What is Franchising?
Franchising is a method of distributing products or services. At least two levels of people are involved in a franchise system: (1) the franchisor, who lends his trademark or trade name and a business system; and (2) the franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor's name and system. Technically, the contract binding the two parties is the “franchise,” but that term is often used to mean the actual business that the franchisee operates.
What Factors Should I Consider when Selecting a Franchise?
Like any other investment, purchasing a franchise is a risk. When selecting a franchise, carefully consider a number of factors, such as the demand for the products or services, likely competition, the franchisor's background, and the level of support you will receive.
Demand Is there a demand for the franchisor's products or services in your community? Is the demand seasonal? For example, lawn and garden care or swimming pool maintenance may be profitable only in the spring or summer. Is there likely to be a continuing demand for the products or services in the future? Is the demand likely to be temporary, such as selling a fad food item? Does the product or service generate repeat business?
Competition What is the level of competition, nationally and in your community? How many franchised and company-owned outlets does the franchisor have in your area? How many competing companies sell the same or similar products or services? Are these competing companies well established, with wide name recognition in your community? Do they offer the same goods and services at the same or lower price?
Your Ability to Operate the Business Sometimes, franchise systems fail. Will you be able to operate your outlet even if the franchisor goes out of business? Will you need the franchisor's ongoing training, advertising, or other assistance to succeed? Will you have access to the same or other suppliers? Could you conduct the business alone if you must lay off personnel to cut costs?
Name Recognition A primary reason for purchasing a franchise is the right to associate with the company's name. The more widely recognized the name, the more likely it will draw customers who know its products or services. Therefore, before purchasing a franchise, consider:
•The company's name and how widely recognized it is. -- If it has a registered trademark. •How long the franchisor has been in operation. •If the company has a reputation for quality products or services. •If consumers have filed complaints against the franchise with the Better Business Bureau or a local consumer protection agency.
Training and Support Services Another reason for purchasing a franchise is to obtain support from the franchisor. What training and ongoing support does the franchisor provide? How does their training compare with the training for typical workers in the industry? Could you compete with others who have more formal training? What backgrounds do the current franchise owners have? Do they have prior technical backgrounds or special training that helps them succeed? Do you have a similar background?
Franchisor's Experience Many franchisors operate well-established companies with years of experience both in selling goods or services and in managing a franchise system. Some franchisors started by operating their own business. There is no guarantee, however, that a successful entrepreneur can successfully manage a franchise system.
Carefully consider how long the franchisor has managed a franchise system. Do you feel comfortable with the franchisor's expertise? If franchisors have little experience in managing a chain of franchises, their promises of guidance, training, and other support may be unreliable.
Growth A growing franchise system increases the franchisor's name recognition and may enable you to attract customers. Growth alone does not ensure successful franchisees; a company that grows too quickly may not be able to support its franchisees with all the promised support services. Make sure the franchisor has sufficient financial assets and staff to support the franchisees.
What are some of the Benefits and Responsibilities of Franchise Ownership?
There are a number of aspects to the franchising method that appeal to prospective business owners. For example, easy access to an established product and a proven method of operating a business reduces the many risks of opening a business. In fact, U.S. Small Business Administration and U.S. Department of Commerce statistics show a significantly lower failure rate for franchised businesses than for other business start-ups.
The franchisee purchases not only a trademark, but also the experience and expertise of the franchiser's organization. However, a franchise does not ensure easy success. If you are not prepared for the total commitment of time, energy and financial resources that any business requires, you should stop and reconsider your decision to enter the franchise business.
A franchise typically enables you, the investor or "franchisee," to operate a business. By paying a franchise fee, which may cost several thousand dollars, you are given a format or system developed by the company ("franchisor"), the right to use the franchisor's name for a limited time, and assistance. For example, the franchisor may help you find a location for your outlet; provide initial training and an operating manual; and advise you on management, marketing, or personnel.
Some franchisors offer ongoing support such as monthly newsletters, a toll free 800-telephone number for technical assistance, and periodic workshops or seminars.
How can I find a lawyer who specializes in franchising?
Entrepreneurs in search of a franchise lawyer can start by checking with your state bar association. Many state bar associations allow member lawyers to identify the areas of practice in which they specialize, and franchise or distribution law is a recognized specialty in an increasing number of states.
The American Bar Association also publishes a Membership Directory of the Forum Committee on Franchising. The Directory, which is organized by state and city, lists the names, addresses and telephone numbers of attorneys who are members of the Forum Committee. You can obtain a copy of the Directory from:
American Bar Association Service Center 750 North Lake Shore Dr. Chicago, IL 60611 (312) 988-5522
What is the Disclosure Document?
