There are two types of franchise: product distribution and business format.
A product distribution franchise sells its product to an independent agent, such as a car dealership. The benefit is the logo and product specific education extended to the franchisee (owner of the franchise). In a business format franchise, the business system and product are licensed by the franchisor (owner of the entity that grants permission to use the logo and system) assuring consistency between all independently owned operations.
The advisory relationship between the franchisor and franchisee is supplemented by a fee to purchase the use of the product and system plus ongoing royalties from profits. Fees to obtain the franchise range between $25,000 for lesser known operations to $350,000 for well-known hotels. To qualify for a franchise, many franchisors require a minimum amount in cash to assure the franchisee is committed to success. In addition, franchisees need to calculate a lease for the operating space into their start-up costs. Most franchises do not realize profits until the second or third year, so make sure your funds are plentiful to sustain your business. Ask other franchisees what their start-up costs were and how long until they made a profit. Financing a franchise through a bank loan or SBA guaranteed loan are common methods. If more capital is needed, you might consider a Limited Partner or loans from family and friends as terms are more flexible. Many investors are using their retirement funds to provide initial capital without taking a distribution and making tax-deferred earnings.
At the minimum, franchise agreements should include information regarding purchase price, royalties, location requirements, equipment and supplies, operating practices and protected territory. With the franchisor, review each part of the contract and determine how it will affect the operation of your business. Some franchises allow negotiations regarding practice and/or price, so it will benefit to ask. You may wish to have a qualified attorney review the contract to assure its accuracy.
Demand, competition, managerial skills, training, support from the franchisor, and the franchisor’s experience and possibility for growth are all necessary factors to consider when researching a franchise. Franchise investment listing services are a great resource for education and finding a franchise that suits your needs.
All examples are for educational purposes only, and should NOT be construed as investment advice. Always contact a qualified tax attorney or advisor prior to making any financial decision.
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