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Guide to Buying a Franchise

Buying a franchise allows you to open a business without starting from scratch. It may also be the right move for an entrepreneur who dreams of running their own venture but needs some guidance. From choosing the right business to managing the startup costs, there is plenty to know about buying and owning a franchise.

Understand the business model before buying a franchise

For a fee, franchisees are licensed to operate a business under the name of the franchiser for a specific number of years as set in a contract. Franchisees could receive:

  • Instant brand recognition
  • Proven operating systems
  • Assistance finding a location to start their new business

A standard franchising contract is between 10 and 15 years, said Mahmood Khan, a professor at Virginia Tech’s Pamplin College of Business.

Some franchisers offer the option to renew, but others don’t. Franchisers have the ability to terminate a contract at any point for various reasons, including:

  • Failing to pay royalties
  • Falling short of performance standards
  • Taking over franchise operations or transferring ownership to a different owner

If your contract is terminated or isn’t renewed, you may lose your whole investment in the business.

One of the most important things a potential franchise owner should analyze is the strength of the concept, Khan said. The business model should be simple and easy to replicate in case the franchisee wants to open multiple locations.

A detailed training program and operations manual can indicate an effective franchise organization.

4 things to know about operating a franchise

When you own a franchise business, you run the day-to-day operations. But you also receive resources and direction from the franchiser in exchange for fees, such as royalties. Here’s what you can expect:

Support

Franchisers provide managerial, technical and promotional assistance that an independent business owner wouldn’t have access to when starting out. A franchiser can assist in site selection and construction, as well as help get everything in place for the grand opening. After the opening, the franchiser can continue to provide support, such as:

  • Training new employees
  • Providing access to products in bulk
  • Advertising the business regionally and nationally
Market research

Franchisees benefit from market research the company does on a large scale. This research could be related to:

  • Market trends
  • Direct competitors
  • Consumer preferences and demographics

Based on their findings, franchisers provide franchise owners with materials to help them make use of the research, such as products or marketing materials. Franchisees in the food industry also benefit from new menu items developed in a company lab.

Operating costs and royalty fees

When opening a franchise, you’d likely need to pay an upfront franchising fee to operate the business. Then, you’d pay ongoing royalty fees for the continuous use of the franchise brand. These fees owed to the franchiser could turn out to be higher than anticipated. Royalties are based on a percentage of the franchisee’s gross sales, and they rise with sales.

Franchisees are also responsible for purchasing any new equipment that franchisers require, such as machines to make new products or new technology systems.

Potentially delayed success

Being a franchise owner could result in unfulfilled expectations, Khan said. There is a misconception among franchisees that buying a turnkey operation means immediate success.

A franchisee could find that they don’t make as much money as they expected they would. All businesses, including franchises, take time to find their footing and become profitable.

Some franchise owners also believe that a large number of franchise locations indicates a successful company when the reality is that many locations could be failing.

How to buy a franchise in 5 steps

Here are steps to follow to become a franchise owner.

  1. Get ready to put a lot of cash on the line
  2. Make contact
  3. Put your best foot forward
  4. Maintain realistic expectations
  5. Get ready for the long haul

1. Get ready to put a lot of cash on the line

Although financing is available for franchise owners, franchisers still want a down payment from money you didn’t borrow. And the startup costs, from equipment to training materials, are just the beginning. Going forward, you’ll be responsible for paying regular royalty fees to the franchiser.

Becoming a franchise owner isn’t a decision to be taken lightly, said Wes Shannon, owner of SJK Financial Planning in Hurst, Texas. He tells clients looking to buy a franchise to write a detailed business plan and map out their expectations.

“Victory loves preparation,” Shannon said. “The people I’ve seen who have not done well usually did not put enough thought and planning into it.”

