Running a new business can be daunting, but by opening a franchise business, you don't have to start from scratch. A franchise business allows you to operate under a recognizable brand name with an established customer base. The best part? Franchise businesses have established business models, training opportunities, support lines, and mentorship that can help you feel less alone in the early stages of business development.
Here, we'll go over everything you need to know about starting a franchise business, including the pros and cons, steps, costs, and commonly asked questions.
What Is a Franchise Business and How Does It Work?
A franchise is a type of business that is formed when two parties — the franchisor and franchisee — agree to collaborate in the formation of a business under the franchisor's name and branding. An established business, known as the franchisor, grants permission to a franchisee to operate.
In return, the franchisee agrees to pay a fee for the right to open a new business location and sell the same products or services as the franchisor. A franchisee will be required to follow the franchisor's processes and pay royalties consisting of a predetermined percentage of earned profits.
Currently, there are close to 800,000 franchise businesses in the United States. Unlike starting a business from scratch, starting a franchise business follows a tried-and-tested business model with a successful track record. The most popular franchise business to date is McDonald’s, with over 38,000 locations in 100 countries.
In addition to McDonald’s, some of the top franchises include coffee shops, service stations, and real estate agencies with well-known names you're sure to recognize, such as Dunkin', Jiffy Lube, and Century 21.
Once the initial franchise fee is paid — for example, at McDonald’s, the fee is $45,000 — the franchisor would also need to pay a monthly service fee consisting of 4% of the location’s overall sales.
Benefits of Starting a Franchise
Aima Irfan, Editor-in-Chief of Inside Tech World, says that, compared to businesses built from the ground up, franchises come with several benefits:
“First of all, you do not need to have any substantial industry experience," says Irfan. "Secondly, you do not have to make an effort to set up an entire business. You are already getting a well-run business that has a captured target market, and you also have ample support from the franchise owner.”
Additional benefits include:
- Name recognition
- Insight into tried and tested products/services
- Location design/decor standards
- Proven techniques for running business
- Procedures for employee training
- Ongoing help with the promotion of products/services
Paw Vej, Chief Operating Officer at Financer.com, points out another benefit: job satisfaction.
“Franchisees are generally happy with their jobs and get much support from their franchisors," says Vej. "You'll also get better advertising and brand recognition if you're part of a larger network.”
How to Start a Franchise in 10 Steps
Now that we've learned the benefits of starting a franchise business compared to starting a business from scratch, let's go over the 10 steps to getting started:
1. Research, Research, and More Research
To choose the right franchise business, research everything from the needs of your consumers to current market conditions for your chosen industry. Ask yourself critical questions:
- What types of services or products is your community lacking?
- Is there a lot of foot traffic in the area you're looking to set up shop? How about places to park?
- Are there other competing businesses close by or that you should know about?
- Will you need to lease or buy any property? How much can you afford?
- What are the stock market trends with your potential franchisor?
For many new franchise owners, the process begins by searching the internet. According to Jonathan Elster, CEO of EcomHalo, there are plenty of websites that list franchise opportunities. "It's important to find one that matches your interests, your skills, and your budget.”
2. Contact Franchises
When you're ready, get in touch with current franchises and gather information. Try searching online for community forums and chatting with fellow entrepreneurs. There may even be message boards where your questions have already been answered.
Even better: Visit current franchise locations, and ask the owners and staff questions. See what attracts customers to the business, and try to find out how much the owners spent to get the business up and running.
3. Estimate Costs
Before you actually buy a franchise, make sure your finances are in order. Do you have the money set aside to cover the initial costs? Do you have partners (or members) of your LLC to share the financial responsibilities with? Are you aware of the lending requirements from your bank? Without the proper funds, you're unlikely to succeed with your franchising plans.
The investment in the initial franchise fee can be hefty — starting in the tens of thousands of dollars. Your total costs for starting a franchise business can even run to over a million dollars for some of the most successful franchises like Culver’s Restaurant, KFC, McDonald’s, and Dunkin’.
4. Have a Business Plan Ready
Whether starting a franchise or not, new small business owners should have a goal in mind and create a plan to meet that goal. Writing a business plan can provide a roadmap for these goals along with milestones of achievement.
For a franchise business, this may translate into increased sales, productivity, or expansion plans. How do you plan to make your franchise business a success? Your business plan should be able to answer this question in full.
5. Start the Application Process
Once you’ve settled on a franchise, it’s time to reach out and begin a conversation with the franchisor.
Big franchise businesses will likely have a process in place for potential franchisees. They'll explain the franchise and delve into the nitty-gritty of how things work by connecting you to key departments or contacts focused on development, construction, operation, real estate, and more.
If everything looks good and the franchisor deems you qualified, you'll be presented with a franchise agreement.
Details in a franchise agreement may include the following:
- Fees and expenses (royalties, marketing, training, etc.)
- Supply of products
- Trademark and intellectual property
- Site selection or location
- Building requirements
- Operation guidelines
- Support and training
- Maintenance and renovations
- Records and bookkeeping
6. Negotiate Terms
Once you’ve identified the franchise you plan to invest in and have met all the qualifications, it’s time to negotiate the terms of the agreement.
Justin Carpenter, who owns and operates a Modern Maids franchise, notes that “depending on the franchise, there may be significant upfront costs involved, ranging from franchise fees to legal and administrative costs.”
Before you sign the contract, negotiate the terms of the agreement. As noted by Carpenter, “This includes things like royalty payments, marketing fees, and other financial considerations."
Review the franchisor’s Franchise Disclosure Document (FDD), a legal document presented to potential buyers during the presale meeting wherein the franchising process is disclosed. This document contains key information about the franchisor, including business experience, initial fees, trademarks, litigation, patents, outlets and franchisee information, and more.
