Small business ownership is on the rise.
The financing company Guidant surveyed small business owners across America in 2023 to identify the latest trends in small business ownership.
One of the key findings was that franchise ownership is growing, highlighting the increasing responsibilities and considerations for becoming a franchise business owner.
Out of the surveyed respondents, a whopping 46% were franchise owners.
If you are one of the many wondering how to buy a franchise, we’ve built a short roadmap for you to get started.
Why start your own business?
Entrepreneurship can be a very fulfilling endeavor. It gives you independence, a sense of ownership, and the ability to make your own way.
There are many paths and motivations for owning a business. You may be passionate about a certain product or industry, or simply crave more independence in your professional life.
Whatever your reasons, starting your own business opens the doors to countless experiences and opportunities.
There are some drawbacks, however.
Being your own boss means you are responsible for everything. Overhead starts to compound, supply chains get backed up, employees become unreliable — you can start drowning when you try to do it all.
A more structured and less risky approach to small business ownership is franchise investments. Buying a franchise means the burdens are not all on you. There is support, help, and an infrastructure to help you succeed.
What is a franchise?
According to the International Franchise Association, a franchise is “…a method of distributing products or services involving a franchisor, who establishes the brand’s trademark or trade name and a business system, and a franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor’s name and system.”
The franchise business model enables investors or franchisees to operate a business by providing a system developed by the franchisor, which includes the right to use the franchisor’s name, and support and assistance from the franchisor.
The most popular form of franchising is Business Format Franchising. Under this format, the franchisor provides the franchisee with an infrastructure and operating plan that includes:
- Trade name
- Products
- Services
- Site Selection
- Business development
- Brand standards
- Marketing plans
- Operational support
Buying into a franchise is much different than starting your own business from the ground up. The benefits of buying a franchise are support from the parent company and instant brand recognition.
However, owning a franchise does limit you in some ways. You will be accountable to the parent company’s way of branding and operating and will be responsible for certain fees involved in owning the franchise. This includes royalty fees that are a certain percentage of your overall sales.
How to buy a franchise
If you feel ready to take on the challenges of buying a franchise business, here’s how to get started.
Understanding the franchise agreement and the overall process of becoming a franchise owner is crucial.
Research good franchises to own
This step is crucial to your success. You may think that a franchise with strong brand recognition automatically means it is profitable, but that is not necessarily the case.
Do your due diligence on this step and evaluate the following criteria.
Local market – consider how big your local market is and how many businesses in your target industry already exist. Some competition is okay, but you don’t want to buy into a saturated market.
Franchisor relationship with franchisees – dive into research on how the franchise you are considering treats its franchisees. Do they have a reputation of being helpful and fair?
Sales records – in the research stage, you want to see demonstrable proof of solid sales in the franchise you are considering.
Growth potential – choose a franchise in a market that is growing, especially in your area. Evaluate the number of franchise locations as an indicator of growth potential.
Franchise fees – every franchise will have fees, but be sure to research how hefty they are and what you get in exchange. It should be a fair trade with good support for marketing, hiring, and training.
Apply to buy your franchise
Once you’ve researched how to buy a franchise and chosen the one you’d like, the next step is to apply.
The application process is where the franchiser screens you, just as you evaluated them before applying.
The specific required paperwork and documentation will vary from one franchise to another, but all will want to see:
- Your financial history and current standing
- Your education and work history
- Reason for buying the franchise
- Your knowledge of the franchise
- Where you are planning to open the franchise
Meet with the parent company
Typically corporations hold what is called a “discovery day” with potential franchisees. This is a one-on-one meeting in which you can meet with a spokesperson for the corporation and ask any questions you may have before committing to buying the franchise. It is also important to meet with the current franchise owner to gather more information about the operation, understand their perspective on running the franchise, learn about the challenges they’ve faced, and determine why they’re selling it.
Glean as much information as you can from this meeting, including tours of the franchise and specifics about how the business model operates.
Review and sign your franchise agreement
After you’ve applied to buy your franchise, you will be given a Franchise Disclosure Document (FDD). Understanding franchise law is crucial at this stage, and seeking legal counsel can help you navigate the complexities of the agreement.
