Buying a Franchise

When starting a business, you have three main options :

a) Start a business from scratch.

b) Buy an existing business.

c) Buy a franchise.

Buying a franchise is generally an expensive option, but mostly a safer option.

Let's first look at what is a franchise. Someone has started a business and it is running very successfully. He decides to expand the business. He now has two options, open another branch by hiring premises, staff, buying the equipment, etc., or franchise his business.

To open another branch means high initial overheads and the problems associated with managing staff from a distance, but it can bring in just as high an income as the first branch. If he decides to franchise, then the franchisee (person who buys the franchise from him) will take most of the profit, but the franchisor (person selling the franchise) doesn't have lay out the initial expenses and receives a smaller, but steady income from the franchise.

Why would you want to buy a franchise and why is a franchise more expensive?

Firstly the franchisor charges you a sum to set up the business. This sum normally includes the actual costs of setting up the business, initial marketing of the business, training in how to run the business, the right to use the franchisor's intellectual property, the advantage of the good will associated with the business and of course of profit for the initial services provided by the franchisor. Most of this makes sense except the intellectual property and good will bit. Buying the right to Intellectual property (IP) is buying the right to use the franchisor's name, logo, slogans, knowledge, systems, etc. Good Will (GW) is the amount of public recognition the brand has, eg., the better the product is known, the more likely the public will make use of it / buy it. If you now start selling that product, you will automatically get people that come in to buy it. You have thus profited from the good will of that brand. A well known brand like KFC charges a huge amount for IP and GW.

It is these costs that push up the initial price of a franchise. The advantage behind that initial cost is that you save way more than the price you paid in branding. Let's stick with the KFC example. If you start your own roast chicken business from scratch, you will have to spend huge amounts telling the public about your product. This doesn't only cost a lot, but it also takes time. People are creatures of habit and afraid of change. They would rather drive across town to buy a product they know than try a product nearby. This is why many companies hand out samples, this way the customer can try the product without spending anything or going out of his way to try it.

If, however, you pay ten times more for a KFC, you can be guaranteed that the customers will be lining up at your door on opening day, simply because they already know & love the product.

So here we have the first point to look out for when buying a franchise : Is the franchise established or not, and how does that reflect in the initial purchase price.

Many people try and franchise their businesses, the problem is that many of these businesses are not even established themselves yet. Most businesses fail within their first three years. If you are buying a franchise where the entire business hasn't even been in existence for 5 years, you are taking a huge gamble. That business could collapse at any time and take you with it. If the business has been running for 5 or more years though, then it could be a good proposition. If the business has been running for more that 10 years, then it probably is a good proposition.

Beware of franchises that are charging high initial start-up costs and low, or no, monthly royalties. Chances are these guys know that the business doesn't make much money so they have to make their money up front. Also beware of franchises that charge high monthly royalties. The worldwide standard is around 13% of turnover or less. Anything more and you will be living on the bread line while the franchisor is coining it. A franchisor that cares more about his franchisees and the business as a whole will charge a lower royalty (6% to 10%) as he knows he has a good business where the franchisee can make a good living, while he can also make a good living from many franchisee's royalties.

Buying a Franchise - To learn more about this author, visit Nolan Clark's Website.

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