5 Important Considerations for Aspiring Franchise Investors

e Whether getting your daily jolt of java, picking up something quick for lunch on the go, or hitting the gym, odds are you’ve probably done business with a franchise at some point this week. The space has exploded in recent years. Reports suggest that trend will continue, with the market size surging from more than $11 billion in 2021 to over $175 billion in 2027.

No, that’s not a typo. 

Owning a franchise appeals to many entrepreneurs. It often 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 franchisee. The franchisee pays for the rights to provide a service or good to the public using the name, branding, and business structure designed by the franchisor.

Not all franchising opportunities operate the same way. Broadly speaking, four types of franchises are out there:

• Business franchise – The most popular kind of franchising opportunity, this arrangement involves the franchisor providing the franchisee with everything they need to succeed. It may include an operational framework, marketing collateral and guidelines, and ongoing training. The most popular franchised businesses include restaurants, fast food, retail, fitness, and business service.
• Product distribution franchise – the franchiser supplies the franchisee or distributor with product, possibly services related to the product, and licenses the franchise to use the franchiser’s trademark. It does not, however, provide a business framework for selling the product. Examples could 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. If you want to work by-and-for yourself, a job franchise might be a good fit. Job franchise opportunities range from home cleaning and pet walking services to work in the trades requiring some level of certification.
• Conversion franchise – These businesses are built by attempting to convert independently owned businesses to a specific franchise model. Like a traditional business franchise, 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 them 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

The costs of owning and operating a franchise are not small. This is especially true when considering the capital required to invest. Upfront costs range from $10,000 on the low end to six figures on the high end. That does not include real estate or ongoing fees. 

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

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.

#2 – Failure Rate Risks

Entrepreneurs often assume that investing in a franchise is a safer proposition than striking out on their own. After all, franchises come with proven business models and brand recognition. Reports claiming franchises have a much lower failure rate than independently owned companies often bolster these beliefs. A 1987 report from the International Franchise Association (IFA) boasted that 90% of franchises were still in business after five years.

This is not necessarily true. Subsequent research has shown that independently owned and franchised businesses fail at roughly the same rate, and even the IFA has urged their members to stop using the outdated figures. The broad market data may also deviate significantly from brand to brand.

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 prior to 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 associated with the specific franchise they’re considering.

#3 – Limits on Independent Action

In a perfect word, entrepreneurs of every stripe operate their businesses in a consistent, optimized fashion. It is not only the best way to ensure delivery of high-quality services and products but shores up customer satisfaction rates and loyalty.

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

Franchisees, on the other hand, are constrained by the standards prescribed in their licensing agreements. There may includtight limits on how a logo is displayed, what items are put 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

A common mistake aspiring entrepreneurs make is assuming that their prior experience in business has sufficiently prepared them for the work involved in running a franchise. While experience and knowledge of the moving pieces that make a business run are helpful, that may not be enough.

Without diminishing the accomplishments of small entrepreneurs, it is fair to say that an independent operation involving a couple of partners or an owner with a handful of employees can differ dramatically from running a franchise. Failure to understand those distinctions and prepare accordingly may compromise a franchisee’s success.

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 common draws is the idea that you won’t be subject to someone else’s demands. You can set your own 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 at the very beginning. 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 so far has you feeling uneasy investing in a franchise, that’s not necessarily a bad thing. That means you’re aware of the risk on the table 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 seemingly countless stories of entrepreneurial success in this arena, and the numbers can be staggering. 

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

At the end of the day, 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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This is an updated version of an article originally published in December 2017. ©2023. DailyDACTM, LLC d/b/a/ Financial PoiseTM. This article is subject to the disclaimers found here.