Carefully consider a number of factors, such as the demand for the products or services, likely competition, the franchisor's background, and the level of training and support you will receive.

Many people dream of being an entrepreneur. By purchasing and starting a franchise, you often can sell goods and services that have instant name recognition, and can obtain training and ongoing support to help you succeed. But be cautious. Like any investment, purchasing a franchise is not a guarantee of success.

Benefits and Responsibilities of Franchise Ownership

To help you evaluate whether owning a franchise is right for you, the Federal Trade Commission (FTC) has provided this information. It will help you understand your obligations as a franchise owner, how to shop for franchise opportunities, and how to ask the right questions before you invest.

A franchise typically enables you, the investor or "franchisee," to operate a business. By paying a franchise fee, you are given a format or system developed by the company ("franchisor"), the right to use the franchisor's name for a limited time, and assistance. For example, the franchisor may help you find a location for your outlet; provide initial training and an operating manual; and advise you on management, marketing, and personnel. Some franchisors offer ongoing support such as monthly newsletters, a toll free 800 telephone number for technical assistance, and periodic workshops or seminars.

While buying and starting a franchise may reduce your investment risk by enabling you to associate with an established company, it can be costly. You also may be required to relinquish significant control over your business, while taking on contractual obligations with the franchisor.
Below is an outline of several components of a typical franchise system. Consider each carefully.

The Cost

In exchange for obtaining the right to use the franchisor's name and its assistance, you may pay some or all of the following fees.

• Initial franchise fee and other expenses. Your initial franchise fee, which may be non-refundable, may cost several thousand to several hundred thousand dollars. You may also incur significant costs to rent, build, and equip an outlet and to purchase initial inventory. Other costs include operating licenses and insurance. You also may be required to pay a "grand opening" fee to the franchisor to promote your new outlet.

• Continuing royalty payments. You may have to pay the franchisor royalties based on a percentage of your weekly or monthly gross income. You often must pay royalties even if your outlet has not earned significant income during that time. In addition, royalties usually are paid for the right to use the franchisor's name.

•  Advertising fees. You may have to pay into an advertising fund. Some portion of the advertising fees may go for national advertising or to attract new franchise owners, but not to target your particular outlet.

Controls

To ensure uniformity, franchisors typically control how franchisees conduct business. These controls may significantly restrict your ability to exercise your own business judgment. The following are typical examples of such controls.

• Site approval. Many franchisors pre-approve sites for outlets. This may increase the likelihood that your outlet will attract customers. The franchisor, however, may not approve the site you want.

• Design or appearance standards. Franchisors may impose design or appearance standards to ensure customers receive the same quality of goods and services in each outlet. Some franchisors require periodic renovations or seasonal design changes.

•  Restrictions on goods and services offered for sale. Franchisors may restrict the goods and services offered for sale.

•  Restrictions on method of operation. Franchisors may require you to operate in a particular manner. The franchisor might require you to operate during certain hours, use only pre-approved signs, employee uniforms, and advertisements, or abide by certain accounting or bookkeeping procedures. The franchisor also may require you to purchase supplies only from an approved supplier.

•  Restrictions of sales area. Franchisors may limit your business to a specific territory.

Terminations and Renewal

You can lose the right to your franchise if you breach the franchise contract. In addition, the franchise contract is for a limited time; there is no guarantee that you will be able to renew it.

• Franchise terminations. A franchisor can end your franchise agreement if, for example, you fail to pay royalties or abide by performance standards and sales restrictions. If your franchise is terminated, you may lose your investment.

• Renewals. Franchise agreements typically run for 15 to 20 years. After that time, the franchisor may decline to renew your contract. Also be aware that renewals need not provide the original terms and conditions. The franchisor may raise the royalty payments, or impose new design standards and sales restrictions. Your previous territory may be reduced, possibly resulting in more competition from company-owned outlets or other franchisees.

Preliminary Considerations

Before investing in a particular franchise system, carefully consider how much money you have to invest.  For additional information, read the “Franchise Financing” side bar in this article and the “Raising Money for Your Home Business” article in this issue.

Selecting a Franchise

Like any other investment, purchasing a franchise is a risk. When selecting a franchise, carefully consider a number of factors, such as the demand for the products or services, likely competition, the franchisor's background, and the level of training and support you will receive.

Demand

Is there a demand for the franchisor's products or services in your community? Is the demand seasonal? For example, lawn and garden care or swimming pool maintenance may be profitable only in the spring or summer. Is there likely to be a continuing demand for the products or services in the future? Is the demand likely to be temporary, such as selling a fad food item? Does the product or service generate repeat business?

