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How to Start a Franchise and Avoid Common Pitfalls

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There are basically two ways to start a business:

  1. You can think up an idea, create a brand, and build everything from the ground up
  2. You can find an existing brand and buy into it

The second one is a franchise.

If you’re interested in running a business, but would rather outsource a good deal of the startup planning, starting a franchise might be a great option for you.

Today, we’ll look at the fundamentals of starting a franchise, some of the benefits for both parties involved, and some of the pitfalls to be on the lookout for.

How to start a franchise: A high-level overview

As with most things, the high-level overview of starting a franchise is deceptively simple. Here are the four basic steps from the budding business owner’s end:

  1. Research. Examine all the franchise opportunities that fit your requirements for upfront capital, industry, effort, and market.
  2. Sign up. Pay some money, sign some forms, and probably pay some more money. Also, probably sign some more forms.
  3. Take over the business. This can either be from the ground up or as an acquisition from a previous franchise owner.
  4. Make a profit.

Each step is obviously more complex than that, but it’s a simple process to wrap your head around.

What is a franchise?

Let’s talk fundamentals for a moment.

A franchise is simply a business that has purchased or been granted license to use another person’s intellectual—and sometimes physical—property.

Panera Bread is a fine example of how this typically works. Panera has developed recipes, marketing material, and other devices that support its network of restaurants.

However, building a new restaurant isn’t a simple process. Just on the logistical side of the things, you have to hire contractors to find a physical location, build a building, find suppliers for fresh produce, contact local markets for advertising, and hire people. And all of that requires time and money.

Alternatively, Panera offers franchise operators a trade: You pay Panera Bread a fee and it allows you to use the name “Panera Bread.” It also gives you help in building a store, finding all those contacts, and getting up and running.

You’ll continue to pay fees to Panera, but you’ll run and own the store. You are now a franchise operator and small business owner. Congrats!

Why would anyone want to open a franchise?

Paying someone else to run their business may seem like a raw deal, but this isn’t a scam.

Note: Sometimes it is a scam. There’s a range in quality for potential franchises. Do your research to ensure you end up with a winner.

Starting a new business is one of the most dangerous things you can do financially. You’re like a baby mouse in the woods. Naked, hungry, and unlikely to generate a profit in your first year. Joining up with a franchise can minimize some of that risk.

They can’t all be winners (Source: Wikimedia Commons)

A franchise is basically a risk management engine. You’re buying into a tested system with support from a larger, more powerful company. In doing so, you decrease the chance that you’ll be saddled with a bad business.

For example, take a second to think about the difference between you opening a sandwich store—let’s call it Mark’s House of Cubans—versus you opening a Panera Bread. People already know Panera’s brand and, for the best-known brands, they may already be clamoring for a location near them.

The risk you take

In exchange for the decrease in startup risk, however, you take on some long-term risk. The viability of your business depends on factors outside of your control. Companies fall out of favor, and not every corporate manager is a winner.

In 2001, Schlotzsky’s Deli had over 750 locations. Today, there are just over 350 stores. Management changes, brand concerns, and poor operational systems can set you back, even if it seems like you, personally, are doing everything right.

How do I find the right franchise?

If you’re looking for a long list to narrow down, Fortune’s 500 Top Franchise List is a nice place to start. The options I’ve already talked about are all restaurants, but that’s just because I’m hungry. There are franchise opportunities in pet care, real estate, and just about every industry—maybe not banking.

There’s more than just picking an industry when it comes to starting a franchise, though. While you need to be happy with the business, there are lots of other bits you need to get lined up. We’re covering three of the big ones here.

1. Experience and financial requirements for franchising

Apart from those fees you’ll pay upfront, many franchise businesses have requirements for their investors. Looking back at Panera, the resume and asset requirements include:

  • Experience as a multi-unit restaurant operator
  • Recognition as a top restaurant operator
  • Net worth of $7.5 million
  • Liquid assets of $3 million
  • Infrastructure and resources to meet the development schedule
  • Real estate experience in the market to be developed

That’s right, if you’re not sitting on $3 million in liquid assets, Panera isn’t interested. Even if you have the cash, you’re not getting in the door without experience in the restaurant industry. In short, this is not a good option for the first time small business owner.

If you are looking for first time franchises, you can check out FranchiseHelp’s list of good franchises for younger folks.

2. Financial and brand value of the business

Brands vary wildly in value. If you’re hoping to run this business for a long time, you need a parent company that’s going to be in business for a long time.

