Wondering how to buy a franchise? For this type of entrepreneurship, you’ll want to research the available options, figure out the specific costs, identify possible lenders, and ensure your business plans and expectations align with the franchisor’s before you sign on the dotted line.
The advantage of franchises is that they often come with built-in branding and name recognition, and even corporate training and support. At the same time, there are usually limitations when it comes to franchisor fees, advertising, and sales territory.
Here’s everything you need to know about buying a franchise, from understanding various contract terms to getting financing in place.
Key Points
• Franchise types vary; business format, product distribution, investment, home-based, and service franchises each have their particular operational and investment details.
• Benefits of franchising include a pre-existing brand, corporate expertise, and established procedures, but high costs and limited control are among the drawbacks.
• Startup costs range widely, and there are many other financial considerations, such as initial fees, ongoing royalties, advertising costs, and operating expenses.
• Legal steps include receiving and reviewing the FDD — a document that contains 23 required pieces of information — and signing a long-term franchise agreement.
• Evaluating and purchasing a franchise involves assessing costs, reviewing the FDD, exploring financing options, signing the agreement, and attending corporate training.
Understanding Franchise Ownership
When you own a franchise, you purchase an existing business model from a company, known as the franchisor. You typically pay to get access to pre-made branding, advertising, and other support from the franchisor
However, there are often rules in place around creating your own marketing, products, or services. And in addition to the initial franchise fee, you typically have ongoing fees you pay to the parent company. Take time to understand these and any other recurrent costs so you can be well informed when you begin looking for a small business loan to get the enterprise started.
Types of Franchises
There are several types of franchise businesses. The most common structures include:
• Business format: This is usually an all-in-one franchise opportunity that includes everything you need to run a turnkey business. Business franchises are common in retail stores and restaurants, such as McDonald’s.
• Product distribution: Unlike a turnkey franchise business, a product distribution franchise often gives you access to sell higher priced items, such as vehicles.
• Investment franchise: An investment franchise involves purchasing the assets behind a brand, such as a real estate brokerage. You may not handle the day-to-day operations but instead play a more strategic role in the managing of your franchise.
• Home-based franchise: Also called a job franchise, this is usually a one-person opportunity that involves sales or services, such as plumbing, cleaning, or real estate.
• Service franchise: A service franchise is often similar to a home-based franchise but on a larger scale. Instead of acting as a solo operator, you purchase a service-based business that may employ multiple employees acting as the service providers.
Benefits and Drawbacks
As you learn how to get a franchise, consider both the pros and cons of this business model.
Benefits
• Pre-existing brand and customer base
• Corporate expertise and marketing plan available
• Operating procedures in place
• Training available from the parent company
Drawbacks
• Upfront capital required
• Ongoing franchise fees
• Less room for creativity
• No ownership of product or trade name
Evaluating Franchise Opportunities
There are several factors to consider before you decide to buy a franchise.
• Cost: Think about the upfront and ongoing costs, plus how soon your franchise business is likely to become profitable. A business valuation is a good starting point to understand the financials.
• Local environment: Gauge the demand for the business in your area, as well as the existing competition.
• Franchisor support: Look at how long the franchise has been in business and what kind of training and marketing support you’ll receive as a franchisee. Your own experience level may affect how much support you want from the franchisor.
Franchise Disclosure Document (FDD)
The Federal Trade Commission, or FTC, requires franchisors to provide potential buyers with a franchise disclosure document (FDD) at least 14 days before you sign any contracts or make any payments.
The FDD must include 23 pieces of information, including:
• Franchisor’s background
• Business background of executives
• Litigation and bankruptcy history
• Upfront and ongoing costs of operating the franchise
• Restriction on suppliers, territory, and customers
• Advertising and training programs
• Renewal terms, termination and transfer rules, and dispute resolution process
• Financial performance representations and financial statements
Financial Requirements
Consider all of the financial implications that come with buying a franchise, including costs that you may need to pay to the franchisor.
• Initial franchise fee
• Ongoing royalty payments
• Advertising fees
Also think about ongoing operating costs, such as rent, inventory, and employee payroll. Finally, depending on the type of financing you select, your lender may require a certain level of collateral, net worth, and/or down payment on the loan.
