Buying a Franchise? Consider these 6 Factors

According to the International Franchise Association, franchise businesses in the US contributed roughly $827 billion in economic output in 2022. If the idea of entrepreneurship excites you, the world of franchising is worth a serious look. A recognizable brand, marketing and training support, and a proven business model are a few of the perks that come with buying a franchise.

Like any other business, franchising carries its own risks. Before you take the leap, you as a prospective franchisee need to closely evaluate the franchise opportunity you are about to invest in. Here is why, and what to look at.

The franchising landscape is vast and keeps evolving. New brands adopt the franchise model every year, which expands the pool of opportunities for prospective franchisees. That range of choice also brings complexity, so a clear evaluation framework helps.

Things to Consider Before Buying a Franchise

1. Location: The epicenter of success

Location plays a pivotal role in the success of any brick-and-mortar franchise. Selecting a site involves more than finding an area with high footfall. Several other factors can shape the success of your business:

• Customer demographics: Examining customer demographics before you invest is a prerequisite for an informed decision. Analyze data such as age, gender, income level, educational background, and family size. With this information, you can judge whether the franchise's offerings align with the needs of the local market and tailor your strategy accordingly. For example, if you want to open a franchise catering to pet owners, such as a grooming service or a pet supply store, your ideal location is an area with pet-owning families who have disposable income to spend on their pets.
• Access and visibility: Check whether any buildings, signs, passing traffic, or other obstructions limit the visibility of your location. For example, a coffee shop in a busy downtown area may seem perfect for foot traffic, but a nearby billboard could block the view of your main entrance from the road and reduce spontaneous walk-ins.
• Competition: Investigate whether nearby businesses will directly compete with yours.
• Complementary businesses: Identify nearby businesses that complement yours and can lift customer footfall and overall performance. For example, a quick-service restaurant near a bank can gain more visibility and drive shared customer visits.

If you are still unsure about site selection, seek advice from the franchisor or visit other franchises in the same system to see how they operate.

2. Financial trajectory and performance

Understanding the financial health of the franchise you plan to invest in can save you from pitfalls down the road. The best way to do this is to review the Franchise Disclosure Document (FDD), which gives you information about the franchise's financial status, including income statements and balance sheets.

Hire an accountant or legal advisor to review the franchisor's financial statements, audit reports, operating margins, revenue trends, and net income. This helps you judge whether the franchise's financial performance aligns with your objectives.

For example, a popular chain that has been in the industry for years might look like an attractive investment at first glance. When you review Item 19 of the FDD, you might find that income statements for the past three years show stagnant revenues, diminishing returns, and rising debt. Those indicators suggest the franchisor may be struggling and the investment may carry significant risk.

3. Total estimated investment: Uncovering the hidden costs

You may already know the initial franchise fee, but several other costs come with the territory. These often include:

• Rent or mortgage payments
• Employee salaries
• Royalties payable to the franchisor
• Marketing and advertising fees
• Utility and equipment expenses
• Initial inventory costs

If you do not account for these additional costs at the outset, they can come as an unwelcome surprise that thins your budget or creates financial strain. The initial franchise fee is often a small fraction of the total. Once you factor in construction, equipment leasing, and miscellaneous expenses, the full investment can run many times higher than the fee alone, so map out the complete cost before you commit.

4. Renewal rights: The future of your franchise business

The long-term sustainability of your franchise relies heavily on renewal rights, an often overlooked part of the agreement. Some franchises allow no renewals, or only a few, after the initial term ends. Certain large brands grant an initial term of around 20 years with no automatic right to extend or renew. This is why you should examine the renewal section, typically Item 17 of the franchise agreement. It explains your renewal rights, the terms and conditions, any renewal fees, and potential changes to the agreement upon renewal.

5. Dispute resolution: Navigating rough waters

Disputes and disagreements happen in franchising, and understanding how they are handled can save you headaches later.

Mediation is usually the first step, where a neutral third party helps the franchisor and franchisee resolve the issue. If that does not work, arbitration may be next, where an impartial panel makes a decision. In some cases, an unresolved dispute escalates to litigation, a court-based process. To avoid frustration later, understand the dispute resolution process for the brand, which is explained in the FDD.

6. Rights to acquire and ownership transfer: A strategic exit

Franchisors include clauses that let franchisees transfer business ownership to another party. This can be useful in cases such as passing the business to family members. Before you sign the agreement, study the franchisor's policy on business acquisition and ownership transfer, usually stated in Item 14 of the Franchise Disclosure Document. By reviewing the rules around selling and transferring your franchise, you can plan a strategic exit without penalties or other consequences.

Becoming a franchisee is a long-term commitment, often with a lock-in period of ten years or more. Do your research, and consider professional advice from financial advisors or legal experts who specialize in franchising. The more you understand the nuances of your potential franchise, the higher your chances of success.