A franchise is a business model where a company (the franchisor) grants an individual or group (the franchisee) the right to operate under its established brand. This includes access to the company’s name, products, services, and business processes. In return, the franchisee typically pays an upfront fee and ongoing licensing costs to the franchisor.

Key Points to Know

• A franchise allows individuals to operate a business using a recognized brand and proven business model in exchange for fees.
• The franchisor is the company that owns the brand and grants licensing rights to franchisees.
• U.S. regulations require franchisors to disclose key business details to potential franchisees.
• Franchisees typically pay ongoing royalties, which can range from 4.6% to 12.5% of revenue, depending on the industry.

How Franchises Work

When a company wants to expand its brand without directly opening new locations, it may sell franchise rights. This creates a partnership between the franchisor and the franchisee. The franchisor provides the name, products, and business model, while the franchisee pays for the right to use them and operates the business.

For entrepreneurs, franchises can be an attractive way to start a business—especially in competitive industries like fast food—since they come with an established name and operational structure. Instead of building a business from scratch, franchisees benefit from the franchisor’s experience, branding, and operational systems.

The History of Franchising

Franchising in the U.S. dates back to the mid-1800s when companies like McCormick Harvesting Machine Company and I.M. Singer Company developed early business distribution models. The first food and hospitality franchises appeared in the 1920s and 1930s, with A&W Root Beer launching in 1925 and Howard Johnson Restaurants opening its first location in 1935. These early franchises paved the way for today’s major chains.

By 2022, there were nearly 790,500 franchise businesses in the U.S., contributing over $500 billion to the economy. Popular franchises include McDonald’s, Taco Bell, Dunkin’, and hotel brands like Hampton by Hilton and Days Inn.

Franchise Agreements and Regulations

Franchise contracts vary by company but usually involve three types of payments:

1. An upfront fee to purchase rights to the brand and trademark.
2. Fees for training, equipment, or other business support.
3. Ongoing royalties based on sales or revenue.

These agreements typically last between 5 and 30 years. Franchisees don’t own the brand—they are essentially renting the right to operate under it. Breaking a contract early can come with serious financial penalties.

In the U.S., franchise regulations differ by state, but the Federal Trade Commission (FTC) enforces a key rule: the Franchise Rule. This rule requires franchisors to disclose important information to potential buyers, such as costs, risks, and company history.

Pros and Cons of Franchises

Benefits of Buying a Franchise

• Proven Business Model – Franchisees follow a tested system rather than starting from scratch.
• Recognized Brand – Customers are already familiar with the business.
• Support and Training – Many franchisors provide guidance and resources.
• Access to Suppliers – Franchisees often receive pre-approved vendor lists.
• Easier Financing – Banks may be more willing to fund an established brand.

Challenges of Owning a Franchise

• High Startup Costs – Some franchises, like McDonald’s, require over $1 million to start.
• Ongoing Fees – Franchisees must pay royalties, usually a percentage of sales.
• Limited Control – Business decisions, such as store design and products, are set by the franchisor.
• Strict Rules – Franchisees must follow the franchisor’s guidelines.
• Location Risks – A poor location or bad management can hurt profitability.

Franchise vs. Starting Your Own Business

If you prefer to build something from the ground up, starting your own business may be a better option. However, independent startups come with high risks—only about 50% survive beyond five years. Unlike franchises, startups don’t have a proven system to follow, so success depends entirely on the owner’s decisions.

Franchising offers a lower-risk path to business ownership, but it comes with costs and limitations. Entrepreneurs who prefer more control and innovation may find starting their own company more rewarding.

How Franchisors Make Money

Franchisors earn revenue through three main streams:

1. Upfront franchise fees – One-time payment for brand rights.
2. Service fees – Charges for training, equipment, or business advice.
3. Ongoing royalties – A percentage of sales, typically 4.6% to 12.5%.

Final Thoughts

Franchising can be a great way to enter the business world with the backing of an established brand. While it requires investment and commitment, it provides a structured path to entrepreneurship. However, success isn’t guaranteed, and potential franchisees should carefully consider the costs, risks, and level of control they are willing to accept.