A franchise enables you, the investor or franchisee, to operate a business. You pay a franchise fee and you get 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 provide you with help in finding a location for your outlet; initial training and an operating manual; and advice on management, marketing, or personnel. The franchisor may provide support through periodic newsletters, a toll-free telephone number, a website, or scheduled workshops or seminars.

Buying a franchise may reduce your investment risk by enabling you to associate with an established company. However, the franchise fee can be substantial. You also will have other costs: for example, you may be required to give up significant control over your business while you take on contractual obligations with the franchisor.

Typically, franchise systems have several components.

Costs

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

• Initial Franchise Fee and Other Expenses - Your initial franchise fee, which will range from several thousand dollars to several hundred thousand dollars, may be non-refundable. You may incur significant costs to rent, build, and equip an outlet and to buy initial inventory. You also may have to pay for operating licenses and insurance, and 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. Often, you must pay royalties even if your outlet is not earning significant income. As a rule, you have to pay royalties for the right to use the franchisor's name. Even if the franchisor does not provide the services they promised, you still may have to pay royalties for the duration of your franchise agreement. Indeed, even if you voluntarily terminate your franchisee agreement early, you may owe royalties for the remainder of your agreement.
• Advertising Fees - You also may have to pay into an advertising fund. Some portion of the advertising fees may be allocated to national advertising or to attract new franchise owners, rather than to promote your particular outlet.

Controls

To ensure uniformity, franchisors usually control how franchisees conduct business. These controls may significantly restrict your ability to exercise your own business judgment. Here are a few examples.

• Site Approval - Many franchisors pre-approve sites for outlets, which, in turn, may increase the likelihood that your outlet will attract customers. At the same time, the franchisor may not approve the site you have selected.
• Design or Appearance Standards - Franchisors may impose design or appearance standards to ensure a uniform look among the various outlets. Some franchisors require periodic renovations or seasonal design changes; complying with these standards may increase your costs.
• Restrictions on Goods and Services You Sell - Franchisors may restrict the goods and services you sell. For example, if you own a restaurant franchise, you may not be able to make any changes to your menu. If you own an automobile transmission repair franchise, you may not be able to perform other types of automotive work, like brake or electrical system repairs.
• Restrictions on Method of Operation - Franchisors may require that you operate in a particular way: they may dictate hours; pre-approve signs, employee uniforms, and advertisements; or demand that you use certain accounting or bookkeeping procedures. In some cases, the franchisor may require that you sell goods or services at specific prices, restricting your ability to offer discounts, or that you buy supplies only from an approved supplier even if you can buy similar goods elsewhere for less.
• Restrictions on Sales Area - A franchisor may limit your business to a specific territory. While territorial restrictions may ensure that you will not compete with other franchisees for the same customers, they also could hurt your ability to open additional outlets or to move to a more profitable location. In addition, a franchisor may limit your ability to have your own website, which could restrict your ability to have online customers. Moreover, the franchisor itself may have the right to offer goods or services in your sales area through its own website or through catalogs or telemarketing campaigns.

Terminations and Renewal

You can lose the right to your franchise if you breach the franchise contract. Franchise contracts are for a limited time; your right to renew is not guaranteed.

• Franchise Terminations - A franchisor can end your franchise agreement for a variety of reasons, including your failure to pay royalties or abide by performance standards and sales restrictions. If your franchise is terminated, you may lose your investment.
• Renewals - Franchise agreements may run for as long as 20 years. At the end of the contract, the franchisor may decline to renew. Renewals are not automatic, and they may not have the original terms and conditions. Indeed, the franchisor may raise the royalty payments, impose new design standards and sales restrictions, or reduce your territory. Any of these changes may result in more competition from company-owned outlets or other franchisees.

If you are considering to buy a franchise, we invite you to visit our Small Business section for further insights.