Thursday, May 26, 2011

Lesson #37: The Plusses and Minuses of Franchising

In this post, we will discuss the plusses and minuses of both: (i) becoming a franchisee; and (2) becoming a franchisor, depending on your needs.

For a franchisee, franchises allow you the opportunity to start your own business, but in a way that reduces your startup risk by piggy-backing on the expertise of the franchisor.  As an example, let's say you wanted to open new fast food restaurant.  You could either design your own business from scratch (which have all kinds of startup risks), or license a franchise from an established chain like McDonald's.  With a franchise, you get the power of the McDonald's brand name and marketing expertise, plus decades of operational learnings.  All you need to do is be the investment capital behind the new store location, and manage that business going forward (with high level support from the franchisor).  McDonald's will find the site, tell you how big the store needs to be, provide the architectural/design specs, source the construction team, source equipment, source systems, design the menu, source food, etc.  And, you write the check and run that business.  Plus, you will need to pay McDonald's a percentage of the ongoing revenues from the business, in exchange for their ongoing marketing and operational support.

The downside of being a franchisee, is your long term financial returns are typically not as high as they could have been, had your launched your own business yourself.  Whatever percentage fees are going to the franchisor, would have been long term monies into your own pocket.  But, it is the classic risk/reward conundrum:  although the rewards would be higher with your own business, the risks and work are certainly higher, as well (e.g., building business plan, store design, location strategy, menu design, marketing plans).  You just need to figure out what your personal appetite for risk is, and go from there.  Do you want to piggy-back on McDonald's coattails for a smaller potential return?  Or, do you want to launch the next great fast food chain, for a bigger potential return (from a lot more work).

For a franchisor, the advantages are pretty clear:  you have opened up a near limitless supply of investment capital from your franchisees footing the bill of your expansion.  That is how companies like Starbucks, Subway and Dunkin Donuts have seen rapid expansion on a global basis.  Yes, you now need to manage this network of franchisees, which can be distracting.  But, no more so than managing your own growth.  And, by franchising, you get your brand to market much faster, before somebody else comes in with a competing concept.  And, what many franchisors do, is use franchising to roll out the brand as quickly as possible, and then buy back their best-performing franchisees over time, as cash from operations start flowing through the business, and they have the resources to scale up revenues with company-owned locations.  Quite a clever model, as the franchisor, with the franchisees taking most of the financial startup risk.  The only downside is the franchisees may not be required to sell, so the franchisor may permanently lose key markets long term (so, plan ahead for which markets will be most critical for your long term strategy).

There are many websites where you can go to research or advertise franchise opportunities.  Here are a few to get you started:  Franchise.com, Franchise Direct, Franchise.org, Franchise Clique and Franchise Gator.  Entrepreneur Magazine also has a great annual list of the Top 500 Franchises, where you can do additional research.  There are franchise opportunities in literally most any business line (e.g., restaurants, retail, education, home services, business services), so it is worth exploring for both entrepreneurs looking for opportunities and established businesses looking for ways to fund their growth.

But before you make any franchise decision as a franchisee: (i) make sure you clearly read the obligations of the franchising agreements (e.g., the UFOC franchise disclosure document), as the devil is certainly in the details, for both the franchisee and the franchisor; and (ii) make sure you have done your due diligence on the franchisor (e.g., how long have they been in business, are they well funded, are locations growing, are other franchisees happy).  The last thing you want to do is start a new franchise without perfect information on your cash obligations or sale restrictions, your franchisor's committed contractual support or a franchisor that is in a weak financial position to back up their promises.  Here is a good article on Franchising.com about key things to look out for in the UFOC.  But, in all cases, call references and get a smart franchise lawyer to help you!!

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