The Federal Trade Commission (FTC) requires sellers of franchises and other business opportunity ventures to provide prospective investors with the information they need to make an informed investment decision. It also requires that all earnings claims be documented, that the information investors receive be complete and accurate and that investors have adequate time to consider and evaluate the disclosures before making any final purchase commitment. All required information is given to prospective investors in the form of a franchise disclosure document, which must be furnished at least 10 business days before any purchase may occur. This document includes 20 important items of information, such as
• Names, addresses and telephone numbers of other franchisees. • A fully audited financial statement of the seller. • The cost required starting and maintaining the business. • The responsibilities you and the seller will share once you buy a franchise. • Litigation involving the company or its officers, if any.
Again, use your professional support to examine all of these issues. Some of the contract terms may be negotiable. Find out before you sign; otherwise, it will be too late.
How Can I Evaluate My Potential To Become a Successful Franchisee?
Perhaps your most important step in evaluating a franchise opportunity is examining your own skills, abilities and experience. The ideal franchisee is a creative, outgoing person who is eager to succeed, but not so independent that he or she resents other people's advice. You must be able to balance your entrepreneurial initiative with a willingness to comply with the business formulas used by the franchiser. Remember, a successful partnership between a franchisee and franchiser involves a mutual understanding of each other's values and achievements.
Determine exactly what you want out of life and what you are willing to sacrifice to achieve your goals. Be honest, rigorous and specific. Ask yourself: Am I qualified for this field
• Physically? • By experience? • By education? • By learning capacity? • Financially?
Ask yourself how this decision will affect your family. Do they understand the risks and sacrifices required, and will they support your efforts? Beginning a franchise business is a major decision that does not ensure easy success. However, an informed commitment of time, energy and money by you and your family can lead to an exciting and profitable venture.
How Can I Prepare Prior to Shopping at a Franchise Exposition?
Attending a franchise exposition allows you to view and compare a variety of franchise possibilities. Keep in mind that exhibitors at the exposition primarily want to sell their franchise systems. Be cautious of salespersons that are interested in selling a franchise that you are not interested in.
Before you attend, research what type of franchise best suits your investment limitations, experience, and goals. When you attend, comparison shop for the opportunity that best suits your needs and ask questions.
Know How Much You Can Invest An exhibitor may tell you how much you can afford to invest or that you can't afford to pass up this opportunity. Before beginning to explore investment options, consider the amount you feel comfortable investing and the maximum amount you can afford.
Know What Type of Business is Right for You An exhibitor may attempt to convince you that an opportunity is perfect for you. Only you can make that determination. Consider the industry that interests you before selecting a specific franchise system. Ask yourself the following questions:
•Have you considered working in that industry before? •Can you see yourself engaged in that line of work for the next twenty years? Do you have the necessary background or skills?
If the industry does not appeal to you or you are not suited to work in that industry, do not allow an exhibitor to convince you otherwise. Spend your time focusing on those industries that offer a more realistic opportunity.
Comparison Shop Visit several franchise exhibitors engaged in the type of industry that appeals to you. Listen to the exhibitors' presentations and discussions with other interested consumers. Get answers to the following questions:
•How long has the franchisor been in business? •How many franchised outlets currently exist? Where are they located? •How much is the initial franchise fee and any additional start-up costs? Are there any continuing royalty payments? How much? •What management, technical, and ongoing assistance does the franchisor offer? •What controls does the franchisor impose?
Exhibitors may offer you prizes, free samples, or free dinners if you attend a promotional meeting later that day or over the next week to discuss the franchise in greater detail. Do not feel compelled to attend. Rather, consider these meetings as one way to acquire more information and to ask additional questions. Be prepared to walk away from any promotion if the franchise does not suit your needs.
Get Substantiation for Any Earnings Representations Some franchisors may tell you how much you can earn if you invest in their franchise system or how current franchisees in their system are performing. Be careful. The FTC requires that franchisors that make such claims provide you with written substantiation. Make sure you ask for and obtain written substantiation for any income projections, or income or profit claims. If the franchisor does not have the required substantiation, or refuses to provide it to you, consider its claims to be suspect.
Take Notes It may be difficult to remember each franchise exhibit. Bring a pad and pen to take notes. Get promotional literature that you can review. Take the exhibitors' business cards so you can contact them later with any additional questions.
Avoid High Pressure Sales Tactics You may be told that the franchisor's offering is limited, that there is only one territory left, or that this is a one-time reduced franchise sales price. Do not feel pressured to make any commitment. Legitimate franchisors expect you to comparison shop and to investigate their offering. A good deal today should be available tomorrow.
