• Understand what a franchise is
• Understand the advantages and disadvantages for franchisees
• Understand the advantages and disadvantages for franchisors

Franchises

franchise

A franchise is a business model that involves one business owner (the franchisor) licensing trademarks and methods to an independent entrepreneur (the franchisee) for a prescribed period of time.

For the franchisor, the franchise is an alternative to expanding through the establishment of a new location, which avoids the financial investment and liability of a chain of stores. Ultimately, the franchisor’s success depends on the success of the franchisees. If the franchisees are successful, then the franchisor can grow its brand and market presence, while the franchisee, in effect, does all of the work. 

The United States is a leader in franchising, a position it has held since the 1930s, when it used the approach for fast food restaurants, food inns, and, slightly later, motels during the time of the Great Depression. Today, the world’s largest franchise chains are U.S. companies:^[1][2][3]

• McDonald’s: With over 40,000 locations around the world and over $112 billion in sales, if you want to sell Big Macs as a franchisee, you should plan on an initial investment of $1.4 to $2.5 million.
• 7-Eleven: Over 78,000 of these convenience stores in 17 countries including the U.S. generate more than $95 billion in sales. The initial investment for one of these outlets is $125,000 to $1.3 million.
• KFC: This franchise can be found in 115 different countries, generating over $31 billion in sales. If you are interested in selling fried chicken flavored with the secret 11 herbs and spices, plan on an initial investment of $1.4 to $3.2 million.

Not all franchises require such large investments up front. For example, Cruise Planners is a franchise affiliated with American Express Travel. When you purchase a franchise, you become a travel advisor, helping customers plan cruises and other vacations. Because you can work from home, the start up costs are relatively low, between $13,000 to $34,000, including the franchise fee.^[4]

Buying a Franchise

The decision to purchase a franchise involves many factors, including how much you can afford to invest, what abilities you have, and what your goals are. Before you decide to purchase a franchise, it’s important to do thorough research. You could lose a significant amount of money if you don’t investigate a business carefully before you buy. By law, franchisors must disclose certain information about their business to potential buyers. Make sure you get all the information you need first before entering into this form of business.

The following strategies can help you gain a solid understanding of what to expect as well as the risks that could be involved:

• Be a Detective. In addition to the routine investigation that should be conducted prior to any business purchase, you should be able to contact other franchisees before deciding to invest. You can obtain a Uniform Franchise Offering Circular (UFOC), which contains vital details about the franchise’s legal, financial, and personnel history, before you sign a contract.
• Know What You Are Getting Into. Before entering into any contract as a franchisee, you should make sure that you would have the right to use the franchise name and trademark, receive training and management assistance from the franchisor, use the franchisor’s expertise in marketing, advertising, facility design, layouts, displays, and fixtures, and do business in an area protected from other competing franchisees.
• Watch Out for Possible Pitfalls. The contract between the two parties usually benefits the franchisor far more than the franchisee. The franchisee is generally subject to meeting sales quotas and is required to purchase equipment, supplies, and inventory exclusively from the franchisor.
• Seek Professional Help. The tax rules surrounding franchises are often complex, and an attorney, preferably a specialist in franchise law, should assist you to evaluate the franchise package and tax considerations. An accountant may be needed to determine the full costs of purchasing and operating the business as well as to assess the potential profit to the franchisee.

Franchise Taxes

The taxation of a franchise depends on the underlying form of ownership. Generally, franchises are required by the franchisor to be established as a corporation or LLC. Ultimately, the franchise agreement governs this, and individuals looking to purchase a franchise should scrutinize any agreements with regard to prescribed legal ownership structure. 

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