Buying into a franchise can be an incredible opportunity for the right kind of entrepreneur — but if you are not careful, you could fall into one of the following traps. Below are four common pitfalls and some steps you can take to avoid each one:
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- Hidden Fees: In addition to receiving a percentage of the revenue, a franchise may have additional costs, such as fees for entry, training and marketing. You should carefully review the franchise disclosure documents to make sure you understand all of the fees you will be expected to pay as a franchisee.
- Lofty Average Income and Revenue Figures: You should be careful when relying on average figures. For example, a few very successful franchisees can make average income figures misleading. Some franchisees have much better skill sets, relevant backgrounds and quality locations. In addition, earnings may vary significantly with geography. Instead, calculate the median income of the franchise owners from your geographic region. Similarly, gross sales figures may only tell part of the story. Even if the gross sales are high, if costs are also high, the actual profits could be disappointing. A better measure of profitability is net profits. Even then, be sure to ask whether the net profits include company owned locations as those often have lower costs.
- A Strict Boss: One of the advantages of having your own business is the independence you have in running it. However, some franchises have strict rules on how you run your franchise, such as the prices you charge and how you can decorate your location. An advantage to buying into a franchise is they give you a playbook that is more likely to be successful than if you start an independent business, but the playbook can include restrictions as well.
- Difficulty Leaving: It can be difficult to leave a franchise, as many franchise agreements include a non-compete provision prohibiting you from conducting similar business for a certain period of time and within a certain number of miles from your franchise location. The franchise agreement may also contain very stringent confidentiality provisions and restrictions on contacting clients of the franchise. You should ask if there is anything in the franchise agreement that would prohibit you from setting up a similar business if the franchise does not work out.
How Can You Avoid These and Other Franchise Pitfalls?
The best thing to do is to reach out to at least 10 current and former franchise owners to learn about their experience. Their contact information should be disclosed in the franchise agreement. Some good questions to ask include:
- In hindsight, would they still make the investment?
- How much management and industry experience did they have prior to opening the franchise?
- How much working capital do they recommend you keep in reserve to make sure you have enough financial cushion for the franchise location?
- Have they been subject to any litigation or bankruptcy as a result of the franchise?
- What is the unique value proposition of the franchise for the customer?
- Are there similar, successful businesses in the area?
- How long did it take them to earn a reasonable income?
- What was their total investment, including unexpected costs?
- Was the franchise training adequate?
- Has the franchisor provided adequate ongoing support?
The answers to these questions can help you develop your own best- and worst-case scenarios for entering into the franchise. Also, review franchisee message boards, such as unhappyfranchisee.com, to see complaints and positive feedback posted by other franchisees.
This article was co-written by Doug Bend and Tucker Cottingham.
Disclaimer: This article discusses general legal issues, but it does not constitute legal advice. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.
Doug Bend is the founder of Bend Law Group, PC, a law firm focused on small businesses and startups. He is also the General Counsel for Modify Industries, Inc. and tIFc LLC and a Legal Mentor in The Hub Ventures Program.
The Young Entrepreneur Council (YEC) is an invite-only organization comprised of the world's most promising young entrepreneurs. In partnership with Citi, YEC recently launched StartupCollective, a free virtual mentorship program that helps millions of entrepreneurs start and grow businesses.