According to the International Franchise Association, nearly 4 percent of all small businesses in the U.S. are franchisees, and that franchise models exist in nearly 300 types of businesses. Franchise businesses large and small generate more than $2.1 trillion in sales each year and contribute more than 18 million jobs to the U.S. economy.

According to the International Franchise Association, the average investment to start up a franchise is around $250,000, excluding real estate costs. The most popular franchise type, unsurprisingly, is fast food.

What is a franchise?

A franchise is essentially a deal between the owner of a brand or trademark and a person or group of investors who want to use that brand or trademark in their business. Basically, in a franchise agreement a larger business allows a smaller business to operate a store bearing the larger business’ name and using the larger business’ products or methods. In most cases, the franchisee will sell products or services that meet the brand owner’s standards.

In most franchise agreements, the franchiser will provide assistance such as marketing advice, management help, financing, employee and management training, etc. that the franchisee would not be able to obtain if he or she was a wholly independent operation.

How franchising works

Basically, franchising comes in two forms: product or trade name franchising and business format franchising.

In product or trade name franchising, the franchiser owns the name or brand of the business and sells the right to operate under that name to a franchisee. Business format franchising is a more involved relationship between franchiser and franchisee, with the franchiser providing a variety of services to help the franchisee, including help with finding a site, financing assistance, training for employees and managers, etc.

Due diligence

When considering getting into a franchise agreement, entrepreneurs should do their homework to find a business model that fits their talents and the area of the country where they’ll be doing business (i.e. a snowmobile dealership probably wouldn’t go over well in Alabama).

Franchisers have a duty to disclose some information about their brand and business to potential franchisees, so be sure to get all of the financial, organizational and other data you can from a franchiser before entering into an agreement. Franchisees can request a Franchise Disclosure Document from the franchiser.

Franchise Disclosure Document

The Franchise Disclosure Document will provide franchisees with a variety of important information, such as:

- How long the franchiser has been in business, and the various laws and regulations that apply to the business.

- Likely competition.

- Who the executives of the franchiser are, and their business experience.

- The litigation history of the franchiser and its executives, including civil and criminal actions.

- Whether the franchiser has ever filed for bankruptcy protection, or if executives have been involved in recent bankruptcies.

- The costs involved with starting and operating the franchise, including franchise fees, royalties and inventory and equipment costs.

- How much the franchisee will invest initially.

- Whether the franchiser will restrict who the franchisee can contract with for products or services.

- Franchisee obligations and franchiser obligations.

- Financing arrangements, if available.

- Rules about the franchise territory.

- Trademarks.

- Intellectual property information.

- Terms of termination or cancellation of the franchisee agreement.

- Earnings information including average earnings for franchisees and methodology concerning how that figure was arrived at.

- List of franchise outlets.

- Existing contracts the franchiser has.

Making it Legal

Franchisees should obtain the rights to use the franchiser’s name and trademarks, get training from the franchiser, get assistance with marketing and supply chains and get a guarantee that the franchiser will not sell franchises to another business in the franchisee’s territory. If you can’t get these basic assurances from the franchiser, the deal’s not worth doing.

When setting up a franchise agreement, you’re going to need the help of an attorney who specializes in franchise law to help you get a grip on the franchise agreement and to help with tax considerations, which can be complicated in franchise deals. An accountant can help you evaluate the true costs of purchasing the franchise, and help you determine whether the profits will cover the costs involved and other financial factors in your decision.

By carefully examining the opportunity presented to your business by a franchise agreement, you can ensure that you’re getting into a business that’s right for you, and avoid making a poor investment.

The main advantages of working with a franchise are the training and management support franchisers supply to their franchisees, the opportunity to use a popular existing brand and the chance to piggyback on another company’s success.

With the right amount of due diligence, franchise agreements can be an excellent opportunity for entrepreneurs who want to be their own boss but don’t want the hassle of starting a new business from nothing.