What Is a Franchise?
A franchise is a type of license that gives a franchisee the right to use a franchisor’s business knowledge, processes, and trademarks. This allows the franchisee to sell a product or service under the franchisor’s business name. In return, the franchisee usually pays the franchisor an initial start-up fee and ongoing licensing fees.
Key Points
– A franchise allows the owner to license their business operations, products, branding, and
knowledge in exchange for a franchise fee.
– The franchisor is the business that grants the license to franchisees.
– The Franchise Rule requires franchisors to disclose important business information to
potential franchisees.
– Ongoing royalties paid to franchisors vary by industry and usually range between 4.6% and
12.5%.
Understanding Franchises
When a business wants to expand its market or geographical reach without spending much, it may choose to franchise its product and brand. A franchise is a partnership between the franchisor, who owns the business, and the franchisee, who buys the right to use the franchisor’s name and business model.
Franchises are a popular option for entrepreneurs, especially in competitive industries like fast food. Buying a franchise gives access to a recognized brand, management expertise, business processes, and tools. You don’t have to build the business from scratch, and you benefit from the company’s established reputation.
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 forms of this business model. The first food and hospitality franchises began in the 1920s and 1930s, with A&W Root Beer in 1925 and Howard Johnson Restaurants in 1935.
As of 2022, there were nearly 790,000 franchise businesses in the U.S., contributing over $500 billion to the economy. Major brands include McDonald’s, Taco Bell, Dairy Queen, Hampton by Hilton, and Anytime Fitness.
Franchise Basics and Regulations
Franchise agreements vary, but they typically involve three payments to the franchisor: an upfront fee for trademark rights, payments for training or equipment, and ongoing royalties based on sales.
A franchise contract is temporary, usually lasting 5 to 30 years. Franchisees do not own the business and face penalties for breaking the contract. In the U.S., franchises are regulated by the Federal Trade Commission (FTC). The FTC’s Franchise Rule requires franchisors to provide detailed disclosure documents to potential buyers, covering fees, business performance, and legal issues.
Advantages and Disadvantages of Franchises
Advantages
– A ready-made business model to follow
– Established brand recognition
– Market-tested products and services
– Large business decisions already made
– Access to a list of approved suppliers
– Training and financial planning provided by the franchisor
Disadvantages
– High start-up costs and ongoing royalty fees
– Lack of creative control or choice of business location
– Risk of inaccurate information from the franchisor
– Potential challenges with financing or poor business management
Franchise vs. Startup
If you don’t want to follow someone else’s business model, you could start your own business. However, launching a new business carries a higher risk. About two-thirds of businesses survive for two years, and only half make it to five years. Starting a business from scratch requires long hours, hard work, and a willingness to take on challenges with little support.
Franchises, on the other hand, offer a more stable path with an established business model, but success is not guaranteed. Entrepreneurs need to decide which path—franchise or startup—best suits their goals and risk tolerance.
The Bottom Line
Franchises offer a structured way to start a business, using an established name and business model. While there are fees and risks involved, many people find franchising to be a good entry point into business ownership. However, success requires effort, and profits are not guaranteed.