Territory Rights
The franchisor may limit where your business operates; this may mean a permanent location or travel within a designated sales territory. While this limitation may curb your operation’s growth, it can also potentially protect your location from competition from other franchisees.
Recommended: Guide to Buying Out a Business Partner
Financing Options When Buying a Franchise Business
Depending on what is included with the franchise purchase, startup costs can range anywhere between $10,000 and $5 million. For many prospective buyers, that may mean you need some type of financing in order to close the deal. Here are three different options that allow for a variety of experience levels and existing business operations.
SBA Loans
An SBA 7(a) loan allows qualified applicants to borrow up to $5 million. This loan program is designed for existing businesses, including certain franchises.
For future reference, SBA 7(a) loans can be a good option for small business expansion as well as for a launch.
Another option is the SBA 504 loan, which can be used for specific types of expenses, including financing for business equipment, machinery, real estate, and buildings.
The SBA used to maintain a franchise directory of eligible brands, but as of 2023 it’s no longer kept up to date. Even so, you can still check to see if the franchise you want is in the directory. That’s no guarantee, but it could help improve your odds of success.
Traditional Bank Loans
Another financing option for buying a franchise is a traditional business acquisition loan. In some cases, the application processing time may be faster than an SBA loan and you may enjoy lower fees as well.
However, most traditional lenders want to see some type of financial track record from the business owner. That can make it more difficult for a first-time franchisee to use bank financing as a startup business loan.
Franchisor Financing
If you’re a rookie entrepreneur buying a franchise business, it’s possible your experience level will prevent you from qualifying for SBA or traditional bank loans. In such situations, franchisor financing may be available to help you get the upfront capital you need.
Some franchisors provide financing options, either directly through the parent company or through a third-party lender that’s familiar with the business model. You may need to provide collateral or a down payment, demonstrate a minimum net worth, and meet credit score requirements in order to qualify.
Recommended: Business Lines of Credit
Legal Considerations
When signing a franchise contract, it usually only lasts for a certain number of years (usually up to 20). You can attempt to negotiate renewal terms, but there’s no guarantee that the franchising company will renew your contract. They may also change the terms, including royalty fees or territory boundaries.
Steps to Purchase
So how do you actually navigate the process of buying a franchise? Follow these four steps:
• Choose a franchise.
• Explore your financing options.
• Research the franchise financials and contract. Consider hiring a franchise attorney to make sure you understand your legal responsibility and limitations.
• Sign the franchise agreement to officially start your entrepreneurial journey.
Once you finalize the paperwork with the franchisor, you may be able to attend a corporate training before you open for business. Next steps should be outlined in your agreement to help create a successful launch.
The Takeaway
Buying a franchise can be an exciting way to become a business owner with a built-in support system. You can choose from a variety of franchise types and decide whether you prefer to sell goods, services, or both. As always, it’s important to do your due diligence when reading the franchise disclosure document and the franchise agreement. It’s also wise to explore your business loan options, whether you’re expanding an existing franchise footprint or looking to launch a business for the first time.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
How much money do I need to buy a franchise?
It depends on the size of the franchise and what is included in the purchase price. Startup sums can range anywhere from $10,000 to $5 million.
What should I look for in a franchise disclosure document?
A franchise disclosure document includes financial and legal information related to the franchisor and its executives. It should also outline ongoing fees, renewal terms, and territory limitations.
How do I finance a franchise purchase?
Experienced business owners may qualify for an SBA loan or a traditional bank business loan. If you don’t have any previous experience, you may be able to get approved for financing from the franchisor or their lending partner, if available.
What legal documents are needed to buy a franchise?
You’re legally required to receive a franchise disclosure document at least two weeks in advance of the purchase. You’ll also need a franchise agreement, which serves as a legally binding contract between you and the franchisor.
How long does it take to buy a franchise?
The purchasing process can take three to six months as you evaluate the franchise and get your financing in place. From there, it typically takes a few more months before you actually launch, depending on the complexity of your franchise business model.
Photo credit: iStock/hsyncoban
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