Business Resource Center

Franchising

Franchising is another way you can experience running your own business without having to build or buy a company. In this instance, franchisees purchase the rights (license) to a franchisor’s proven business model as well as the physical location from which to operate the business. Franchisors already have the infrastructure of the business in place (business plans, distribution channels, branding, packaging, etc.) and the franchisee is trained in the operational procedures for implementation into their location. This eliminates some of the risk taken on by the franchisee because there are already standardized processes and an established customer base with a well-known brand in place (think, McDonalds, Dunkin Donuts, Days Inn, etc.). The franchising model has worked for many and can lead to one franchisee operating many locations, which can be very lucrative.

If you are the type of person who likes to be in full control, this may not be the best option for you. Franchising involves binding agreements in which certain requirements must be met. There is little to no room for independent decision making on the part of the franchisee. Another difficulty in running a franchise is the effects of bad publicity. For example, if an incident happens at a McDonalds in Louisiana and it is widely covered by the media, this could affect your sales despite the good reputation you have built in your community. The incident will be associated with the brand you are licensing, not your own personal reputation. It is also the case that not all franchise systems are comprehensive and some may not be as supportive as others in terms of training and resources.

It is important to conduct research on the franchise you are considering to find out all of the details involved and to make sure it is a good fit for you. You can also consult with lawyers who are specifically trained in franchising agreements. 

SOURCE: Franchise Basics found in Entrepreneur Magazine

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Franchising Fees

Franchisees pay a one-time franchising fee to the franchisor. The amount can vary from a few thousand dollars to several hundred thousand dollars, depending on the profitability of the business. There is also a periodic royalty or licensing fee that is usually paid every week, month, or quarter for the use of the company's proprietary information and resources. The amount can range from 2% - 10% of gross sales or a set figure, depending on the franchising agreement. 

Advertising Fees & Signage

Because you are dealing with an established brand, you don't need to worry about building advertising campaigns and signage. However, you will most likely be required to pay a fee for advertising (since you will be benefiting from it), as well as a sign package that is compiled by the franchisor. 

Physical Location & Equipment

As a franchisee, you will be responsible for obtaining a physical location for business operations. You can either purchase or lease a building for which you are fully financially responsible. In either case, you will have to pay for leasehold improvements, which are the necessary customizations needed for the location to resemble the franchise's brand theme. Sometimes a franchisor will provide a stipend for these modifications, which have an average range of $10,000 - $35,000. You will also be responsible for the purchase or lease of any equipment needed for business operations. 

Opening Inventory

The specifics of this topic are generally outlined in the franchise agreement, but you can expect to have a minimum two-week supply of inventory on hand. 

Working Capital

You will need to make sure you have enough cash on hand to pay for initial costs such as, rent (deposit, first and last month’s, and security fee), utilities, salaries, money for the cash register, etc.

Federal Regulations

The Federal Trade Commission (FTC) established the Franchise Rule on October 21, 1979, which requires franchisors to provide a full disclosure of the information about the franchise before the final investment decision is made. The disclosure of information is found in the Franchise Disclosure Document (FDD), which must be delivered to the franchisee at least 14 days before the signing of official contracts and documents.

The FDD is designed to highlight in detail all of the information needed to ensure the franchisee understands the conditions of the franchise agreement. It is comprised of three main parts:

  • 23 characteristics of the franchising system
  • Franchisor’s financial statements
  • Copies of the contract and any accompanying forms franchisee will sign upon agreement

This document is long and can be tedious to get through, but it is important that you read through it carefully and make sure you understand and agree to the terms. Legal and financial consulting is highly recommended for this phase of the process. 

Download information on franchise regulations:

State of New Mexico Franchise Laws

Franchises are subject to laws of the state in which they conduct business, so you will need to check the legal requirements for franchises in your state. Some states require registration with the government, but New Mexico is not one of these states. It is important to keep yourself updated on the legal and regulatory changes of the business environment in order to avoid unintentionally falling into violation.

Much like starting your own business or buying an existing one, you will want to first evaluate the type of franchise you want to license based on personal interests and skill sets. In what industry are you familiar? Is there an industry that is particularly interesting to you? Do you think you can learn the skills required for that industry and apply your existing skills to that type of work?

Consider the geographic location of the franchise, its market performance, reputation, and whether or not it has been involved in any lawsuits or bankruptcies. This type of information should be easy to find in newspaper articles and other online resources. For instance, Entrepreneur.com has several listings on this topic:

You can also check with the New Mexico Secretary of State's Office to see if there are any serious issues with the franchise company.

Industry Associations & Trade Shows

Another resource for finding the franchise that is right for you is to become familiar with franchise industry associations and attend trade shows. Industry associations are organizations that offer information on the industry, tips for best practices, and much more. Benefits to joining these associations include discounts to trade shows, connections with suppliers and distributors, and other special offers.

Attending trade shows is a good way to personally interact with people from franchises, gather information, and get a more definite sense of the dynamic of franchising. Many different franchises go to these events so you can ask questions about the different systems and requirements for licensing. Go prepared with your research and readily available questions. Below are just a few links to introduce you to some franchise industry associations and trade shows. Perform your own online search on tradeshows for more information.

Traditional Forms of Financing

Some franchises are ideal for traditional forms of financing such as investing your personal funds or obtaining mortgage-backed or business loans. These loans are relatively easy to secure if you have a good credit score, own enough of your home, and are franchising with a well-established company that has a proven record of success. Often you will be required to put as much as 20% of the amount needed into the franchise before a loan will be issued. However, these loans are hard to obtain for new franchises that are not well-established as well as for new franchisees (unless there is a previously established relationship with the bank).

SBA Loans

SBA loans may be a better option for new franchisees and/or new, less established franchise locations. These loans carry less risk because they are backed by the government, and are referred to as 7(a) loans. They are available in short- and long-term maturities, and approximately 10% of SBA loans are awarded to franchisees for entry fees, improvements, or working capital.

Franchisor Financing

Franchisors rarely offer financing to franchisees, however, some have built financing programs within their company structure or have built relationships with lending companies to assist franchisees with financing. Ask the franchisor if such a program exists. 

SOURCES: How to Finance a Franchise Purchase found in the Wall Street Journal and Financing 101 found in Franchise Solutions.