Starting a Small Business:
Investing in a Franchise

Essentially, franchising is a plan of distribution under which an individually-owned business is operated as part of a large chain. Services or products are standardized. It is a system used by a company (the franchisor) which gives the individual dealer (you, the franchisee) the right to market the franchisor's product or service by using the franchisor's trade name, trade marks, reputation, and way of doing business. The franchise agreement (or contract) usually also gives the franchisee the exclusive right to sell or otherwise represent the franchisor in a specified area. In return, the franchisee agrees to pay either a sum of money - a franchise fee, a percentage of gross sales or both, and frequently to buy equipment or supplies from the franchisor - or some combination of these considerations.

Among the advantages of franchising to you as a franchisee are that you can start a business with:

1. Limited experience. You can use the franchisor's experience which you might otherwise have to obtain the hard way - through trial and error.

2. A relatively small amount of capital and a strengthened financial and credit standing. Some franchisors give financial assistance so you can start with less than the usual amount of cash. For example the franchisor may accept a down payment with your note for the balance of the needed initial capital. Or, the franchisor may allow you to delay your payments for royalties, purchases, or other fees to help you over the initial rough spots. With a well known, successful franchisor behind you, your standing with local financial institutions and credit associations is strengthened.

3. A well developed consumer image and goodwill with proven products and services. Because the goods and services of the franchisor are well-known, your business has "instant" pulling power. To develop equivalent pulling power on your own might take years of promotion and considerable investment.

4. Competently designed facilities, layout, displays and fixtures. The franchising company has effectively designed facilities, layout, displays and fixtures prepared by experts and proven by nationwide usage.

5. Chain buying power. You should receive savings through the franchisor's quantity purchasing of products, equipment, supplies, advertising materials and other business needs.

6. Business training and continued management assistance from experienced company personnel. You can expect advance training in the mechanics of your particular business. Some franchisors will guide you in day-to-day operations until you are proficient. Moreover, management consulting service is provided by many franchisors on a continuing basis. This usually includes help with record keeping and other essential activities.

7. National or regional promotion and publicity. National and/or regional promotions of the franchisor will help your business. You will receive help with local advertising. The franchisor's research and development program will assist you in keeping up with competition and changing times. Best of all, the immediate identification many franchise operations enjoy will bring pre-sold customers to your door.

Now, what are the disadvantages of franchising? Some of them are the:

1. Required standardized operations. You cannot make all of the rules. Contrary to the "be your own boss" lures in franchise advertisements, you will not be your own boss. You must subjugate your personal identity to that of the franchisor. If an important satisfaction to you is to have your business known by your name, a franchise operation is not for you. Most franchisors have the right to exert control and pressure you (1) to conform to standardized procedure; (2) to handle specific products or services which may not be particularly suitable or profitable in your marketing area; and (3) to follow other policies which may benefit others in the chain but not always you. You lose the freedom to make most decisions. In other words, you are not your own boss.

2. Sharing profits with the franchisor. The franchisor nearly always charges a royalty on a percentage of gross sales. The royalty fee must ultimately come out of your profits. Sometimes it must be paid whether you make a profit or not, and it must often be paid before the operation is established. On the other hand, the franchisor does not usually share your losses.

3. Lock of freedom to meet local competition. Under a franchise you may be restricted in establishing selling prices, in introducing additional products or service or dropping unprofitable ones, regardless of the local competition you must meet.

4. Danger of contracts being slanted to the advantage of the franchisor. Clauses in some contracts, imposed by the franchisor, may provide for unreasonably high sales quotas, mandatory working hours, cancellation or termination of the franchise for minor infringements, and/or restrictions on the franchisee in transferring his franchise or recovering his investment. The territory assigned the franchisee may be overlapping with that of another franchisor or may be otherwise inequitable. In settling disputes of any kind the bargaining power of the franchisor may be greater than that of the franchisee. In the past, fast food franchisees worked a median of 60 hours a week; some families as much as 120 hours. As the owner, you may still opt to do this. Alleged infringement of the franchisee's exclusive territory, long a major source of friction between franchisee and franchisor, need not be if your attorney oversees the contract. The power imbalance in favor of the franchisor is usually due not only to the franchisee's smaller financial resources but to a lack of information - information which the franchisor usually has.

5. Time spent preparing reports for the franchisor. Franchisors require specific reports and you may consider the time and effort in preparing them inordinately burdensome. On the other hand if these reports are helpful to the franchisor it is likely that they will also help you to manage your business more effectively.

6. Sharing the burden of the franchisor's mismanagement. While ordinarily the franchisor's chain develops good will among consumers, there may be instances in which ill will is developed by one of the units. As one link in the chain, you may suffer despite the excellence of your particular unit. Fortunately, in recent years this has been an infrequent occurrence.

The Franchisor

• How many years has the firm offering you a franchise been in operation?
• Has it a reputation for honesty and fair dealing among the local firms holding its franchise?
• Has the franchisor shown you certified figures indicating exact net profits of one or more going firms which you personally checked with the franchisee(s)?
• Will the firm assist you with:

• A management training program?
• A public relations program?
• Credit?
• An employee training program?
• Capital?
• Merchandising ideas?

• Will the firm help you find a good location to carry out its stated plan of financial assistance and expansion?
• Is the franchising firm adequately financed to carry out its stated plan of financial assistance and expansion?
• Is the franchisor a one-man company or a corporation with experienced management in such depth that there will always be an experienced person at its head?
• Exactly what can the franchisor do for you which you cannot do for yourself?
• Has the franchisor investigated you carefully and successfully enough to be assured that you can operate one of their franchises at a profit both to them and to yourself?
• Has the franchisor complied with the law regulating the sale of franchises?
• How much equity capital must you have to purchase the franchise and operate it until your income equals your expenses? Where will you get it?
• Are you prepared to give up some independence of action to secure the advantages offered by the franchise?
• Do you really believe you have the innate ability, training and experience to work smoothly and profitably with the franchisor? Your employees? Your customers?
• Are you ready to spend much or all of the remainder of your business life with this franchise company, offering its product or service to your public?

• Have you made any study to determine whether the product or service which you propose to sell under franchise has a market in your territory at the prices you will have to charge?
• Will the consumer population in the territory given you increase? Remain static? Decrease over the next 5 years?
• Five years from now, will the product or services you are considering be in greater demand? About the same? Or in less demand?
• What competition for the product or service you contemplate selling already exists in your territory? Nonfranchise firms? Franchise firms?