Table of Contents
If you want to run a business, you don’t necessarily have to start from scratch. Instead, you could buy into a franchise, a business arrangement that lets you operate under an established brand and follow a proven business model. Franchisors often offer marketing support and training while you manage the day-to-day operations. In exchange, you’ll pay fees and follow the franchisor’s guidelines for running the business.
Here’s more on how franchising works, along with its pros and cons, so you can decide if this business model fits your entrepreneurial goals.
Key Points
• A franchise allows a franchisee to operate under an established company’s brand name, using its products, systems, and business model.
• Product franchising focuses on supply chain management, and business format franchising typically includes training, marketing, and location support.
• Buying a franchise requires signing a legally binding agreement that outlines the rights and responsibilities of both the franchisor and franchisee.
• Costs may include an initial franchise fee, plus ongoing royalty and marketing fees.
• Franchising offers brand recognition and proven systems but comes with high startup costs, ongoing fees, and less freedom to make independent business decisions.
Franchise Meaning in Business
So, what is a franchise? A franchise is a type of business arrangement in which an established company (the franchisor) lets you (the franchisee) operate under its brand name. As the franchisee, you can use the company’s products and systems to run the business.
Depending on the exact arrangement, the company may also provide training, marketing, assistance finding a location, and other support to help you get up and running. In exchange, you’ll need to pay fees — often an upfront fee plus ongoing royalties.
For franchisors, this arrangement helps them expand into new locations without owning every branch. Franchisees get the opportunity to start a business that already has an established reputation and systems rather than building one from the ground up.
Franchisor vs Franchisee
Here’s a quick look at the different roles that a franchisor and a franchisee play.
| Franchisor | Franchisee |
|---|---|
| Owns the brand and business model | Buys the right to operate under the franchisor’s brand |
| Develops systems and standards | Runs the business’s daily operations |
| Provides training, marketing, and other support | Pays franchise fees and ongoing royalties |
| Sets quality and branding requirements | Has to follow franchisor’s guidelines |
| Keeps developing products and services | Focuses on serving customers and growing the local business |
How a Franchise Agreement Works
When you buy a franchise, you’ll need to sign a franchise agreement. This legally binding contract outlines the rights and responsibilities of both the franchisor and franchisee.
It’s important to read and understand it fully to be sure you know how the franchise works.
It typically contains the length of the franchise agreement (sometimes as long as 20 years) and any penalties for terminating the contract early. It will also go over required fees or ongoing royalties, as well as the conditions for renewing the contract.
For the franchisor, the contract will outline the support it will provide, such as marketing and training. The franchise agreement will also detail all the standards the franchisee will need to meet to operate under the brand.
Recommended: First-Time Business Loans
How Does a Franchise Work?
Franchises involve a structured process. You need to apply, get approved, and pay fees, after which you can set up your business. You’ll operate under the franchisor’s system and receive training and support.
Fees, Royalties, and Ongoing Costs
Running a franchise isn’t free. You’ll need to pay both upfront and ongoing fees, which may include the following.
• Initial franchise fee: This may range from tens of thousands of dollars to hundreds of thousands of dollars, depending on the business. You may be able to use a small business loan to help cover this.
• Setup costs: You’ll also pay to rent, build, and/or equip your outlet and purchase inventory. Plus, you may have to pay for operating licenses, insurance, and a “grand opening” event. A business acquisition loan may be able to help with some of these costs.
• Ongoing royalties: Franchisors also usually collect royalties that are based on a percentage of your revenue. You usually have to pay these fees even if you’re not making money.
• Advertising fees: The franchisor may ask you to pay into an advertising fund which promotes the entire business, rather than your individual branch.
Training and Support
In exchange for these fees, the franchisor should provide a certain amount of training and support to help your outlet succeed. It may help you scout a location for your branch and provide training on its systems and operations.
You might also get support with marketing, management, and personnel. Some franchisors offer continuing education through workshops or seminars or provide a support number you can call with questions about operating the business.
Recommended: Different Types of Business Loans
Types of Franchises
Some franchises simply provide products for you to sell, while others offer a more comprehensive business plan. Here are two common types of franchises you might encounter.
