This article is part of a larger series on Starting a Business.
Buying a franchise is a good option for entrepreneurs who want to start a business but don’t want to go through the hard work of establishing a new brand and system. However, purchasing a franchise is not as simple as it may seem. This article will show you how to buy a franchise in eight steps.
1. Research Potential Franchise Opportunities
The first step when buying a franchise is to do your initial research on the different franchise opportunities available. It’s important to find the right franchise according to your budget, qualifications, and personal interest. There are many franchises available in the United States, and typically you can find them listed on various online sources.
To know which franchise is a good fit for you, it’s important to first research typical franchise requirements to ensure you qualify and have the proper information. Then, conduct a self-analysis and determine your own skills, resources, and interests. Once all of this is done, you can use an online franchise website like FranchiseGator to find opportunities that fit your needs.
Let’s look at each component of your research in detail.
Typical Franchise Qualification Requirements
Franchisors typically set minimum requirements to ensure that all their franchisees are qualified in terms of personal finances and professional experience. This is because the success and/or failure of their franchisees directly affects their business reputation, brand, and bottom line.
Qualification requirements vary significantly depending on the franchisors and the type of franchise you’re buying. However, the following often are taken into consideration:
- Credit score: Minimum credit scores vary by franchisor but, generally, a score of 680 or higher is ideal; check your credit score for free here
- Net worth: If your franchise requires a large initial investment, you’ll need a comparatively higher net worth to qualify
- Cash on hand: You need to have enough cash on hand to either cover the franchise costs or cover a down payment if financing the purchase
- Outside income: You should have other forms of income and resources to help with living expenses while you get the franchise off the ground
- Industry experience: Although some franchises do not require business or industry-related experience, franchisors are typically all more confident if you have relevant experience
- Management experience: As a franchisee, you will be primarily responsible for leading a team and managing a business; lack of management experience can be a red flag that you might not succeed
To help you understand whether you’ll qualify, we’ve included average franchisee demographics below, according to the International Franchise Association (IFA). Franchisees are typically:
- Between 35 and 55 years old
- Have an average income of $60,000 or higher
- Have a net worth of $250,000 or higher
- Have corporate management experience
- Have an individual retirement account (IRA) or 401(k) retirement plan
- Have not owned a business before
Personal Resources, Skills, and Interests
A self-analysis on your personal skills, interests, and resources is essential when buying a franchise, especially because franchisors will ask you about your finances and professional experience. Knowing what you are capable of―financially, skillfully, and professionally―will also help you narrow down your options when finding the right franchise opportunity.
You’ll need to prepare a net worth report that lists down all your assets, liabilities, income, and your credit score―check your credit score for free here. You also need to prepare a resume highlighting all your professional, managerial, and industry experience, showing why you are best suited for a particular franchise.
It is also a good idea at this point to draft your timeline carefully for buying a franchise. This will include how much time you can allocate toward initial research, contacting franchisors, reviewing franchise disclosure documents and franchise agreements, obtaining financing, and choosing a location.
Find Franchise Opportunities
When you have information on your budget and net worth, have assessed your experience, skills, and personal interests, and set a timeline that works for you, it’s time to find a franchise that fits your needs. The perfect franchise is one that best suits your skills, interests, and budget. Don’t be tempted to buy a franchise just because it’s trendy.
You can find a lot of options for franchises based on different industry types, available locations, and initial investment required. A great place to start looking for these options is through various franchise websites that list franchises for sale.
Also, it’s recommended that you find reviews and complaints filed by owners or customers regarding the franchises you are considering. You can visit the Better Business Bureau (BBB) and Unhappy Franchisee to understand potential franchise opportunities better based on the experience of existing franchisees and customers.
When finding a franchise opportunity, here are a few of the things that you need to consider:
- Total investment required: This includes franchise fees, training expenses, costs for leasehold improvements or real estate, employees, inventory, marketing, furniture and fixtures, and equipment.
