5 Important Considerations for Aspiring Franchise Investors

Whether it’s getting your daily jolt of java, picking up a quick bite, or hitting the gym, you’ve likely done business with a franchise recently. The space has exploded in recent years. Reports suggest the trend will continue, with the market size surging from just over $100 billion in 2021 to nearly $280 billion in 2032.

No, that’s not a typo.

Owning a franchise appeals to many entrepreneurs. It allows you to be your own boss under the banner of an established brand, providing a balance of independence and structured support.

That doesn’t mean owning a franchise is an easy endeavor. Weighing the risks and benefits of investing in one can help determine if it’s right for you.

How Franchise Structures Differ

A franchise may be generally understood as a business arrangement between a franchisor and a franchisee. The franchisee pays for the rights to offer a service to the public using the franchisor’s name, branding, and business structure.

Not all franchising opportunities operate the same way. Four types of franchises are out there:

• Business Franchise: This is the most popular type of franchise. The franchisor provides the franchisee with everything they need to succeed. It may include an operational framework, marketing collateral and guidelines, and ongoing training. Common examples include restaurants, fast food, retail, fitness, and business services.
• Product Distribution Franchise: In this type of franchise, the franchisor supplies the franchisee or distributor with products and possibly related services. They also license the franchise to use the franchisor’s trademark. However, they do not provide a business framework for selling the product. Examples include Pepsi-branded soda in a vending machine or a car dealership.
• Job Franchise: This type of franchise is often a home-based operation run by a franchisee looking to work solo with minimal entry costs. A job franchise might be a good fit if you want to work for yourself. Opportunities range from home cleaning and pet walking services to trade work.
• Conversion Franchise: These businesses retrofit independently owned businesses to a specific franchise model. Franchisors provide basic operational and marketing guidelines and support. The franchisees, in turn, get paid per conversion. Target companies are usually service providers, ranging from hair salons to medical practices.
• Investment Franchise: These larger franchises require a large amount of capital upfront. The category includes businesses such as hotels or fine-dining restaurants. For the average investor, the cost of starting and operating an investment franchise makes it out of reach.

Regardless of the type of franchise you’re considering, investing in one comes with pros and cons. Whether or not the opportunity is right for you requires consideration of multiple variables.

#1 – The Cost of Investing in a Franchise

Though an understanding of the numbers behind your business is critical to the success of any entrepreneurial venture, it is even more important for a franchisee. Failure to account for upfront and ongoing expenses may kill your investment before it has a chance to get off the ground.

The costs of owning and operating a franchise are not meager. Upfront costs range from $10,000 on the low end to six figures on the high end. However that does not include real estate or ongoing fees.

The recommended available capital prior to investment may be much higher. For instance, a KFC franchise requires a net worth of $1.5 million whereas McDonald’s and Taco Bell franchises expect $750,000 in liquid assets. For many investors, these numbers serve as significant barriers to entry.

#2 – Failure Rate Risks

Entrepreneurs often think investing in a franchise is safer than starting their own business. Franchises come with proven business models and brand recognition. Reports even claim they have a significantly lower failure rate than independent companies. A 1987 report from the International Franchise Association (IFA) stated that 90% of franchises were still operating after five years.

However, owning a franchise has its own risks. Later research showed that independent and franchised businesses fail at roughly the same rate. Even the IFA urged members to stop using the outdated figures.

It’s essential to understand that franchises, like any other investment, come with substantial risks. In the US, the FTC requires franchisors to provide a full disclosure document 30 days before purchase so the risks and benefits of the investment can be adequately assessed. Failure to do so means the agreement becomes unenforceable.

That rule, however, does not govern the publication of content promoting franchise investments. Unfortunately, that has only helped disseminate inaccurate and misleading information. Before investing, aspiring franchisees should look hard at the data. Is the franchise they’re considering the right fit for them?

#3 – Limits on Independent Action

In a perfect world, entrepreneurs operate their businesses consistently and optimally. This ensures the delivery of high-quality services and products, boosting customer satisfaction and loyalty.

Being an independent business owner may be challenging, but it also grants flexibility. You’re your boss, and you own the brand. You can go the extra mile for a customer, even if it requires you to stretch outside your operational standards. You can do so if you have to pivot to ensure high performance.

On the other hand, franchisees are constrained by the standards prescribed in their licensing agreements. These may include tight limits on how a logo is displayed, what items are on a menu, and where trademarked language may be used. This makes pivots based on local or regional trends more difficult. Depending on how strict the franchisor’s requirements are, it can also hinder your ability to stay customer-centric.

#4 – Operational Complexity

Understanding your business finances is crucial for any entrepreneur, but it’s even more vital for a franchisee. If you overlook upfront and ongoing expenses, your investment could fail before it even begins.

Running an independent operation with a few partners or employees is very different from managing a franchise. If you don’t understand these differences or prepare accordingly, it can compromise your success as a franchisee.

This is especially true of entrepreneurial hobbyists. Just because something you enjoy has generated income for you in the past does not mean you are prepared to operate within the structure of a franchise. The logistical, legal, and financial expectations are far more complex and less flexible.

#5 – Time Commitment Requirements

Being your own boss appeals to entrepreneurs for many reasons, but one of the most obvious draws is that you won’t be subject to someone else’s demands. You can set your schedule, work the way you want, and (ideally) get to a point where the business almost runs itself.

Experienced entrepreneurs know this isn’t always true, especially initially. Starting a new business is hard work, and as the top dog in your company, the buck stops with you. Someone calls off? It’s up to you to get coverage, even if it means rolling up your sleeves and doing it yourself. Profitability slipping? You’re the one in charge of identifying and addressing the problem. Cash flow issues? That’s your challenge and responsibility.

A well-managed business may eventually reach the point where the owner’s required time commitment isn’t as high. That doesn’t happen overnight, though. Potential franchisees should keep that in mind before getting stars in their eyes.

It’s Not All Downside!

If the discussion has made you feel uneasy about investing in a franchise, that’s not necessarily bad. It means you’re aware of the risk and will be better able to make the right choice for you and your goals.

Though the risks may be substantial, there is also significant upside potential. After all, the franchising business model remains popular for a reason. There are countless stories of entrepreneurial success in this arena, and the numbers are staggering.

Though it varies from brand to brand, a successful franchise location can generate over $1 million in annual revenue. The financial payout can be astronomical when an investor can scale their operations to multiple locations. You might be surprised how many well-known celebrities have made hefty (and successful!) franchise investments, from Super Bowl champ Patrick Mahomes to notorious rapper Rick Ross.

Franchise investments can be attractive if complex opportunities for well-capitalized and experienced entrepreneurs. We strongly recommend doing your homework before pulling the trigger on investing, but the owners of the more than 750,000 franchise locations in the U.S. alone can’t all be wrong.

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[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can listen to at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Understanding Risk Management Basics for Business Owners
2. Turning an Idea or Product Into a Business
3. Legal Issues for Innovators & Inventors

This is an updated version of an article originally published in December 2017 and updated on February 20, 2023.]

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