As originally appeared on American Express
How to Start a Franchise in 5 Steps
Interested in how to start a franchise? These experts say do your research before buying into a well-known brand.
Journalist, freelance writer
If you’re wondering how to start a franchise, you’re hardly alone. It’s an extremely popular type of business.
As you probably know, a franchise is a business system that corporations sell to interested parties. Optimists call it a “business in a box.” It’s that idea that you’re buying a business that will run itself once you open the doors. It isn’t quite that easy, of course, but people buy franchises in order to purchase a brand that has a proven following and business model.
The franchisee pays (often a lot of) money upfront to buy the rights to purchase a franchise, and there are franchise fees to pay as well. Franchisees will usually pay a monthly royalty fee (often 4 to 12 percent of the revenue) and a marketing fee (varies but think 2 percent of monthly revenue).
Understand the Available Franchise Types
When you think of franchises, you probably think of restaurants because they’re everywhere. Yet there are so many different categories of franchises.
“There are over 4,000 franchise brands out there. That’s more choices than there are stocks on the NASDAQ or the NYSE,” says Kenny Rose, the founder and CEO of Semfia, a Chicago-based franchise consultancy that caters to people who want to invest in franchises.
- fitness centers
- automotive repair
- commercial and residential cleaning services
- dry cleaners
- home health-care providers
- pet-care providers
- education and tutorial services
- tax preparation services
Corporations tend to start franchising when they want to expand the business and spread the financial risk that comes with expansion. People who buy a franchise pay good money to do that. Let’s run down some of the issues you should consider if you’ve been wondering how to start a franchise.
There’s a lot to it.
Step 1: Research your options.
John Stodghill owns two Closets by Design in Austin and San Antonio. Before he became a franchise owner, Stodghill worked for the customized closets company as a vice president. Still, he wasn’t immediately sure if he wanted to own a Closets by Design or try something completely different. He looked at quite a few franchises, mostly restaurants and fitness centers, but neither fit his background or work experience.
“I had a friend who had achieved a very high level of success owning franchise restaurants, and he advised me to find something where I can directly apply what I have learned over 25 years of working for others, versus something I’ve never done before,” Stodghill says.
Once he did that, Stodghill realized it did make sense to go with Closets by Design. It would still be a completely new experience but not completely foreign either.
If you’re wondering how to start a franchise, first determine what type of franchise you want to buy. There are numerous franchise websites where you can research what’s out there. There are also franchise brokers, franchise coaches and even franchise coaching services that are franchises themselves. There’s no shortage of ways to discover what’s out there in the world of franchising.
And a franchise really needs to be a good fit for you. You may feel like you have the experience to run a franchise, but ideally, you also want to be interested in what your business produces.
“You will be all-consumed for a while as you get your business up and going. You must enjoy it! So do something new, but at least picture yourself liking it before jumping in,” advises Brant Wilson, the president and COO of Palm Beach Gardens, Florida-based TBC Automotive Operations at TBC Corporation. (TBC Corporation owns the franchises Midas and Big O Tires.)
Step 2: File for incorporation.
This doesn’t necessarily need to be the second step, but many franchisors prefer to work with a corporation or LLC.
There are other reasons too: You’re forming a company so it’s your business that’s buying the franchise. It may seem like semantics, but from a legal standpoint, you’re separating your personal assets from your business liabilities.
Step 3: Arrange financing.
“When it comes to funding it’s always important to get pre-qualified just like buying a home. Most people don’t get pre-qualified before they start researching because they’re still exploring the idea of franchising,” Rose says.
Still, before you get in too deep (and possibly disappointed by the types of loans you can get), it’s worth looking into financing.
“I usually recommend to first look at minimum liquidity requirements the franchise needs to make sure you qualify. This liquidity is 20-30 percent of the entire investment and the rest will come from an SBA loan,” Rose says. “Your liquidity can come from cash, lending against securities or most commonly to utilize the Rollover for Business Startups (ROBS) so you can use pre-tax dollars from a 401(k) or non-Roth IRA, tax free and penalty free.”
In general, a prospective franchise owner should have at least $50,000 in liquid assets, a $150,000 total net worth, and a 680 credit score, he says. (Rose suggests talking to a lender that specializes in franchising when you’re 100 percent on board with opening a franchise.)
That said, there are some franchises that specialize in people who don’t have a lot of access to funds. You may find a franchise you can run from your home office, which would help cut down your startup costs.
