How Do I Know that a Franchise Opportunity is a Good Deal?

Franchises will always be an attractive option for entrepreneurs because they offer a proven system and high success rate. When I see someone hesitate to make the investment, it’s often a question of weighing the costs and fees against the value the franchisor provides. Here’s what I tell them:

Learn about and compare the costs associated with startup. Every franchisor will charge an initial franchise fee, and usually, the bigger the brand, the larger the fee. New franchisees might think that this is pure profit for the company, but franchisors don’t really make money on the one-time fee. It covers the cost of getting a new unit (along with the owner and staff) up to speed on the processes and standards, and providing the training needed to succeed.

I always recommend that a prospective franchisee compare brands in the same market. If there’s a significant cost differential, what justifies it? Smaller, newer franchisors might charge less to grow, for example, while larger franchisors with more units might try to prevent cannibalization by recruiting fewer owners and charging higher fees.

Research what the fees will fund. Royalty fees are the lifeblood of a franchisor. They allow them to grow, innovate, and provide better support for franchisees and customers. The initial franchise fee guarantees a protected territory (which can be negotiated), so your unit has the best chance of success in the local market.

One reason franchises are so appealing is their transparency. They are heavily regulated, and the Franchise Disclosure Document (FDD) must make all financial information, fees, standards, and expectations completely clear. There might be build-out, remodeling, or brand updating costs that can run into the hundreds of thousands of dollars, so the Franchise Disclosure Document is essential to understanding how profitable you’ll be and how quickly you’ll get there.

If you buy an existing business from an individual owner, you don’t know what you might not know about the cost of doing business. With a franchise, youwill know exactly what the terms of your partnership with the parent company are.

Talk to other franchisees. Franchisees are free (and encouraged) to speak their mind about the brand, the company, the market, and how much money they’re making. Ask about their relationship with the franchisor and the support they’re getting in exchange for the monthly royalty fees, which usually run 6-8% of gross sales. The 1-2% of gross sales the franchisor charges covers national advertising and supports regional marketing; ask whether they think they get a good return on the investment. The marketing fees also cover the cost of the technology that supports the business, including online advertising and systems used for ordering and other customer functions.

You can thank Ray Kroc, the founder of the McDonald’s franchise model, for recognizing that he was selling a system, not simply a location, to new franchisees. His ideas are the foundation of franchising, and why franchises have an 85%-92% survival rate after five years, almost double the success rate of independent businesses.

Ultimately, whether a franchise opportunity is a good deal or not is how you and your partner(s) feel about it. Your retirement or exit timeline, your financial position and existing debt, and your commitment to the time it takes to get off to a successful start all play a role. But if you have the drive and work ethic to run the business and follow the system, your investment will almost certainly pay off.