Study the Franchisor's Offering Do not sign any contract or make any payment until you have the opportunity to investigate the franchisor's offering thoroughly. As will be explained further in the next section, the FTC's Franchise Rule requires the franchisor to provide you with a disclosure document containing important information about the franchise system. Study the disclosure document. Take time to speak with current and former franchisees about their experiences. Because investing in a franchise can entail a significant investment, you should have an attorney review the disclosure document and franchise contract and have an accountant review the company's financial disclosures.
Are There Additional Sources of Information?
Before you invest in a franchise system, investigate the franchisor thoroughly. In addition to reading the company's disclosure document and speaking with current and former franchisees, you should speak with the following:
Lawyer and Accountant Investing in a franchise is costly. An accountant can help you understand the company's financial statements, develop a business plan, and assess any earnings projections and the assumptions upon which they are based. An accountant can help you pick a franchise system that is best suited to your investment resources and your goals.
Franchise contracts are usually long and complex. A contract problem that arises after you have signed the contract may be impossible or very expensive to fix. A lawyer will help you to understand your obligations under the contract, so you will not be surprised later. Choose a lawyer who is experienced in franchise matters. It is best to rely upon your own lawyer or accountant, rather than those of the franchisor.
Banks and Other Financial Institutions These organizations may provide an unbiased view of the franchise opportunity you are considering. Your banker should be able to get a Dun and Bradstreet report or similar reports on the franchisor.
Better Business Bureau Check with the local Better Business Bureau (BBB) in the cities where the franchisor has its headquarters. Ask if any consumers have complained about the company's products, services, or personnel.
Government Departments Several states regulate the sale of franchises. Check with your state Division of Securities or Office of Attorney General for more information about your rights as a franchise owner in your state.
Federal Trade Commission (FTC) The FTC publishes information that may be of interest to you, including business guides.
How can I find out about complaints against a company?
No federal or state agency or private organization can tell you whether a company is legitimate or operates in good faith. The FTC or the Better Business Bureau can report on whether consumers have complained about a company. But, operators of fly-by-night franchise and business opportunity scams know this, and may change the name and location of their company every few months to avoid a record of consumer complaints.
There is no substitute for checking the track record of a franchisor or business opportunity seller by personally talking to at least 100 prior purchasers. That’s why the Franchise Rule requires companies to give consumers a list of the names, addresses and telephone numbers of at least 100 prior purchasers who are geographically closest to you. Interview these prior purchasers about their experiences. Ask questions to verify that they have purchased the franchise or business opportunity and that they are not being paid to provide a favorable review. A scheming promoter of a bogus business opportunity may line up "singers" who provide phony testimonials. Visit their business locations in person.
If you want information about consumer complaints from the FTC, request it in writing. Address your request to:
Freedom of Information Act Request Federal Trade Commission Washington, D.C. 20580.
Please identify your letter as a "FOIA Request" and include (1) your name, address and daytime phone number, and (2) the name and address of the company you are asking about.
In most cases, the FTC does not charge the public for searching, reviewing documents, or copying. Still, it is a good idea to state the maximum you are willing to pay, so we can contact you in the unusual event that any applicable fees for these services will be higher than your limit.
You can also request information from the Better Business Bureau and look up information about the franchise or business opportunity seller online at: www.bbb.org.
How can I file a complaint against a company?
If you are having a problem with a franchisor or business opportunity seller, consider talking with a private attorney about bringing a lawsuit, or taking other action that may help resolve the problem.
We encourage you to file your complaint with the FTC because consumer complaints help us identify companies and practices that affect a broad segment of the public, and are useful for law enforcement purposes.
You can file your complaint online using our Complaint Assistant at: https://www.ftccomplaintassistant.gov, or by telephone at 1-866-382-4357.
We also accept complaints in writing, but please be aware that postal mail to federal agencies is subject to delays for security reasons. Please describe your problem or concern writing. Tell us what you think was misleading or deceptive in the company's promotional materials, disclosure document or offering circular. If you want your letter kept confidential, please print the words, "Privileged and Confidential," on the top of each page. Include your name, address, and a daytime telephone number where we can reach you. It will help if you can send us copies of any written claims in promotional materials or elsewhere that you believe are false. Send copies, not originals, of any documents you think we should have.
Please address your complaint to:
Consumer Response Center Federal Trade Commission - Rm. 130 600 Pennsylvania Ave., NW Washington, D.C. 20580.
How do I know what must be included in a Franchise Disclosure Document?
The amended Franchise Rule states what must be disclosed. It is published in the Code of Federal Regulations, Volume 16, Part 436 (16 CFR § 436). The Franchise Rule Compliance Guide, which is designed to assist franchisors in complying with the amended Rule are available at: www.ftc.gov/bcp/edu/pubs/business/franchise/bus70.pdf.