Product Distribution Franchises
Product franchising is the simpler approach. It focuses on supply chain management. The franchisor manufactures and supplies products for the franchisee to sell. The franchisee purchases the right to use the business’s name and trademark.
Business Format Franchises
Business format franchising is the more comprehensive approach. In addition to products, the franchisor also provides services like training, marketing plans, and help selecting a location. As the franchisee, you’ll have an ongoing relationship with the franchisor and may benefit from its full business management approach.
Recommended: How to Apply for a Small Business Loan
Pros and Cons of Franchising
Buying a franchise has both pros and cons that are worth considering before you take the leap.
thumb_up
Pros:
• Operate under an established brand
• Follow a proven business model and operating systems
• Get training and continuing support
• May benefit from national marketing and brand recognition
• Don’t have to start from scratch
thumb_down
Cons:
• High upfront investment and startup costs
• Ongoing royalty and marketing fees
• Less freedom to make your own business decisions
• Must follow franchisor rules and standards
• Less flexibility and creative control
If you’d like to join a business with structured systems and branding already in place, you might appreciate the franchise model, despite the potentially high fees. If you’re looking for more creative control and the flexibility to build your own brand, you may prefer to start your own independent business.
Recommended: Small Business Startup Grants, Loans, and Programs
How to Buy a Franchise
Buying a franchise involves a great deal of research and due diligence. Here are some steps for navigating the process.
1. Research franchise opportunities: Start by comparing different franchises, including their growth potential, fees, and potential return on investment.
2. Review the Uniform Franchise Offering Circular (UFOC): Request this official document, which will give you details on the franchise’s financial, legal, and personnel history.
3. Read the contract and guidelines: Learn about the operating guidelines you’ll need to follow and any support the franchisor will provide, such as marketing or site scouting.
4. Research licensing rules and other requirements: You may need to apply for business licenses and follow zoning laws and environmental regulations.
5. Evaluate your finances: Review your financial situation and explore financing options if necessary, such as small business loans or SBA loans.
6. Consult professionals: Consider hiring an attorney and accountant to help you understand costs and tax requirements. They can also help you put together documents like a letter of intent, financial statements, sales agreement, contracts, and leases.
7. Apply and sign the franchise agreement: After getting approved, your final step will be signing the franchise agreement, going through training, and preparing to open your franchise outlet.
If you need financing, you may consider loans to buy a business. These could include SBA loans or startup business loans, for instance.
Learning about business loan requirements can help you evaluate your qualifications and narrow down your options.
The Takeaway
When you buy a franchise, you can benefit from a business’s established brand and operational systems. You’ll often get training and other forms of support that can help your business succeed.
But fees can be costly, and you’ll have less flexibility and creative control than you would from running your own business. It’s worth weighing the pros and cons of franchising vs. starting your own business before moving forward.
Ready to grow your business? SoFi Small Business Loans can give you fast access to the capital you need. Check your eligibility in minutes.
FAQ
What is a simple definition of a franchise?
In simple terms, a franchise is a business arrangement in which a company lets an independent owner operate under its brand and systems in exchange for fees. The franchisor usually provides marketing and other support, while the franchisee abides by the company’s guidelines and standards.
How is a franchise different from starting an independent business?
With a franchise, you operate under an existing company’s brand in exchange for fees. You can benefit from their established reputation and systems, but you’ll have less flexibility and creative control. When you start your own independent business, it’s up to you to create your own brand, products, marketing, and systems. You won’t have to pay fees to a franchise, but you’ll have more responsibility for running and growing your business.
What fees are involved in buying a franchise?
You often have to pay an upfront fee to purchase the franchisor’s trademark, along with fees for training and equipment. You might also pay ongoing royalties or a percentage of your sales to the franchisor.
What are the most common types of franchises?
Two common types of franchises are business format franchises and product/trade name franchises. With business format franchises, a company usually offers a complete business system with training and operational support. With product/trade name franchises, a company mainly provides products for a franchisee to sell using its name and trademark.
Can you get a loan to buy a franchise?
You can get a loan to buy a franchise if you meet lender requirements. These often include a minimum credit score and detailed business plan.
Photo credit: iStock/filadendron
SoFi's marketplace is owned and operated by SoFi Lending Corp.Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
SOSMB-Q326-087