7. Create Your Business Entity
A franchisee will operate the franchise as an independent contractor, which won't provide any protection to your assets. Forming a Limited Liability Company (LLC) or other business entity means your personal property and assets stay protected and separated from the business in case of bankruptcy or a lawsuit. You'll also have more options on how to file your taxes, potentially leading to savings.
To form your entity, you’ll need to follow the requirements of your Secretary of State, which will include filing Articles of Organization, assigning a Registered Agent, and creating an operating agreement — all of which Incfile can help you with.
8. Get the Right Licenses and Permits
Understand the types of permits and licenses you’ll need to legally run your business and make sure to acquire them. If you're opening a food service such as a restaurant, for example, you'll need a food service license, food handler’s permit, and health permit. If you serve alcohol, you’ll also need a liquor license.
Incfile's Business License Research Package uncovers all the licenses and permits you'll need by checking with the city, county, and state. Make sure to also check with your franchisor for any additional requirements.
9. Hire and Train Your Employees
Before hiring, check with the franchisor or reach out directly to other business owners in your franchise to see if they have any job roles, descriptions, or requirements you should be aware of when seeking employees.
Franchisors may also provide you with training manuals and guidelines to follow in the hiring process. But when it comes to making the final decision on staffing, hiring the right people is your responsibility. A reliable, motivated, and trustworthy staff will help cultivate a pleasant work environment that will benefit employees and customers alike.
10. Promote Your Business
Advertising and marketing for your business will help get the word out, but that doesn’t necessarily mean you need to break the bank — and operating with a limited budget doesn’t mean you still can’t plan big.
Social media and online ads can reach a large audience in a short period of time. A grand opening may also be a great opportunity to provide special offers and product promotions. Consult with the franchisor, who might have a tried-and-true strategy for making your grand opening a success on multiple social media websites.
Franchise Costs + Other Financial Considerations
As stated earlier, a franchisee will need to pay the franchisor an initial franchise fee followed by monthly royalty payments on gross profits. Depending on the agreement and the percentages, this can comprise a sizable portion of the business’s revenue.
To get an idea of costs, let's use the sales data of an average McDonald’s monthly revenue along with royalty percentage payments.
According to the graph above, the yearly cost of running a McDonald's franchise is roughly $119,999.76. Keep in mind that the first year of operation also includes the initial fee of $45,000, bumping this up to a whopping $164,999.76.
Additional expenses can add up quickly:
- Advertising and marketing
Pros and Cons of Opening a Franchise
There is no easy path to follow when it comes to small business ownership, and that holds true when starting a franchise business. Entrepreneurs and small business owners should understand the advantages and potential risks and disadvantages of owning a franchise business:
Pros of Starting a Franchise
- You are starting a company with a history, reputation, and recognizable brand.
- You know the product and service you're selling and can forgo the trial-and-error process since it's already been done.
- You are marketing and advertising a known brand or product, which is less costly than introducing a new product or service.
- You may already have a strong customer base in place for your business.
- You have the support of the franchisor when it comes to process and training.
Cons of Starting a Franchise
- Starting a franchise will come with higher startup costs, including fees and royalties.
- You may have limited options when it comes to working with vendors or offering products that are not part of the franchisor’s brand.
- Your independent decision-making may be limited if not restricted by regulations and rules set by the franchisor.
- Your finances may be open to scrutiny by the franchisor.
- You will need to follow the terms stipulated in your contract.
The last con on this list is critical, as Jonathan Elster from EcomHalo reminds us. As with any business venture, you must pay close attention to your contract.
"These are typically long-term contracts," says Elster. “Your contract will possibly state when and how you can sell the business or what changes you can make to it."
Franchise Frequently Asked Questions
How Much Money Do You Need to Start a Franchise?
On average, initial licensing costs can range between $20,000 to $50,000. Above and beyond that fee, it’s important to have the liquid capital to cover additional expenses, including equipment and supplies, rent, and staff. In total, $100,000 would be a good round number — however, liquid cash obligations may also vary depending on the franchise and the requirements of the franchisor.
The larger, more well-known the business franchise, the more money will be required to run the business. For example, McDonald’s franchise applicants are required to have $500,000 in liquid capital. However, newer franchises can be cheaper because they have lower fees and royalties.
Do Franchise Owners Make Money?
According to Vej, “Franchising has the potential to be a profitable venture for those willing to make a significant, long-term investment. The average annual income of franchisees in the U.S. is $80,000, according to a study by Franchise Business Review in 2021. This figure can vary widely depending on the industry, franchise size, and location.”
Ultimately, however, the amount of money earned by a franchisee will depend on how well the business is doing overall. An owner's income will depend on how much is left once royalty fees, loans, rent, supplies, salaries, and other expenses have been paid.
Can You Just Buy a Franchise?
Anyone approved by a franchisor can buy a franchise as long as they have the financial means, either through personal capital, a partnership, or loans.
How Do You Become a Franchisor?
If you are a business owner with a successful product or service, one option for expanding your business and earning more money is to become a franchisor. If you are at that stage, here’s what you’ll need to do to attract potential franchisees:
- Prepare your Franchise Disclosure Document (FDD).
- Establish terms of the franchise, including the initial fee and royalties.
- Create manuals on how to operate the business and train staff.
- Set up a business plan to attract franchisees.
Start Your Franchise Business With Incfile
Thousands of small business owners have ventured into entrepreneurship by starting a franchise. Although this path comes with many benefits, including support from a franchisor, it's always good to have additional help along the way.
Here at Incfile, you can use our Start a Business Checklist to ensure you've handled initial business formation, found a Registered Agent, submitted annual reports, secured your finance and bookkeeping needs, and more.