Competition

What is the level of competition, nationally and in your community? How many franchised and company-owned outlets does the franchisor have in your area? How many competing companies sell the same or similar products or services? Are these competing companies well-established, with wide name recognition in your community? Do they offer the same goods and services at the same or lower price?

Your Ability to Operate the Business

Will you be able to operate your outlet even if the franchisor goes out of business? Will you need the franchisor's ongoing training, advertising, or other assistance to succeed? Will you have access to the same or other suppliers? Could you conduct the business alone if you must lay off personnel to cut costs?

Name Recognition

A primary reason for purchasing a franchise is the right to associate with the company's name. The more widely recognized the name, the more likely it will draw customers who know its products or services.

Training and Support Services

Another reason for purchasing and starting a franchise is to obtain training and support from the franchisor. What training and ongoing support does the franchisor provide? How does their training compare with the training for typical workers in the industry? Could you compete with others who have more formal training? What backgrounds do the current franchise owners have? Do they have prior technical backgrounds or special training that helps them succeed? Do you have a similar background?

Franchisor's Experience

Many franchisors operate well-established companies with years of experience both in selling goods or services and in managing a franchise system. Some franchisors started by operating their own businesses. There is no guarantee, however, that a successful entrepreneur can successfully manage a franchise system.

Carefully consider how long the franchisor has managed a franchise system. Do you feel comfortable with the franchisor's expertise? If franchisors have little experience in managing a chain of franchises, their promises of guidance, training, and other support may be unreliable.

Growth

A growing franchise system increases the franchisor's name recognition and may enable you to attract customers. Growth alone does not ensure successful franchisees; a company that grows too quickly may not be able to support its franchisees with all the promised support services. Make sure the franchisor has sufficient financial assets and staff to support the franchisees.

Shopping at a Franchise Exposition

Attending a franchise exposition allows you to view and compare a variety of franchise possibilities. Keep in mind that exhibitors at the exposition primarily want to sell their franchise systems. Before you attend, research what type of franchise best suits your investment limitations, experience, and goals. When you attend, consider the amount you feel comfortable investing and the maximum amount you can afford. Consider the industry that appeals to you, is best suited for you to work in, and that offers more realistic opportunities.
Comparison shop by visiting several franchise exhibitors engaged in the type of industry that appeals to you. Listen to the exhibitors' presentations and discussions with other interested consumers.

Investigating the Franchisor's Offering

Do not sign any contract or make any payment until you have the opportunity to investigate the franchisor's offering thoroughly. The FTC's Franchise Rule requires the franchisor to provide you with a disclosure document containing important information about the franchise system. Study the disclosure document. Take time to speak with current and former franchisees about their experiences. Have an attorney review the disclosure document and franchise contract and have an accountant review the company's financial disclosures.

Disclosure Documents

Before investing in any franchise system, be sure to get a copy of the franchisor's disclosure document, sometimes called a Franchise Offering Circular. Under the FTC's Franchise Rule, you must receive the document at least 10 business days before you are asked to sign any contract or pay any money to the franchisor. You should read the entire disclosure document. Make sure you understand all of the provisions. The following outline will help you to understand key provisions of typical disclosure documents. It also will help you ask questions about the disclosures. Get a clarification or answer to your concerns before you invest.

Business Background

The disclosure document identifies the executives of the franchise system and describes their prior experience. Consider not only their general business background, but their experience in managing a franchise system. Also consider how long they have been with the company.

Litigation History

The disclosure document helps you assess the background of the franchisor and its executives by requiring the disclosure of prior litigation. The disclosure document tells you if the franchisor, or any of its executive officers, has been convicted of felonies involving, for example, fraud, any violation of franchise law or unfair or deceptive practices law, or is subject to any state or federal injunctions involving similar misconduct. It also will tell you if the franchisor, or any of its executives, has been held liable or settled a civil action involving the franchise relationship.

Bankruptcy

The disclosure document tells you if the franchisor or any of its executives has recently been involved in a bankruptcy. This will help you to assess the franchisor's financial stability and general business acumen and predict if the company is financially capable of delivering promised support services.