Contact several franchisees and explain that you are considering opening a franchise. If the franchisees are even halfway chatty, you should quickly get a sense of whether this is a franchise that you want in on.
Still, there’s no doubt that many franchises are expensive. Stodghill needed to raise around $400,000 for the two franchises he ended up buying.
“I got the majority of the funds through an SBA loan. The remainder came from a few close friends who were willing to help and possibly get a return as well,” he says, adding: “They all got a nice return.”
Nancy Rhodes owns an Enviro-Master Services in Columbia, South Carolina and purchased an existing franchise from someone who wanted to sell.
“To finance, I used a mechanism called ROBS, rollovers as business startups,” Rhodes explains. “The IRS allows one to use dollars set aside in an IRA for retirement to buy stock in one’s own company without triggering a tax liability.”
There are a lot of ways to find funds for your franchise, from commercial business loans to lines of credit. But it does help to have a healthy credit score and the type of background that gives a lender the confidence that you’re a good risk.
Step 4: Talk to the franchisors and franchisees.
When you’re looking into opening a franchise, you might encounter franchisors in a variety of ways: by reaching out directly, through their website, at a franchise convention… Many franchisors even have Discovery Days, where prospective franchisees attend the company’s headquarters to talk with corporate executives and learn about what it takes to buy the franchise.
At the Discovery Days for Midas and Big O Tires, prospective franchisees “meet executives from operations, marketing, real estate, IT, product management, training and other organizations that will support them each day as their franchisor,” Wilson says.
But you should also make room in your schedule to talk to individual franchisees, the people who were once like you—looking in from the outside and wondering how to start a franchise. Many franchisors will tell you that it’s a good idea to talk to the franchisees.
“Talk to them about their relationship with other franchisees—it’s great to have a culture where they get together regularly to share with each other,” Wilson says. “Talk to them about the franchisor. Let’s face it—no franchise system is perfect. But get all the info you can to make the best decision.”
While no franchise system is perfect, some are run very well and some aren’t. Contact several franchisees and explain that you are considering opening a franchise. If the franchisees are even halfway chatty, you should quickly get a sense of whether this is a franchise that you want in on or one you want to steer clear from.
Step 5: Hire professionals.
At some point, you will probably want to start seeking professional help beyond relying on the franchisors you’re talking to.
For instance, you might want to hire a franchise attorney—one who hasn’t been recommended by the franchisor and who will be working for you to make sure your interests are served as much as the franchisor. There is so much to pore through, such as the Franchise Disclosure Document (FDD), a legal document that every franchisor has to send to you before you actually invest your money into a franchise.
If you’re going to buy a franchise, you don’t want to wing this. Why? Because you want to make sure you really understand what you’re getting into, says Ron Humes.
Humes has kind of done it all—often at the same time. The vice president of Post Modern Marketing, a marketing agency in Lexington, Kentucky, Humes has also been a realtor and owner of his own realty company for two decades. Some years back, he bought a franchise and turned his realty company into a franchise realty firm. That didn’t go so well.
“Most franchises have requirements for compliance. These will include the type of space you lease or purchase, the way you decorate the space, the way you keep and report your books and the way you run your business,” Humes says.
He knew that going in, and “during the courting period with the franchise salesperson, we were promised simplicity and assistance.”
But after Humes became a franchise owner, he felt all of the rules his company had to follow were hurting his company’s productivity rather than helping it.
“Make certain you have a very good understanding of the burden that will be placed on you and your team,” says Humes. He eventually got out of the franchise contract and became an independent firm again.
“Also, be sure to get a clear understanding of your contractual obligations, rights and liberties,” he adds. “Once you sign the franchise agreement, you will be contractually and legally bound. These agreements can be hundreds of pages and are often written in [the] legal speak of franchise attorneys representing the interests of the franchisor.”
And while there’s nothing wrong with that, you may want your own attorney and other professionals, such as an accountant, representing your interests.
Rhodes hired an attorney who specializes in franchises, which helped her a lot. In fact, she says, the least stressful part for her was buying the franchise.
“What was stressful was the first year,” Rhodes says, listing a mix of personal ups and downs as well as the standard roller coaster ride of business ownership. But she did well, and the Enviro-Master Services corporation named her Rookie of the Year.
Stodghill of Closets By Design has a pretty good rhythm going now, but he admits, “The first year and a half aged me 10 years. I wish I was joking.”
Franchises may not really be businesses in a box, but they’re the closest thing to them. As you begin the process of figuring out how to start a franchise, the more you prepare and educate yourself, the better off you’ll be.
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