7 Questions to Ask Before Investing in a Franchise
If you fancy yourself an entrepreneur, you’ve probably considered becoming a franchisee. It seems like a simple way to rake in money hand over fist. After all, the franchisor has done all the hard work of creating a business framework.
As an investor, you can buy the rights to open a McDonald’s, a Dunkin Donuts, or a frozen yogurt shop. You’ll also have to pay ongoing percentage of all sales to the franchisor.
Once you’ve paid those fees, you keep what’s left over. All you have to do is catch a ride in a money-making machine, right?
Franchises can be an amazing investment opportunity, but before you jump into a franchising agreement, you need to ask these seven questions.
1. How Risky is This Business?
During an economic boom, you’ll see franchise restaurants, retail stores, and fitness centers popping up in every strip mall across the country. But franchises can be hit hard during recessions. Businesses that promise luxury and convenience struggle to turn a profit during economic downturns. But every business struggles during downturns.
Whether you’re peddling elder care or fro-yo, you need to understand how risky a business is.
Some franchisors will get you excited about your upside potential with the brand, but your first concern needs to be downside protection. To gauge your investment risk, ask questions like…
- How many franchise locations shut down between 2008 and 2009?
- Can you explain how revenue projections change during economic downturns?
- If my business fails to turn a profit, how does the franchisor help?
2. What’s My Expected Return on Investment?
A franchising company should offer helpful guidance that makes it easy for you to build a business plan. They should provide you with insights on average revenues and how revenues change over time and by season.
You should be able to calculate exact fixed costs and develop reasonable expectations for inventory and labor costs. Once you know your revenues and your expenses, you can calculate a range of profits. If the profits offer a compelling ROI, the franchise might be worth moving forward. Just remember, the profits aren’t guaranteed.
3. How Does the Company Support Franchise Owners?
Most franchisors offer franchisees brand credibility, but brand credibility alone isn’t enough for a successful business. A great company gives franchise owners the structure needed for launching and growing a business. They should provide guidance on locations, startup equipment, and how to grow the customer base. Franchisors may provide back-office support, product innovation, and employee-training opportunities.
As an investor, you’ll pay ongoing franchising fees, so make sure that you get your money’s worth.
If a company can’t explain a clear value proposition, it’s probably best to consider a different opportunity.
4. What are the Franchising Fees?
As a franchisee, you’ll pay an upfront franchising fee and a percentage of all sales as royalties. Depending on the size of the franchisor, these fees may be negotiable. Before you sign any franchising agreements, talk to current franchise owners and get a feel for any negotiations that they did. You may also want to speak to a lawyer before signing any contracts.
5. How Much Can I Finance?
Franchising fees are only part of your startup costs for a franchise. You’ll also need to pay for inventory, and capital equipment, as well as land and building expenses. Franchise companies may help you find small business loans for your capital outlay, but they usually require some level of personal investment. McDonald’s requires upfront liquid capital of nearly a million dollars. On the other end of the spectrum, HealthyYou Vending requires just $30,000 in liquid capital (and even that can be partially financed with the right fit).
The more you finance, the riskier your business. Not only will you have to earn larger profits to stay afloat, but you will have higher cash-flow needs that could put you out of business during a recession.
6. How Much Flexibility Do I Have as a Franchise Owner?
Franchisees must adhere to some, but not all corporate directives. Some agreements allow franchisees to add or eliminate products or services that aren’t profitable, while other agreements aren’t so lenient. The franchisor may also require you to purchase equipment upgrades on a regular schedule. However, those upgrades may be suggestions, rather than mandates.
On the other hand, restaurants are usually required to accept corporate coupons. Sometimes that ends up being a huge fiasco (as it was when KFC franchise locations had to eat the cost of grilled chicken advertised by Oprah).
7. How Much Work Will This Be?
“If you build it, they will come,” right? No. A franchise is not a zero-work investment. It’s a business, and you should expect to put in significant work to make it profitable. Some franchisees work 70- to 80-hour weeks for several years before they manage to turn their franchise into a semi-passive investment.
Speak with current franchisees before you jump into franchising. You may be surprised by just how much work investing in a franchise will take.