There are franchise registration and disclosure laws in a number of states that require a filing of a franchisor’s Franchise Disclosure Document (“FDD”) with a state agency. In most of those states, it is unlawful to offer or sell a franchise until the agency has registered the franchisor’s FDD after reviewing the filing. Information about these state law requirements can be obtained from:
North American Securities Administrators Association 750 First Street, Suite 710 Washington, DC 20002 (202) 737-0900 www.nasaa.org/Industry___Regulatory_Resources/Uniform_Forms/
You can also find the current state and federal guidelines in the Business Franchise Guide, published by Commerce Clearing House, Inc., in many law libraries.
Where can I get a company's pre-sale disclosure document?
The Franchise Rule requires franchise and business opportunity sellers to provide to prospective purchasers with a Franchise Disclosure Document. The FTC does not require filings of these documents, so we are unable to provide copies to consumers. A total of 13 states keep franchise offering circulars on file, and 26 states require business opportunity disclosure filings. Most states provide copies of these disclosures, usually by allowing visitors to their offices by appointment to review or copy the documents.
A few private companies may make franchise disclosure documents filed in one or more states available for a fee. The FTC doesn’t support or endorse these companies:
FRANDATA Corporation 1665 North Fort Meyer Dr., Suite 410 Arlington, VA 22209 (703) 740-4707 www.frandata.com
FranchiseHelp, Inc. 101 Executive Boulevard, 2d Floor Elmsford, NY 10523 (800) 401-1446 www.franchisehelp.com
Franchise-Insider.com 745 Campbell Way, Herndon, Va 20170 (877) 674-6677 www.franchise-insider.com
In addition, two non-commercial services make Franchise Disclosure Documents filed in California available on line without charge:
Cal-EASI (Documents not word-searchable) California Department of Corporations 1515 K Street, Suite 200 Sacramento, CA 95814-4052 866 ASK-CORP http://www.corp.ca.gov/CalEASI/caleasi.asp
OpenFran - The Franchise Openness Project (Documents word searchable) PO Box 25514 Scottsdale, AZ 85255 480-264-0050 http://www.openfran.org
How Widespread is Franchising?
The answer may surprise you. By 2001, there were 767,483 business establishments in all domestic franchise systems (either owned by franchisors and franchisees), which employed almost 10 million people, with direct output close to $625 billion, and a payroll of $230 billion. These establishments account for significant percentage of all establishments in many important lines of business: 56.3% in quick service restaurants, 18.2% in lodging, 14.2% in retail food, and 13.1% in table/full service restaurants
What is 'Business Format' Franchising?
In business format franchising, the franchisor prescribes for the franchisee a complete plan, or format, for managing and operating the establishment. The plan provides step-by-step procedures for major aspects of the business and, anticipating most management problems, provides a complete matrix for management decisions confronted by the franchisees. The major advantage of buying a business format franchise is that the “system,” the means for distributing goods and or services, has been developed, tested, and associated with the trademark. As a result, rapid expansion of a successful retail concept can occur more quickly than through company-owned expansion.*
Sales by business format franchisors continued to increase steadily throughout the 1990s and into the 21st century. In 2001, comparing business format franchising to product distribution franchising, business format franchising had about 4.3 times as many establishments, employed 4 times as many workers, generated 2.5 times the payroll, and produced nearly 3 times as much output.
What Should I Consider Before Buying a Franchise?
Among the points which IFA recommends for investigation are:
a. the type of experience required in the franchised business;
b. a complete understanding of the business;
c. the hours and personal commitment necessary to run the business;
d. who the franchisor is, what its track record has been, and the business experience of its officers and directors;
e. how other franchisees in the same system are doing;
f. how much it's going to cost to get into the franchise;
g. how much you're going to pay for the continuing right to operate the business;
h. if there are any products or services you must buy from the franchisor and how and by whom they are supplied;
i. the terms and conditions under which the franchise relationship can be terminated or renewed, and how many franchisees have left the system during the past few years;
j. the financial condition of the franchisor and its system.
Both the Federal Trade Commission (www.ftc.gov) and IFA (www.franchise.org ) have many helpful publications and resources. Equally important, IFA recommends that you engage an attorney to examine the contract. It is important to work with an attorney who understands franchising, especially the antitrust laws, the trademark laws, the Federal Trade Commission Franchise Rule, and applicable state laws. It is also recommended that you ask a competent accountant to examine your anticipated expenses, your financing needs, and your prospects for achieving your desired level of profitability before you sign any agreement.
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