Once signed, the FDD is a binding document that outlines your fees, obligations, and agreement.
Now is the time to enlist professional help. A lawyer and an accountant will help you understand the nuances of the agreement and the full cost of the purchase.
Don’t be shy about asking questions at this stage. If you need any clarification or adjustments, express them. Especially if there are any discrepancies between verbal agreements made in person and what the contract is reflecting.
How much do franchise fees cost?
If you want to buy in a franchise, how much it costs is probably the first question you have.
Let’s break it down.
- Franchise fee: This is the initial cost you pay to the franchisor to use their brand and business model.
- Operating costs: These include ongoing expenses such as rent, utilities, and salaries. Additionally, the investment required for a franchise location includes costs like leasehold improvements, equipment, and initial inventory.
- Royalty fees: These are ongoing payments to the franchisor, usually a percentage of your revenue.
- Marketing fees: Contributions to the franchisor’s marketing fund, which helps promote the brand nationally.
Franchise costs
Here are the fees you can expect from buying a franchise.
Franchise fee – this is the fee you pay to get in the door, your upfront capital. The initial franchise fee varies widely between franchises. It can be as little as a couple thousand to many millions. This directory allows you to search franchises by cost.
Royalty fees – these fees are a percentage of your sales that you owe to the corporate owners of the franchise you bought. The percentage that will be charged for royalties also varies widely between franchises. According to the U.S. Small Business Administration (SBA), you can expect your royalty fees to range from 4%-12%.
Operating costs – operating costs include real estate, equipment, payroll, inventory, utilities, marketing, and anything else it takes to keep the business running. Some franchise agreements help with equipment, inventory, training, and marketing costs, and some don’t. This is why you want to read your FDD very carefully with your lawyer to understand what you are liable for.
Professional consultation – having a lawyer and accountant on your business team is essential for protecting your interests when buying a franchise, but the cost of retaining their services needs to be factored into your budget.
How to finance buying a franchise
If you don’t have the liquid capital to buy a franchise outright, there are several financing options available to you.
Proper financial planning is crucial for running a successful franchise, as it involves managing high upfront costs, ongoing fees, and ensuring adequate funds for initial and ongoing training.
SBA Loans
SBA (Small Business Administration) loans are popular for franchise owners because they are specifically designed to help small businesses launch.
Small business loans typically require lower down payments and have longer repayment terms and smaller interest rates than traditional loans, making it easier to get started with your franchise.
The most common and flexible SBA loan program is the SBA 7(a) loan. Those who qualify can secure up to $5 million for 10 years (for operating costs) and 25 years (for real estate).
The SBA 504 Loan Program is another popular choice. It is primarily used for fixed assets such as heavy equipment or real estate. You can finance up to $5.5 million on a 10, 20, or 25-year payback plan.
Business Term Loans
A Business Term Loan provides you with the entirety of the borrowed funds in one lump sum. This sum will be paid back over a set amount of time known as a “term.”
Business Term Loans are similar to SBAs, but the terms are not as flexible. For instance, the standard repayment schedule of a Business Term Loan is 5 years, whereas an SBA loan can go as long as 25 years, making the monthly payments more manageable.
Business Lines of Credit
A Business Line of Credit is different from a Business Loan in that instead of drawing one lump sum in a large amount, you draw only the money you need and only pay interest on the amount you withdraw.
A Business Line of Credit is most advantageous if:
- You need to cover cash-flow gaps
- Want a lower interest rate
- Don’t anticipate needing a large sum upfront
- Want reassurance that future purchases will be covered
- Can’t qualify for a traditional loan but still need financing
How Homebase can help you
Homebase takes the chaos out of small business operations by offering an all-in-one solution for scheduling, payroll, and time clocks.
Explore the easy-to-use interface that makes daily business run seamlessly and without hassle. Trusted by over 100,000 small businesses, Homebase makes work simple and easy.
Starting a franchise can be overwhelming, but managing your team doesn’t have to be. Let us do the heavy lifting.
Remember: This is not legal advice. If you have questions about your particular situation, please consult a lawyer, CPA, or other appropriate professional advisor or agency.
