The lowdown on franchising

"Think about it more as renting an apartment than as buying a home."

USA Today
April 12, 2002

The lowdown on franchising

What do McDonald's, Singer Sewing Machine, and Minnie Pearl have in common? They're all important names in the history of franchising.

The concept of franchising – allowing other businesses to use a company's name and products – developed over two centuries ago. In the 1840's, German brewers gave franchises to taverns allowing them to sell their beer. During the Civil War, Singer introduced franchising to the United States, by franchising the right to sell their sewing machines.

If you're a first-time entrepreneur, franchising seems attractive. As a franchisee, you're getting an established brand name, the marketing muscle of the parent company, a proven business plan, training, yet you're still self-employed.

In turn, the franchisor is able to expand the company rapidly by working with eager entrepreneurs who make the capital investment for new locations and put in the sweat equity.

But it's more complicated than that.

Franchising companies have spent years building a name brand and improving their business methods. They, rightfully, want to protect the quality of their outlets and ensure consistent products, services and standards. Some of the steps they take to achieve those goals are fair; others severely limit your rights and increase your costs.

"What other trillion-dollar industry do you know that is not regulated?" says Susan Kezios, President of the American Franchisee Association, an organization representing franchisees.

Few laws protect franchisees. The Federal Trade Commission requires franchisors to disclose the terms of the franchising arrangement through a Uniform Franchise Offering Circular (UFOC). But that doesn't cover business practices. Only 12 states have laws dealing with franchises (the Minnie Pearl chicken chain prompted the first of those).

Because federal and state laws are so limited, the protection you have is your contract with the franchisor. These are complicated documents. Be certain to get a franchise attorney – not just a general business attorney – to review and negotiate your contract. As Kezios advises, "In real estate, the three most important things are location, location, location. In franchising, the three most important things are the contract, the contract, the contract."

Here are a few things to watch for:

  • Fees: In addition to the upfront cost of a franchise, you will pay royalties, marketing fees, and other fees.
  • Protected territory: You can work hard to build a successful franchise only to have another one open across the street. Some companies keep the right to sell franchises or open company stores in your territory.
  • Supplies: Many franchisors require you to buy supplies from them or their approved suppliers.
  • Financing: Getting financing from the franchisor may seem attractive, but make certain you look at comparable terms and rates.
  • Non-compete provisions: Many companies prohibit you from starting the same type of business once the franchise term ends. California prohibits non-compete provisions.

Franchise proponents will tell you success rates for franchises are much higher than for independent businesses. But a study conducted for the Small Business Administration in 1996 on failure rates of small franchises concluded that independent small businesses (non-franchises) had a higher chance of survival and "much higher" average profit than franchises.

Before you enter into any franchise agreement:

  • Interview a lot of franchisees; don't just speak to those the franchisor recommends.
  • Talk to franchisees about their complaints. Make a particular effort to talk to unhappy franchise operators.
  • Try to talk to former franchisees. What made them decide to leave? How were they treated once they left?
  • Look for companies that have good relations with an independent association of their franchisees. This shows they work with – not against – their dealers.
  • Go to work for a franchise before you pay for one. See how it works from the inside.

Finally, understand what you're getting when you enter into a franchise arrangement. In many cases, when the term of the contract is through, you do not own anything – even the right to continue the agreement on the same or similar terms, or to go into the same kind of business on your own.

As Kezios advises, "Think about it more as renting an apartment than as buying a home."


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Risks: Susan Kezios, American Franchisee Association, AFA, Lawsuits, Encroachment (too many outlets in area), Corporate stores competing with franchisees, Must buy only through franchisor (tied buying), Non-compete restrictions, Survivability (franchisee and franchisor), Franchisee association, independent, Non-compete restrictions not enforced in California, Independent businesses survive longer than franchised ones, Independent businesses much higher profit than franchised ones, Renting a business, Current franchisees can’t talk freely, Encroachment (too many outlets in area), Renting a business, Canada, 20000412 The lowdown

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