- Ongoing costs: This includes royalty fees and marketing/advertising fees on top of your regular operational expenses.
- Training and support: Find out what training and support are provided by the franchisors, if you will be charged for these and how much, and where the training will take place.
- Competition: Know how close other franchises to your location and if there are any existing businesses already in competition with you
If you prefer to buy an existing franchise that’s already operating and have more than $50,000 in a qualified retirement account, you can use this money to finance your own franchise with a rollover for business startups (ROBS). Talk to a ROBS expert at Guidant to learn more.
2. Contact Franchisors for Initial Applications and Franchise Disclosure Documents (FDDs)
After doing your self-assessment and your initial research, you should narrow down your options to one or two franchises that best suit your preferences and budget. The next step is to fill out the franchisor’s preliminary questionnaires/application forms. The preliminary application helps franchisors screen and eliminate aspiring franchisees that won’t be a good fit.
It’s recommended that you fill out these initial forms completely and accurately to help the franchisors better assess your qualifications. Assuming that you meet the franchisor’s initial requirements, there’s a good chance that you can set a meeting with the franchisor’s representative and get a copy of the franchise disclosure document.
An FDD, also known as the Uniform Franchise Offering Circular (UFOC), is a 50-plus page document that outlines your responsibilities as a franchisee, the fees you need to pay, and the rules and regulations that you need to follow. It also includes information about the franchisor, including its financial and legal history. Getting an FDD will give you all the information you need to know if a potential franchise opportunity is a good fit.
Franchisors are mandated by the Federal Trade Commission (FTC) to provide prospective franchisees with an FDD at least 14 days before any binding agreements are signed and payment made. Franchisees are advised to read and review the FDD carefully. All FDDs follow the same 23-step format. However, the level of disclosure and transparency varies from one franchisor to another.
The following are few of the common types of information included in the FDDs:
- The franchise system’s size and three-year growth trends
- The franchise’s brand presence in the prospect’s state
- The franchisor’s leadership team and their experience
- The initial investment, one-time fees, and potential ongoing charges
- Support offered to the franchises like training, financing, and operational assistance
- The franchisor’s financial performance
Most FDDs often don’t include information on the average franchise business performance, average unit volume (AUV) and typical profit/loss, reasons for unit closures, franchisor’s investment in future growth, and industry comparisons. You can also sometimes find this information from the franchisor’s press releases, annual reports and public filings, and independent third parties like FRANdata.
Typically, banks, lenders, or external investors who will help finance your franchise startup will also want to see the FDD. As the FDD will affect many aspects of your business plan, it is important that you know how to read and understand it thoroughly. Read this guide on how to read a franchise disclosure document to help you understand each section and know what to look out for.
If you need some professional help figuring out the franchise disclosure and other legal documents, check out Rocket Lawyer. It has expert attorneys available to offer you legal advice. Visit Rocket Lawyer to learn more and get your first seven days free.
3. Attend the Franchisor’s Discovery Day
After receiving a federal disclosure agreement, you will have the opportunity to meet the franchisor’s management team personally during discovery day, which typically takes place in the franchisor’s head office. This is the chance for both the franchisor and potential franchisee to get to know each other and ask questions about anything that will affect the success of the business.
Discovery Day for the Potential Franchisee
Discovery day is a great chance for a potential franchisee to get to know the franchise and its management team. This is also an opportunity to learn more about the company culture and individual personalities of the people with whom you’ll be working. Discovery day is the perfect time to ask questions and voice concerns that were not addressed in the FDD.
A discovery day’s typical agenda involves group presentations, one-on-one meetings and interviews, and visits to existing franchise locations. Try to look out for possible red flags during discovery day, which include the following:
- Personality or cultural misfits
- Disorganization at the corporate level
- Promises or assurances that are not put in writing
- Questions that are not answered directly
- Concerns that are not addressed clearly
- Hard sells
Also, try to learn more about the business’s growth plans. Another red flag to watch out for is how fast the business intends to expand. If the company attempts to expand too quickly, it could mean that management does not have a sustainable plan in place, which could create havoc for your business even before it starts.