2. Make contact

Existing franchises for sale and new franchise opportunities are listed on online portals such as:

After selecting a company, you would typically submit forms online. At Dunkin’, for example, the first step is submitting an online application. Once you send the forms, which may ask about your personal financials, the number of franchises you want to own and where you’d like to operate, the company’s franchise development department would reach out for an initial phone call. If all goes well, you could have several more calls with the franchising department before getting invited to an in-person meeting.

Find a good franchise to buy based on your personal goals, said Rick Bisio, a franchise coach and co-author of “The Educated Franchisee.” You should choose an industry and business type that best fits your skill set, as well as the return on investment and lifestyle that you’re looking for. The quality of the franchiser is also important to consider, and you should avoid a company with a high number of franchise closures.

“If you match all of that right, you will dramatically increase your chance at success and your chance at happiness,” Bisio said.

3. Put your best foot forward

During the in-person meeting, which Bisio said is often called “discovery day,” the potential franchisee meets with the franchiser team and visits the franchise location. If the store hasn’t yet been built, the group will check out possible sites for construction.

The purpose of discovery day is for you to get to know the franchiser and understand how the company operates. If you don’t get a good vibe from your visit, you could walk away from the arrangement.  The company could also decide you’re not a good fit.

If the company does seem to be a good fit, it would be time to sign a contract and pay the upfront franchising fee. For instance, the initial franchising fee to open a new McDonald’s is $45,000.

4. Maintain realistic expectations

The likelihood of being approved as a franchise owner is quite small, Bisio said, especially with large national brands. “Any large national brand that’s out there, they receive thousands of inquiries a day,” Bisio said. Applicants also tend to be denied because they live in an area where the company has already sold a franchise.

The Federal Trade Commission requires all franchisers to provide prospective franchisees adequate information to understand the risks and benefits of making an investment in the business. Under the FTC franchise rule, franchisers must provide a Franchise Disclosure Document to potential franchisees containing details about the franchise it’s offering, its officers and other franchisees.

Carefully review the disclosure document to ensure your expectations about the franchise and the company as a whole line up with reality.

5. Get ready for the long haul

It can take months — if not more than a year — to get to opening day. At Sonic Drive-In, for instance, it takes an average of six to eight months to secure a site, then an average of 90 days to open the restaurant.

During this period, generate ideas to bring to the table. Franchisers tend to look for business owners who want to be heavily involved in the business rather than someone looking to invest, Khan said. Some franchise owners see themselves as a hands-off owner, he said, but franchisers want to give opportunities to people interested in actively growing the business.

Buying a franchise: Requirements, upfront fees and more

Here are some important things you’ll encounter financially when buying a franchise.

Financial requirements

Your savings could be a make-or-break factor when buying a franchise. Most people who apply ultimately don’t meet the financial requirements related to net worth and liquidity. For example, Gold’s Gym requires a minimum personal net worth of $1 million with liquidity, or cash assets, of $400,000. Your personal assets communicate your financial health to a franchiser, giving them an idea of how big of a risk you would be as a franchisee.

Upfront fees

The fee must be at least $500 and is due within the first six months of operation, although some fees could be in the tens of thousands. Starting a traditional Sonic Drive-In, for example, requires a franchise fee of $45,000 for a single unit, while the total franchise investment ranges from $1.24 million to $3.53 million (not including land).

This upfront franchising fee may not be refundable even if your contract is terminated. When reviewing the franchising contract, franchisees should be sure of what they’re getting out of the deal, Shannon said. Sometimes the initial fee includes the cost of equipment, tools or the building, but it may only cover the rights to the business name.

“I tend to be a little leery if it’s a high upfront fee and there’s no property or equipment that goes with it,” Shannon said.

Down payment

When buying a franchise, most companies will require a down payment in cash, which typically can’t be financed. McDonald’s, for example, requires 40% of the total cost of a new restaurant, or 25% of the total cost of an existing restaurant. Since the cost of a restaurant fluctuates, the minimum down payment varies for each franchisee. But generally, McDonald’s requires about $500,000 of your own money.