Costs

The disclosure document tells you the costs involved to start one of the company's franchises. It will describe any initial deposit or franchise fee, which may be non-refundable, and costs for initial inventory, signs, equipment, leases, or rentals. The following checklist will help you ask about potential costs to you as a franchisee.
• Continuing royalty payments.
• Advertising payments to local and national advertising funds.
• Initial business promotions.
• Business or operating licenses.
• Product or service supply costs.
• Real estate and leasehold improvements.
• A computer system.
• Training.
• Legal fees.
• Financial and accounting advice.
• Insurance.
• Compliance with local ordinances.
• Health insurance.
• Employee salaries and benefits.

It may take several months or longer to get your franchise started. In your total cost estimate, include operating expenses for the first year and personal living expenses for up to two years.

Restrictions

Your franchisor may restrict how you operate your outlet. The disclosure document tells you if the franchisor limits:
•  The supplier of goods from whom you may purchase.
•  The goods or services you may offer for sale.
•  The customers to whom you can offer goods or services.
•  The territory in which you can sell goods or services.

Terminations

The disclosure document tells you the conditions under which the franchisor may terminate your franchise and your obligations to the franchisor after termination. It also tells you the conditions under which you can renew, sell, or assign your franchise to other parties.

Training and Other Assistance

The disclosure document will explain the franchisor's training and assistance program. The level of training and assistance you need depends on your own business experience and knowledge of the franchisor's goods and services. Keep in mind that primary reasons for investing in the franchise, as opposed to starting your own business, is training and assistance. If you think the training might be insufficient to handle day-to-day business operations, consider another franchise opportunity more suited to your background.

Advertising

You often must contribute a percentage of your income to an advertising fund even if you disagree with how these funds are used. The disclosure document provides information on advertising costs.

Current and Former Franchisees

The disclosure document provides important information about current and former franchisees. Determine how many franchises are currently operating. A large number of franchisees in your area may mean increased competition. Pay attention to the number of terminated franchisees. A large number of terminated, cancelled, or non-renewed franchises may indicate problems. A number of different owners over a short period of time may also indicate that the location is not a profitable one, or that the franchisor has not supported that outlet with promised services.

The disclosure document gives you the names and addresses of current franchisees and franchisees who have left the system within the last year. Speaking with current and former franchisees is probably the most reliable way to verify the franchisor's claims. Visit or phone as many of the current and former franchisees as possible. Ask them about their experiences. See for yourself the volume and type of business being done.

Earnings Potential

You may want to know how much money you can make if you invest in a particular franchise system. Insist upon written substantiation for any earnings projections or suggestions about your potential income or sales. Franchisors are not required to make earnings claims, but if they do, the FTC's Franchise Rule requires franchisors to have a reasonable basis for these claims and to provide you with a document that substantiates them. This substantiation includes the bases and assumptions upon which these claims are made. Make sure you get and review the earnings claims document.

Financial History

The disclosure document provides you with important information about the company's financial status, including audited financial statements. Be aware that investing in a financially unstable franchisor is a significant risk; the company may go out of business or into bankruptcy after you have invested your money.

Additional Sources of Information

In addition to reading the company's disclosure document and speaking with current and former franchisees, you should speak with the following:

Accountant and Lawyer

Investing in and starting a franchise can be costly. An accountant can help you understand the company's financial statements, develop a business plan, and assess any earnings projections and the assumptions upon which they are based. An accountant can help you pick a franchise system that is best suited to your investment resources and your goals.   

Franchise contracts can be long and complex. A contract problem that arises after you have signed the contract may be impossible or very expensive to fix. A lawyer can help you understand your obligations under the franchise contract, so you will not be surprised later.

Banks and Other Financial Institutions

These organizations may provide an unbiased view of the franchise opportunity you are considering. Your banker should be able to get a Dun & Bradstreet report or similar reports on the franchisor.

Better Business Bureau

Check with the local Better Business Bureau (BBB) in the cities where the franchisor has its headquarters. Ask if any consumers have complained about the company's products, services, or personnel.

Government Departments

Several states regulate the sale of franchises. Check with your state Division of Securities or Office of Attorney General for more information about your rights as a franchise owner in your state.

Buying and starting a franchise is investing in your future. The International Franchise Association (IFA), one of the world’s oldest and largest associations representing the franchise industry, wants tomorrow's franchise owners to make educated decisions about their futures. For more information about franchising, visit IFA's web site at www.franchise.org or the FTC’s web site at www.ftc.gov. HBM

Source: exerted from Federal Trade Commission (FTC), www.ftc.gov. Excerpted from the FTC’s “Consumer Guide To Buying A Franchise.” Also reprinted with permission of the International Franchise Association, www.franchise.org. V17-5 HP: ? CAR: ? 2/2012