How To's
The 10 Questions You MUST Ask Before You Buy a Franchise [2024]
Buying a franchise is a substantial investment. Most franchisors require a one time “franchise fee,” which can be as low as $10,000 or well over $100,000. The typical fee for a single unit generally falls in the $20,000 to $40,000 range. In addition, most single unit concepts also require substantial initial capital outlays in order to open. Franchisees must pay expenses for line items like construction, fixtures, equipment, and decor. These can be extremely low if no physical location, build-out, or expensive equipment is required. They can also be extremely high ($500,000 to $1,000,000+ range) if those are needed.
Given these significant upfront costs and ongoing fees and expenses, it is important to understand your investment before you buy.
Fortunately, the Federal Trade Commission requires franchisors provide prospective franchisees a a helpful tool to do so. The document, known as the Franchise Disclosure Document or “FDD” summarizes the terms of the franchise agreement in plain-English. The FDD also offers a general overview of all costs associated with launching a concept location. It must also include the franchisor’s standard franchise agreement.
The Franchise Disclosure Document is a valuable resource if you are considering investing in a particular brand. When reviewing the FDD and franchise agreement, these are the ten questions you NEED to ask before you invest.
(1) How much is the royalty fee and how often will I have to pay?
Most franchisors require you pay a continuing royalty fee for the duration of the franchise relationship. Most franchisors require franchisees pay their royalty fee as a percentage of weekly or monthly gross income. Royalty fees vary significantly industry-to-industry, but typically fall somewhere in the 3%-10% of gross income range. Franchisors may also require royalty fees in another form including a flat monthly or weekly fee.
Understanding your profitability potential in light of the royalty fee is very important. You will be paying this amount for the entire term of the franchise agreement.
You should also understand some additional pieces of information about the royalty fee. Typically, you pay royalties for the right to use the franchisor’s name, even if you are losing money. You may have to pay royalties for the duration of your franchise agreement even if the franchisor doesn’t provide the services it promised. Additionally, you may have to continue paying royalties even if you decide to terminate your franchisee agreement early.
Also, know how frequently the royalty must be paid. Is it paid weekly, is it monthly, and understand how this will affect your cash flow.
Where to look: Check Item 6 of the FDD.
(2) What are the advertising costs?
You also may have to contribute to an advertising fund and/or be required to spend a certain amount on local advertising. Many franchisors require franchisees to contribute a flat-rate amount or a percentage of gross income to a “brand fund.” Some portion of the “brand fund” may be allocated to national advertising or to attract new franchise owners, rather than to promote your outlet.
Be sure you understand both how much you are required to spend on advertising and where the money is going.
Where to look: Check Item 6 of the FDD.
(3) How much am I in for off-the-bat?
Your royalty and advertising fees will be incurred over the length of the franchise agreement. But what expenses do you have up front to launch your location? And how much do you really need to actually start your franchise location?
There are a number of factors that often affect the answer to that question. The amount can vary widely from franchise to franchise, but there are some general, common costs. Make sure you know whether the franchise requires these costs and, if so, how much each is.
- The initial franchise fee (the fee you pay to enter into the franchise system).
- Training expenses (how much you have to pay for, or to attend, your franchisor’s training).
- Real property (the cost to purchase or lease a location is required).
- Leasehold or capital improvements (the costs associated with outfitting your store per the franchisor’s requirements).
- Furniture, fixtures, and equipment.
- Beginning inventory.
- Business licenses and fees.
- Cash on hand you will likely need during the “initial phase” of operations.
Where to look: Item 7 of the FDD, which requires the disclosure in a prescribed five-column table of the estimated initial investment costs a franchisee can expect to incur.
(4) How long am I bound by the agreement?
Given the large capital outlay and continuing fees, it is extremely important to understand how long you are tied to your franchisor. Franchise agreement terms vary industry-to-industry and franchisor-to-franchisor. But contract duration will directly affect your bottom line. Know whether you will be paying a 10% royalty fee and a 2% advertising fee for five years, ten years, or fifteen years. Also know whether there are any early termination provisions, fees, or requirements if you terminate your franchise agreement early.
Where to look: Item 17 of the FDD and the Franchise Agreement
(5) Is the franchisor someone I can see myself partnering with for the entire term of the agreement?
Ask yourself whether the franchisor is somebody you truly want to work with. If you enter into the franchise agreement, you will be tied to the franchisor for the length of the term. Can you see yourself working with the franchisor’s representatives? Are the franchisor’s representatives people you actually get along with?
You should understand whether they are, and will be, responsive, caring, and easy to work with. It is also very important to know whether they value their franchisees’ opinions. Will you have a say in system development and changes you may like effected? Do your interests align with the franchisor’s?
Where to look: All of your interactions leading to the point of potential purchase. Review emails, and think about in-person conversations you have had.
(6) Under what circumstances can I exit the franchisee system?
Most franchise agreements are term agreements, providing for termination in very limited circumstances. These include termination by consent of the parties–that is, both you and your franchisor mutually agree to terminate the franchise agreement–and termination by the franchisor.
This means, that in most situations, you must fulfill your obligations under the contract for the length of the term. You may also be able to sell your franchise (see #8)
Where to look: Check Item 17 and “termination” section of the franchise agreement.
(7) If I want to remain in the franchise system, how much will it cost?
Understand whether you are entitled to renew your franchise, and if so, how much it will cost. Many franchise agreements permit renewal for at least one term, but charge a renewal fee. The fee is usually less than an initial franchise fee, but still can be substantial.
You should also understand what conditions may be imposed on renewal. Know whether you have to meet certain obligations in the initial agreement before renewal. Also understand how many terms you may renew your agreement for.
Where to look: Item 6 and Item 17.
(8) If I want to sell my location, can I, and how much will it cost?
What if you need to sell your franchise at some point down the road, can you? Many franchisors permit sale, but will charge a transfer fee, which can be substantial. Some franchisors charge flat fees of several thousand dollars. Others may charge a percentage of the current franchise fee, and/or a percentage of the sale price.
Where to look: Item 6 and Item 17.
(9) What do other Franchisees have to say about their experience in the franchise?
Who better to know what it’s like to be in the franchise system you are thinking of purchasing than a current or past franchisee. Contact them and find out what their experience with the franchisor was or has been.
Where to look: Check Exhibits to FDD for list of current and past franchisees.
(10) Can I negotiate any terms?
Many franchisees forgo asking whether fees can be reduced, requirements waived, or terms altered. It never hurts to ask. Some franchisors (especially if they are determined to make a sale) may be very willing to negotiate the terms of the franchise agreement.
Where to look: Consult with an attorney (highly recommended) or discuss with your point of contact for the franchisor.