initial term rather than a shorter one, although you also need to avoid locking yourself into a long-term agreement with no way of getting out if your franchise simply isn’t profitable.

5. Operational restrictions and support

When you buy a franchise, what are you paying for? In most cases, you are paying for two things: (i) the right to use the franchisor’s trademarks; and, (ii) the right to use the franchisor’s business system and receive operational support as a franchisee. If you need support and you can’t get it, you are not going to be satisfied, and you are going to wish that you had chosen a different franchise.

Another factor to consider is the extent to which each franchisor restricts its franchisees’ operations. You can get a sense of this by reviewing Items 8 and 11 of the FDD, and also by speaking to current and former franchisees of each system. While you want to know that your franchisor will offer and enforce system-wide standards in order to establish uniformity and foster customer loyalty, you also need to make sure that you will have the flexibility you need to run a successful business.

6. System size and growth

While bigger isn’t necessarily better in franchising, there is certainly something to be said for a franchisor being able to build and manage a nationwide system with hundreds of franchisees who are (mostly) able to stay in business for multiple years. At the same time, there can be advantages to joining a fledgling franchise system as well—as long as the franchisor has the personnel and financial resources needed in order to grow the system effectively.

When comparing franchise opportunities, it is a good idea to spend a decent amount of time reviewing Item 20 of each franchisor’s FDD. Item 20 contains multiple tables (with footnotes) that describe franchisee signings, openings, closings, and terminations. Item 20 must also contain a state-by-state list of projected openings, and you can speak with each franchisor’s representative to find out if they are on track to meet or exceed their projections.

7. Post-termination covenants

In addition to the possibility of facing liability for “lost future royalties” as discussed above, as a prospective franchisee, it is important to be aware of any other post-termination covenants in your franchise agreement as well. These can vary widely from one franchise system to the next, so you will want to carefully review the termination provisions of the franchise agreement for each franchise opportunity you are considering.

Non-competition and non-solicitation covenants are both fairly standard, although some franchisors attempt to impose restrictions that are far more stringent than others. You can also expect to have to stop using the franchisor’s system and trademarks promptly, although you may be able to find some short-term leeway here as well.

Do your due diligence

This list is by no means exhaustive; and, before choosing a franchise and signing a franchise agreement, it is critical to conduct thorough due diligence and reach a sound decision that is based on your personal belief in your ability to succeed. Make sure that you develop a business plan to help you navigate your decision and ensure that your franchise choice can be succesful.