Four questions to ask before starting a franchise

Opening a franchise is a tempting approach to entrepreneurship. You get a playbook and an established brand, and the franchising opportunities appear virtually endless. But it’s not all froyo and free lunches. Before you sign any franchise agreement, ask yourself these four questions.

Shannon Stapleton/Reuters/File
An advertisement for job openings is seen outside a Burger King franchise in Port Washington, New York (September 16, 2015).

Opening a franchise is a tempting approach to entrepreneurship. You get a playbook and an established brand, and the franchising opportunities appear virtually endless. FRANdata, a franchise-focused research and advisory firm, estimates that two to three franchise brands are launched each day, with the lodging industry, health and fitness businesses, and sit-down restaurants leading the charge.

Business-owners-to-be have taken notice. The International Franchise Association Educational Foundation estimates that franchise employment will be up 3.1% in 2016, compared with a growth rate of 1.9% in nonfarm private-sector employment, continuing a steady trend established in 2011.

But it’s not all froyo and free lunches. Franchise owners face many of the same problems as traditional entrepreneurs, including finding small-business funding, managing a staff, and keeping customers happy.

Before you sign any franchise agreement, ask yourself these four questions:

1. Are you comfortable running a franchise?

Yes, a franchise comes with guidelines from the company to help you get started, but you have to feel comfortable executing the vision, says Darrell Johnson, CEO of FRANdata.

“That involves two strategies: outward facing and inward facing,” he says. Outward-facing strategies are consumer-focused and include customer service, marketing and sales. Inward-facing strategies involve the nitty-gritty of business management, such as human resources and financial management. “You have to be good at both, or feel comfortable putting people in a position to do those things for you,” Johnson says.

Even with the support of a brand behind you, you’re still entering a world where you are in charge of hiring — and firing — employees, managing finances, and turning a profit.

“You can’t just say, ‘I love yogurt and want to sell frozen yogurt,’ ” Johnson says.

This is true, he notes, not just of opening a franchise but also of starting any type of business.

2. Do you have money, and then some?

“Whatever you think you’re going to need in the way of capital to get started,” Johnson says, “have a fair amount of cushion beyond that.”

Beyond traditional costs associated with starting a business, franchisees also face specific fees required to get their store off the ground. They include a franchise fee charged by the brand, potentially costing tens of thousands of dollars, and royalty and marketing fees, regularly taken as a percentage of sales.

Outside of fees and startup costs, Johnson recommends having a healthy amount of working capital to help get you through unexpected events, such as liability issues when a customer slips and falls, or broken equipment.

“The day you run out of cash is the day you close,” he says. “You need that working capital to last you longer than you’re led to believe or think is necessary.”

3. What brand will you pick?

Just because you like a certain hotel chain doesn’t mean you should hit up the nearest location and start talking numbers. Doing your due diligence before picking a shop is crucial because different franchisors, even within the same industry, may be drastically different.

Take, for example, a franchise restaurant with a full menu versus one that specializes in just a few items, like a wing joint or an ice cream parlor. Although both are in the food industry, one situation may be better suited to a first-time franchisee or vice versa.

How do you gauge?

Johnson’s advice is to step away from the computer and into a franchise store. A good strategy is to interview franchisees who have already opened a store to get their insights on how well the brand functions.

Start by asking them whether they would do it again given everything they now know about the brand and the franchisor, Johnson advises. If they say yes and are excited about it, ask them questions about how to succeed. If they say no, you may get hints through your interview about how many of their problems were because of the brand and how many were the fault of the owner. A strong owner can make a huge difference in the success of a company.

Follow up with specifics: Ask about how customers in the area receive the brand, and what customer service challenges the franchisee has experienced. Deep insight into the brand can help you determine how well it will fit into your desired market.

If you need additional guidance, a franchise broker can help you decide what company to partner with, and a franchise attorney can help you understand a specific company and the implications of franchising with it.

4. Does the franchise offer support?

In the franchise world, you’re never truly in business by yourself. However, even though you have access to the brand’s marketing strategies, the day-to-day operations are still your responsibility.

You’ll likely get guidance about store cleanliness and signage, Johnson says, but you should ask a franchisor what type of business and management support you would receive. “It’s not when everything is working that [the prospect] should be concerned,” he says. “It’s when [he or she] has questions, issues and challenges. Where do they turn to get guidance and support?”

If you’ve never run your own store, ask if the franchise offers basic business training to help you understand your finances and insurance policies, as well as management training to help with tricky human resources issues, like dealing with a problem employee. Knowing upfront how much you can rely on the brand is crucial to determining whether you feel confident opening up a storefront on your own.

A word of caution

Although franchises might seem like a relatively easy business investment, they’re not bulletproof. A 2014 Wall Street Journal analysis of SBA 7(a) loan default rates found that Planet Beach, Huntington Learning Centers, Quiznos and Cold Stone Creamery were the franchises with the highest default rates between 2004 and 2013, totaling more than $90 million.

To avoid a franchise flop, read the company’s franchise disclosure document carefully and create a business plan for the store you plan to open. You can also check out the Federal Trade Commission’s Consumer Guide to Buying a Franchise, which offers advice about identifying potential opportunities and evaluating your earnings.

Jackie Zimmermann is a staff writer at NerdWallet, a personal finance website. Email: Twitter: @jackie_zm. This article first appeared at NerdWallet.

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