Meanwhile, a company that has no plans for growth or expansion could mean it lacks a strong vision for the future and intends to remain static. This could also jeopardize your business because a franchisor that does not plan to grow will limit your prospects as a franchisee.
Discovery Day for the Franchisor
Franchisors need to be selective of their franchisees because they have to make sure they’ll be a good fit for their business and meet their financial requirements. Therefore, discovery day is also time for the franchisor to finally get to know you and ask the necessary questions that aren’t addressed in your application.
Aside from making sure that you meet their specific qualifications, a franchisor will also evaluate your level of commitment and enthusiasm for their business. They also want to ensure that you’re willing to follow their rules and policies. They want franchisees who have the attitude of leaders and, at the same time, are good team players.
4. Review the Franchise Agreement Carefully
The franchise agreement is the formal contract that a franchisor will provide after discovery day if they see you as a good franchisee candidate. This contract gives you the legal right to own and open a franchise under their rules and regulations. It’s wise to hire a lawyer with franchise experience to review and discuss the contract with you so you can understand everything fully.
If the franchisor made verbal promises or deals during your meeting, it’s important that they are written in the contract. For example, if the franchisor promised to provide legal support in the event of a lawsuit, make sure this is written in the contract. Rules on suppliers, pricing, transfer of ownership, protection of territory, royalty fees, hiring staff, training, and other relevant support must also be indicated clearly in the contract.
Any discrepancy between what was discussed verbally and what is written in the contract must be brought up for clarification with the franchisor immediately. Sometimes, you may be able to negotiate amendments to the agreement to match what was discussed. There are times, however, when the franchisor will insist that what is written in the contract are the actual terms and can’t be changed.
If you’re looking for expert legal advice, check out Rocket Lawyer, an online legal service provider. It has a team of expert attorneys that provide services such as document review and answering legal questions. Sign up with Rocket Lawyer to gain access to experienced attorneys who will provide you with advice on your franchising agreement.
5. Get the Right Financing for Your Franchise Startup
After you review and sign the franchise agreement, the next step is to obtain financing. You will need funds to cover the costs associated with buying a franchise. The first that you need to pay is the franchising fee, which typically is due after you return the signed agreement.
You need a strong and convincing business plan, including years of growth projections, if you intend to borrow funds for your franchise. It’s important to address things in your business plan that are not included in the franchise disclosure document, such as your franchise location’s potential revenues, startup and normal operating expenses, and cost of financing. It’s recommended to use a business plan software to make the process easier.
In most cases, lenders will not loan you money to cover the franchising fee. However, your franchising fee can be considered part of your down payment if you apply for a Small Business Administration (SBA) loan or any conventional bank loan. You can find more details on what needs to be paid in the franchise disclosure document.
You can consider any of the following funding options to finance your franchise startup:
- ROBS: A ROBS lets you use it to fund your franchise without having to pay early withdrawal penalties and taxes. A ROBS is not a loan, doesn’t require lender approval, and typically is faster than most startup loans. If you have at least $50,000 in a qualified retirement account, you can speak with our recommended ROBS expert, Guidant, for more information.
- SBA loan: SBA loans are guaranteed by the government and have low interest rates, which make them one of the best options to fund a business. However, the requirements for SBA loans are strict, and it’s more difficult for new businesses to get qualified. Typically, you’ll need a credit score of 680 or higher and a 20% down payment.
- Bank loan: Conventional bank loans are sometimes more difficult to qualify for when compared to SBA loans because they are not guaranteed by the government. However, if you have a good credit history, have a high net worth, and have existing business dealings with the bank, you might qualify.
- Financing from franchisor or partner lenders: Some franchisors offer financing to help fund all or portion of the franchise costs. Others may be able to connect you with partner lenders who are already familiar with the franchise’s business model and track record. This makes it easier for you to qualify.
