If you want to run your own business but don’t want to go to the trouble of launching an idea from the ground up — or just don’t have an idea — purchasing a franchise may seem like a good opportunity. But how do you know whether a franchise purchase is a wise investment? Here are a few indicators.
1) Are the fees fair?
Along with the initial franchise fee, you’ll also be required to pay ongoing franchise royalties, which may be either fixed or based on a percentage of sales. You may also be subject to marketing fees, equipment costs, and various other potential fees. All of these financial details must be laid out clearly in the franchiser’s Uniform Franchise Offering Circular. To determine if the rates are fair, consider the average franchisee’s average profit after expenses: Entrepreneur’s franchise coach, Jeff Elgin, suggests that the owning company should reasonably expect one-third of pre-tax profits from a franchise, with the remainder going to the franchisee.
2) Is the company expanding?
Even if a franchise is a well-known brand, its reputation could be in decline. To determine whether you’d be buying into an out-of-date business, check out the company’s Franchise Disclosure Document to find out whether the company’s number of franchise units has increased or decreased in the last several years. If the company is losing franchisees, it’s a red flag that the business is going downhill. Search for an up-and-coming company instead.
3) How is the company’s financial health?
Franchises must include three years’ worth of financial statements in their Franchise Disclosure Document. Consult with your accountant to go over the statements, looking for indicators of problems such as substantial debt, lack of capital reserves, and a high accounts receivable balance.
4) How many restrictions will be imposed on you by the franchisor?
Franchising companies are free to impose a wide manner of regulations on their franchisees, including which vendors they can buy from, what brands of equipment to buy, and even what hours and days they can operate. Examine numerous franchise policies to find out whether the one you’re interested in is overly restrictive. You might consider talking with a lawyer as well.
5) How do existing franchisees feel about the business?
The best way to tell if something is a good fit for you is to get the opinion of others who’ve done the same thing. Before committing to purchase a franchise, spend time visiting other franchisees and talking to their owners about how their businesses are going. Even if they aren’t open to revealing too many details, you can generally get a good sense of the situation simply by monitoring the popularity of the store. If you’ve stopped in five times and never seen a single additional customer, it’s a pretty good indicator that this is a business you don’t want to buy into.
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