Royalties

Franchisees may owe the franchiser a percentage of their weekly or monthly gross income. The royalty fees typically range around 5% to 7.5% but can get as high as double digits, depending on the company. At Dunkin’, for example, the ongoing royalty fee is 2% to 6% of gross sales.

The franchiser doesn’t consider the franchise’s profit and will continue to take a cut even if the location is losing money. “This is where [franchisees] get dissatisfied,” Khan said.

Equipment expenses

Franchisees cover the cost of their own equipment, employee training and necessary supplies like uniforms or kitchen ingredients, Khan said. Equipment and pre-opening costs for a new McDonald’s franchise could cost from $1.3 million to $2.3 million, for example.

Franchisees also contribute to a companywide advertising fund, which may not benefit individual owners if they’re out of range of ad circulations.

Autonomy

Although you’ve purchased your own business, franchisers retain control over how you operate. Franchisers have the right to approve all site selections and set design and appearance standards. Franchisers also regulate procedures and could restrict the goods and services that you sell.

Financing your franchise investment

As noted, most companies will require a down payment of personal funds, meaning you have to have liquid assets upfront. Once you cover your down payment, you may be able to finance the rest of the purchase price. At McDonald’s, for example, franchisees can finance the remainder of the purchase price (the fast-food chain doesn’t offer financing), but their loan term can be no more than seven years.

Borrowing money for an investment such as a business is always a risk, Shannon said, and he advised new franchisees to tap into their personal assets whenever possible.

For those turning to borrowed funds to buy a franchise, there are a few franchise financing options.

Bank loans

A benefit of franchising is the ease of obtaining bank loans to finance the purchase as the risk is lower than that of starting a new business, Khan said. Banks will require:

  • Financial statements
  • Tax returns
  • Proof of your franchise’s profitability

This is where the overall success of the company comes into play, as it indicates that you’ll be able to make payments as a franchisee of a profitable business. Franchise owners also have an easier time accessing business lines of credit because they’re associated with an established company.

SBA loans

SBA loans are commonly used to finance franchises that appear in the SBA Franchise Directory. They’re provided through SBA-backed banks, and the SBA guarantees the loan if you default.

The 7(a) loan, the SBA’s primary loan for small business owners, allows you to borrow up to $5 million, with interest rates set at a base rate plus 2.25% to 4.75%. Loan terms range from 10 to 25 years, and there’s no prepayment penalty if your term is less than 15 years. However, the application process could be lengthy, and collateral is usually required for loans exceeding $350,000.

Loan from franchiser

Some companies offer in-house financing to new franchisees. If an existing franchisee wants to open an additional location, the franchiser may also loan the business owner money to start a new franchise. The UPS Store, for example, provides help through Guidant Financial with startup costs and equipment.

The advantage of borrowing from your franchiser is they understand the business and the risk involved, and they may give you more money than the standard bank, Shannon said. However, getting into debt with the franchiser gives them more power.

“It’s dangerous in that all your eggs are in one basket,” he said. “Not only do they control your franchise agreement, but they basically control you through the loan.”

Looking for more specifics on how to finance a particular franchise? Here are some LendingTree roundups:

FAQs

Are franchises worth it?

Certain personality types are best suited for franchising. Some entrepreneurs have an urge to follow their passion and do things their own way. Others are focused on achieving results as efficiently as possible. Entrepreneurs who want to run their own establishment but are willing to follow direction work best in franchise systems.

How can I open a franchise with no money?

You most likely can’t open a franchise with no money. Potential franchisees should make sure they’re financially prepared to put a lot of money into the business. Although franchisees can take out small business loans to cover expenses, you should wait to open a franchise until you’ve built up your own savings.

How does a franchise business model work?

Franchisees use the business name, operating systems and branding of a franchiser to operate a business. Franchisees must make an upfront investment in the business and pay ongoing fees, such as royalties, to the franchiser. In some cases, franchisees may receive additional resources from franchisers, including training or marketing materials.

 

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