If you look back at Fortune’s list, you’ll see some great brands near the top; McDonald’s, Dunkin’ Donuts, UPS, and ACE Hardware all make the top 10. Conversely, brands such as Quizno’s and RadioShack have fallen on hard times.

Finding a business that’s going to last requires a lot of work. You’re investing time, energy, and your good name into this brand, so you need to make sure it’s going to last. Dig into financial statements, talk to current and former franchise owners, visit multiple locations, and ask every pertinent question you can think up.

Even with all that work, you still might stumble into a dying industry. RadioShack and Blockbuster were at the top of their games—until they weren’t.

3. Finding a fit for your local market

Most franchise corporations will do the research to figure out where they want stores opened up. Schlotzsky’s, for instance, provides a map of the U.S., with the areas it wants to move into in green.

Sorry, New Mexico (Source: Schlotzsky’s)

That state-level research is a good starting point, but you need to do your own homework. Maybe you’re thinking of opening an ACE Hardware and the company has indicated that it would like one in your town. But what does the local competition look like? You need to consider the following questions:

  • What kind of growth is Neighborhood A seeing compared to Neighborhood B?
  • Where exactly would the store go?
  • Would you have enough people to staff the place?
  • Is there a similar business that recently went under, or one that’s growing now, potentially generating stiff competition?

All of these are questions you’ll need to address before you choose a franchise to work with. Some options are naturally going to be a better fit for your area than others.

Contracts, terms, and franchise commitments

After you find the perfect fit, it’s time to sit down with your new business partners and make everything official. At this point, almost everyone recommends hiring a franchise accountant and a franchise attorney. There are lots of niche knowledge areas here, and having someone on your side who’s familiar with the process can really help.

At this point in the process, you’ll also be settling things such as how much area you’re allowed to expand into, what your ongoing fees will look like, and how you can sell or retire from your new franchise. These franchise startup terms will determine a lot about the future of your business, so pay very close attention.

You’ll pay also a franchise fee to get everything rolling. This is the initial fee that says, “I’m buying the rights to use your name.”

This won’t get you a roof over your head or a marketing campaign, it just covers the brand.

After you pay your fee and sign some paperwork—once you’ve reviewed all of it with your attorney— you’ll start the opening process. Depending on which brand you’ve signed up with, this can include location scouting, more market research, or just jumping into the permitting and construction process.

These costs are often underestimated, which can mean you’re on the back foot before you even open the doors. Again, working with experienced professionals can help you avoid common building, permitting, and hiring pitfalls.

If you’ve gotten through the paperwork, fees, negotiation, and startup (don’t forget the franchise management software!), congratulations—you’re a franchise owner.

Common franchise pitfalls

We’ve touched on a few of the problems potential owners might face, but here are four you should be on the lookout for.

  1. Optimistic financial planning. “Prepare for the worst; hope for the best” should be your motto. Opening a franchise is a costly experience and, like all building or business costs, it’s prone to overrun. Make sure you build in time and money buffers wherever you can.
  2. Thinking you run the show. While you’ll end up being a small business owner, you’ll also have a boss. They might not tell you when you can take vacation, but they’ll guide your displays, menu items, opening hours, and even discounting programs. Looked at from another angle, this is exactly the reason franchises are good things: There’s a system imposed on them.
  3. Settling for less than you want. The range of brands offering franchise opportunities does mean there’s room for scams and for boneheaded management. The better franchises are harder to get into, because they’re in demand. Don’t settle for a system you don’t feel comfortable with just because it’s what you can afford. Save up, hold out, and land the brand you love.
  4. Forgetting the future of your business. Some brands, such as Panera, require you to open multiple locations over a period of time, but not all do. Make sure you think about how you’re going to grow your business, and how your neighbors are going to grow theirs. Spots where territories border each other can cause tension between franchise owners, so figure out where those spots are ahead of time.

Building the next American classic

If you plan well, work with good people, and sign with a good brand, building a franchise can be an incredibly rewarding experience. America is full of great brands with great franchising opportunities.

While you should never settle, that doesn’t mean you can’t get in on the ground floor. If you do your financial research, talk to owners, and survey the market, you can find young brands with lots of potential.

If you’ve had experience with building a franchise, I’d love to hear from you. Drop a line in the comments below about your experiences. Good luck.

For more tips on getting started, check out:

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About the Author

Andrew Marder

Andrew Marder is an analyst at CEB. His background is in retail management, banking, and financial writing. When he’s not working, Andrew enjoys spending time with his son and playing board games of all stripes.


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