Author: Nathan McKown, Senior Director, Commercial Banking
When it comes to starting a business, owning a franchise has some definite benefits for new entrepreneurs. However, purchasing and operating a franchise isn’t right for everyone.
Before you take the leap, make sure you fully understand the pros and cons of franchise ownership and what becoming a franchisee will entail.
Before considering a franchise investment, it’s important to understand the underlying business model. By purchasing a franchise from a franchisor (which is a company that sells or grants a franchise), owners are granted an exclusive license to the proprietary business knowledge, processes and trademarks of the organization.
Often included in this investment are business processes that have been vetted for efficiency and cost effectiveness. Franchisees are also given access to the franchisor’s brand and trademarks. Given that approximately 20% of new businesses will fail within the first two years of opening, starting with a well-recognized name and operating structure can provide new business owners with a more solid footing for success.
Despite the benefits, investing in a franchise comes with some stipulations as well. For one thing, a franchisee may only sell the products or services related to that brand. For example, if you buy a franchised burger restaurant, you are not allowed to sell hot dogs unless the product is specifically created and sanctioned by the franchisor.
You may also be required to adhere to company pricing, as well as mandates on where and when you can spend money and even the furniture you use.
When evaluating a franchise opportunity, it’s important to understand the restrictions and to consider how these may impact your ability to do business in a particular location. For example, local zoning regulations may prohibit some elements of outdoor branding required by the franchisor, including signage and building style. Issues like these will need to be fully vetted with the franchisor before taking ownership.
That’s why it is important to understand the level of support you will receive from the franchisor. Generally, larger and more mature franchise concepts are recognized for providing higher levels of support, including but not limited to site selection and employee training, as well as help in making day-to-day business decisions to better manage cash flow and navigate challenges. Smaller, less mature franchisors may not yet have developed the extensive internal infrastructure necessary to participate as fully in your operation.
Deciding to open a franchise requires serious consideration of several factors. The first is the issue of control. If you want to determine the products you sell or even the colors you use in your branding, owning a franchise is not for you.
Since the franchise you purchase will determine your offering, it’s also important to believe in the product or service being offered, as well as the business model, as these are two primary things you won’t be able to change.
When considering a franchise purchase, it’s also important to understand the associated costs. Most commonly, you’ll pay an up-front fee for licensing of controlled rights or trademarks. However, you’ll also be required to pay royalties as a percentage of sales and may also be asked to fund other mandatory costs, such as employee training or even remarketing or rebranding costs.
Remarketing can take many forms and can be costly. For example, in the hotel world, these are referred to as property improvement plans and can hold the franchisee responsible for everything from mechanical upgrades to major exterior and interior renovations. Understanding the frequency and costs of such requirements is an important step in evaluating the franchise opportunity and budgeting accordingly.
When it comes to gaining funding for your new franchise, the process is more complex than financing a business you start from scratch since there is a third party involved, so it may take longer for your financial institution to review your loan application.
There may be legal agreements that will need to be put in place to finance a franchise with the bank. For example, you can’t just sell a branded franchise to another business owner without consent of the franchisor, so the lender will need to make sure the appropriate agreements are in place within the financing deal.
While these factors may add up to longer turnaround times when securing financing for a new business venture, they are not deal breakers, and your financial institution likely has experience with this type of transaction. The best way to get started is by speaking with your commercial banker who can help guide you to the right resources and facilitate your loan transaction.
Are you looking to finance a new franchise? Contact our team to learn how we can help.
About the Author
Nathan believes that trust is the foundation of any good relationship. He enjoys building trusting relationships with his clients and providing a variety of Corporate and Industrial Lending solutions.
The articles in this blog are for informational purposes only and not intended to provide specific advice or recommendations. When making decisions about your financial situation, consult a financial professional for advice. Articles are not regularly updated, and information may become outdated.