Many people who are interested in owning a small business consider investing in a franchise or distributorship. These are businesses that pay for the right to sell a company's goods or services in a specific area.
Regulations and Disclosure
Franchising is regulated by federal and, in some cases, state laws. The laws govern the relationship between the franchisor (the company that owns the brand) and franchisees (the people who own the individual businesses). These laws are designed to ensure that people have detailed information before investing in a franchise, and that franchise owners are treated fairly while they own the franchise and if they decide to terminate the relationship.
The Federal Trade Commission's Franchise and Business Opportunity Rule requires the franchisor to give prospective purchasers a Franchise Disclosure Document at least 10 days before a potential customer pays for a franchise or otherwise commits to buying a franchise. It will include:
- Contact information for the 10 most recent franchise purchasers in your area
- The company's financial statement
- Biographical information about the company's executives
- Estimated costs for starting and running a franchise
- An explanation of your responsibilities and the seller's responsibilities if you invest in a franchise
Do Your Research
It's important to always remember that franchises are, first and foremost, designed to make money for the franchisor–the company that owns the brand<–>before they make money for the franchisee. For this reason, it is vital that potential franchise owners do their homework before deciding to invest in a franchise. Don't let the excitement of becoming a small-business owner cloud your judgment. You have to make the decision to invest based on the facts. Otherwise, you're almost certain to become an unhappy franchise owner or a poor former franchise owner.
The Federal Trade Commission requires franchisors to provide a disclosure document so that potential franchisees can do research and analyze the investment in a franchise. If you don't understand the information contained in the disclosure statement, or don't understand how to invest it, you should work with a lawyer and accountant to review the information.
Consider the following when analyzing a potential franchise investment:
Start-Up Expenses: How much are the start-up costs? These would include the franchising fee, equipment and inventory. How long will it take for you to recover these costs?
Monthly Cash Flow: How much can you reasonably expect to sell each month, and what are typical expenses? How much profit can you reasonably expect to make in a month?
Competition and Client Base: How close is the nearest franchise? Does the company make any promises about exclusive territory? How close is the nearest competitor? If possible, spend time observing the business of the nearest franchise and nearest competitor. For example, if you're thinking of investing in a fast-food restaurant, pay several visits to the nearest location at peak and off-peak times. Notice how many customers they have and try to estimate how much revenue they're generating. Then contact the other franchisees whose information was provided to you in the disclosure documents. Are they satisfied with their investment? How much money are they making? Do their revenue descriptions sound accurate given your observations of their business?
Questions for Your Attorney
Before investing in a franchise, hire an attorney who is experienced in working with franchisees to help you analyze and understand the investment materials.
Among the questions to consider asking your attorney:
- Have you previously represented franchisees?
- Have you previously worked with clients who own franchises of the company I'm considering?
- What red flags should I be aware of?
- What are the risks associated with my investment?
- What experience have your other clients had with this franchisor?
- How much do you charge for your services?