Growing a business can be done in many ways, including through organic and inorganic growth, through mergers and acquisitions, and by expanding into new markets. Each has its advantages and disadvantages. Franchising may be an option for some businesses and, if done correctly, can fuel rapid and exponential growth.
Select Funding provides affordable financing to small businesses and that includes loans to power a franchising plan. Franchising requires careful preparation if it is to be a successful growth model. If franchising is something you’re considering for your business, here is our guide for how to franchise your business plus 11 advantages and disadvantages to consider.
What is Franchising?
Franchising is a form of business expansion where the person or persons who started a company and established its brand, products, and trademark makes these things available to others to open remote locations under the same name. The original business is known as the franchisor and the person who pays them for the right to open a business is known as the franchisee. Technically, the relationship between the two parties is the franchise although it’s more common to refer to each business location as a franchise.
There are two main types of franchising but one is more commonly known than the other:
- Business format franchising involves the franchisor providing the franchisee not only with its trade name and business services or products, but also with a complete system for setting up and running a business. A McDonald’s franchise is the best-known example of this.
- Production distribution franchising involves the franchisor manufacturing a product and the franchisee distributing it. This type of franchising is most common in manufacturing and in the automotive, gas, and bottling industries.
Franchising is one way to scale your business growth because the franchisees take on most of the financial responsibility of opening a location and most of the risk.
How Do You Know if You Should Franchise Your Small Business?
Franchising can power business growth, but how do you know if your business is one that can and should be franchised? Here are some signs to consider:
- You have a proven business model.
- Your small business is consistently profitable.
- You have a reliable team in place.
- Your business runs smoothly even without your presence.
- Your business would find an audience in many locations.
- Your business growth has slowed and you need a new way to keep it growing.
- You can teach other people to do what you do.
- You’re excited by the possibilities of helping entrepreneurs start businesses.
- You’ve been approached by more than one person asking about franchising with you.
The first four items are necessary. You should not franchise your business if you’re not profitable or if your business model is untested. While franchising may seem like a way to save a struggling business, that’s not the case. Franchising requires a lot of work and an initial investment of both time and money.
11 Advantages and Disadvantages of Franchising
As you might expect, a franchise operation has advantages and disadvantages for the franchisor. Here are some things to consider before you franchise your business.
Advantages of Franchising
As we mentioned above, franchising can be a method to scale your business. These are the advantages of franchising.
#1: Franchising Fuel Rapid Expansion
Franchising can fuel rapid business growth because it shifts most of the responsibilities of opening a business to the franchisee.
#2: Little Capital is Required
Franchisees pay franchise owners for the right to use the business name and sell its products. That means that there is little up-front investment required for the franchisor.
#3: The Franchisee Assumes the Risk
In most cases, the franchisee pays an up-front fee and puts their name on the lease for the franchise business location. That means that the franchisor has very little risk associated with franchising.
#4: Brand Recognition Increases
One of the biggest advantages of franchising is that your brand visibility and recognition will increase with new locations opening. The recognition can help your business continue to grow as more people decide to buy franchises.
#5: Franchisees Generate Income
Franchisees have a financial interest in the businesses they open and that makes them motivated to turn their location into a successful franchise business. You’ll receive royalties when they are successful, thus increasing your cash flow and profits.
#6: Franchising Doesn’t Add to Your Workload
The responsibility of opening a new location and running it falls to the franchisor. While you will need to do some work when you create your franchise model and build resources for franchisees, it’s mostly a hands-off way of expanding your business.
#7: Your Buying Power Will Increase
As new franchises open, you can use your company’s increased need for raw materials to negotiate lower prices for the things you buy.
Disadvantages of Franchising
Here are some of the potential disadvantages of franchising.
#1: You Won’t Have Complete Control Over Your Franchise Brand
Even though you’ll provide franchisees with information about your brand and how to promote it, franchising your business means giving up some of your control over your brand and how people perceive it.
#2: The Startup Costs May Be Significant
Franchising can fuel rapid business growth but you should be prepared to make an upfront investment. You’ll need to work out a franchising plan, hire a lawyer to write your contracts, and create documentation and resources for franchisees to use.
#3: There’s an Increased Risk of Litigation
Any business agreement carries with it the possibility of a legal dispute. Your franchise attorney can help to minimize your legal risks with a well-crafted legal contract for franchisees to sign, but you’ll need to consider the possibility that legal disputes may still arise.
#4: You’ll Need to Consider Federal and State Regulations
The Federal Trade Commission has created a franchise rule that requires franchisors to disclose 23 items to franchisees. Some states don’t require franchisors to file franchise disclosure documents but others do, so you’ll need to check to be sure you’re in compliance.
What Are the Steps to Franchise a Business?
If you do decide to sell franchises for your business, here are the steps you’ll need to follow:
- Protect your intellectual property. Franchisees will need access to your intellectual property in some cases but you’ll need to identify what they need and what they don’t and be sure to communicate with your lawyer to include protections in your franchise agreement.
- Create a franchise strategy. You’ll need to think about where and how to sell franchises, what you’ll require, and whether you want to offer incentives if people refer prospective franchisees to you. Your strategy should include location information, marketing plans, and anything else that might contribute to the success of your franchises.
- Prepare your franchise disclosure agreement. The disclosure document is required by the FTC’s franchise rule, which we mentioned above. You’ll need to provide a copy to every franchisee at least two weeks before they sign a franchise agreement and update it annually.
- Draft a franchise agreement. The agreement is what governs how the prospective franchisee must operate their business and lays out their legal obligations. It should include information about franchise fees and royalties, minimum gross sales requirements, an opening timeline, limitations on transferring the franchise to a third party, and legal protections for you including a confidentiality agreement, a non-compete clause, and franchise territory protections.
- Create an operations manual. The operations manual is where you will lay out the process of opening a franchise location. It must be confidential. Ideally, it should be digital and include links to supporting documentation and resources, including videos. You should update the manual as needed.
- Screen potential franchisees. While it might be tempting to sell franchises to everybody who wants one, do not skip the step of performing your due diligence on prospective franchisees. You should do both a soft credit check and a criminal background check. The former will reveal whether the potential franchisee struggles with money by revealing past delinquencies, bankruptcies, or tax liens. The latter will tell you whether the prospect is someone you should trust with your brand.
- File or register your franchise disclosure. The franchise disclosure agreement must be filed with the FTC and may also need to be filed with the state where you’re doing business. You should know that some states that do not require filing of the disclosure agreement have other requirements, such as registering a trademark.
We suggest that you have a system for checking in with your franchisees regularly. In addition to reviewing financial reports from franchisees, you may also want to visit locations to observe operations or implement a secret shopper program. You may also want to ask the franchisee to send you copies of customer complaints.
Get Working Capital to Franchise Your Business with Select Funding
Franchising under the right circumstances is one of the most effective ways to scale your business and increase your profits. If you do the preparation required up front and protect your brand and intellectual property, your franchise locations can increase your brand awareness and fuel exponential growth.
Do you need working capital to create a franchise strategy and business plan? Select Funding is here to help! Click here to learn about our business financing and apply today.