Financing New Construction or a Long-term Lease
Typically, you’ll need funds for new, ground-up construction or to lease a space for your new franchise. Make sure that you coordinate closely with the franchisor and your potential lender since they might have certain rules about the location, and you might need their approval before you start building or renovating your space.
Financing Equipment for a Franchise
If the franchise requires a significant investment in equipment, the franchisor will likely recommend a distributor or wholesaler. They might also offer financing, which typically will be structured as a lease and have a term of up to five years.
Make sure to consider your cash flow for the next few years before you agree to short term loans used to finance things like equipment. Ideally, longer-term loans are preferable since recurring payments will be lower, and it can help make your first few years easier. For more information on financing your franchise, you can read our in-depth guide on franchise funding options.
If your money is in a qualified retirement account, you can use this money to cover your franchise costs through a rollover for business startups (ROBS). A ROBS allows you to access your retirement fund to start a business without paying early withdrawal penalties and taxes. Plus, it’s a lot faster and easier to get because it doesn’t require lender approval. If you have at least $50,000 in your retirement account, you can speak with our recommended ROBS expert, Guidant, for more information.
6. Choose a Location
If your franchise is not home-based or mobile, you need to choose a location where you can run your business. Franchisors will likely provide you with guidelines to ensure that you meet their location requirements, which may require a certain distance from other franchises, minimum area, and the number of parking spots. You can seek help from a commercial real estate agent to ensure you find the most suitable place that meets these requirements.
Buying vs Leasing Your Location
For a start, most franchise owners will lease property since it requires less money upfront and therefore is less risky. However, if you have more funds, you may also want to consider buying your own property, especially if you expect to be in the same location for seven years or more.
If you plan to purchase a property for your franchise location, our complete guide on commercial real estate loans will help you get started with your financing needs. However, as a startup, you might find it more difficult to qualify for a commercial loan from a conventional lender. Luckily, there are nationwide lenders like South End Capital that are willing to finance nonconforming real estate deals.
If you want to lease a property, consider the following things:
For Retail Spaces
- Consider the safety and accessibility of your location. Also, see if the area is near your target customers or competitors
- Estimate the square footage you need as accurately as possible
- Negotiate your rent without extending your lease longer than necessary
For Office Spaces
- Consider the location of your employees, clients, and other specific business needs
- Negotiate your rent without extending your lease longer than necessary
It’s always a good idea to get an attorney to review any potential lease before you sign on the dotted line. If you need some legal help, check out Rocket Lawyer. It has experienced small business attorneys who can help you with buying your franchise. Get your first seven days free.
7. Take the Necessary Training & Workshops
The next step is to take all the necessary training and workshops to equip you and your staff with the skills and knowledge necessary to run your business. The franchisor typically will provide the training sessions, which will take place in their headquarters, at a franchise location, or virtually and usually last for one to two weeks.
Typical training sessions will cover everything you need to know, including the franchise’s products and services, the systems you’ll be using, and the policies and guidelines you need to put in place. Some franchisors offer training in marketing, negotiating with suppliers, hiring and managing employees, filing permits, bookkeeping, creating reports, and more. These sessions will likely combine classroom lessons, hands-on work, and on-site training with equipment and systems.
8. Prepare for Your Grand Opening
Once you have completed all the necessary training and your location is ready, the next step is to open for business. The franchisor will likely offer assistance in the actual opening of your franchise, which will mostly be centered on promotional and marketing programs to ensure that you build your customer base quickly.
It is a good idea to allocate a chunk of your first year’s marketing budget to promote your grand opening. Also, it’s recommended to ask your franchisor what successful franchise locations have done for their opening ceremonies. Learning what has worked for franchisees in the past is critical, as these things can help you prepare for your opening day.
Buying a franchise does not take the risk out of starting a business. However, if you know how to buy a franchise, find the right franchise for you, review the FDD and franchise agreement carefully and obtain the right financing, you’ll be on the path to a successful business.