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Buying a Franchise

Some entrepreneurs can take an inspired idea and create an entirely new business. Others prefer the relative security of purchasing an established business. Still others may buy a franchise, in many ways a hybrid approach.

A franchise is typically an established business model that one can purchase to begin a new enterprise. A “franchisor” (the person offering the franchise) typically sells the right to operate a certain kind of business under the franchisor’s trademark within a certain territory and in accordance with a detailed business plan. Think of McDonalds or Subway restaurants or even an auto dealership. The franchisor will help the franchisee find a location, train the franchisee, monitor compliance with the franchisor’s policies, and promote the brand. For this, the franchisee usually pays an initial fee and then a percentage of revenues monthly, as long as the relationship continues.

Under state and federal law, franchisors usually have to disclose a great deal of information about the business, including how other franchisees are succeeding. These disclosure documents and the franchise agreement are often voluminous documents. The franchisee rarely has the opportunity to negotiate the terms of the agreement with the franchisor. That document usually regulates strictly the manner in which products and services can be marketed and sold. The franchisee must pay the monthly fees whether or not the business succeeds. If the franchisee discontinues the relationship, the franchisor may become entitled to assume the lease, phone number, and franchise records. The franchisee is often prohibited from continuing in the same line of business for a period of years after the relationship ends.

Is a franchise worth buying? It depends. Though the terms of the franchise agreement are usually non-negotiable, it is critically important to identify and understand all the costs, restrictions, and obligations at the outset.

When weighing the purchase of a franchise, it is also useful to consider the pros and cons of establishing a similar business outside of the franchise format. Think of a hamburger stand or a sub shop. At a minimum, that analysis will bring into focus what the franchisee is truly getting for all of the required charges and restrictions. In some cases, an entrepreneur can largely duplicate the business model at lower cost. And, in other cases, the entrepreneur may conclude that the training, security, and trademark are worth the investment. In any event, the principle of caveat emptor applies. The prospective franchisee must take care to know what exactly he or she is buying.