When does buying a franchise make sense?

Many entrepreneurs would have, at one stage or another, considered buying a franchise instead of starting up their own business. Becoming a franchisee has its pros and cons. However there are situations where the amount paid to purchase a franchise make it worthwhile. Similarly, there are other situations in which the money could be better spent in investing in your startup.

An entrepreneur generally obtains three things of value when buying a franchise.  The first are the rights to the use of a brandname and/or trademark or servicemark over the second which is an exclusive area or territory. The third is the transfer of the knowhow of running and managing the business from the franchiser to the franchisee. In return, the franchisee has to pay a usually substantial upfront fee to the franchiser for these rights. In an area franchise, the franchisee has additional rights to sell the franchise to other franchisees over the allocated area or territory, unlike a single unit franchise.

The risks involved in investing in a franchise is somewhat similar to putting money to acquire equity in a company. Acquiring an established and well known franchise is like investing in a low risk blue chip company in a Dow Jones index stock which pays regular dividends. At the other end of the scale, joining a franchise which was recently set up is as risky as putting your money in a cousin’s start up. In between the risks range from investing in initial public offerings (IPOs) to a stock in a small company index. Thus the choice is essentially related to your risk profile.

In terms of upfront fee payable, the amount for joining an established and well known franchise could be substantial. Furthermore it may not be available in the area that you desire. On the other hand, you probably have to pay less upfront and stand a much better chance of buying a franchise which is relatively new or not as well known. For all you know, the franchise could be a hit like an IPO which gives you a hundred times return. On the other hand, the franchiser could go bust in a short period of time.

The upfront fee that you pay to buy into a franchise is like a tuition fee that you pay to learn the ropes of the business. The thinking that you could totally avoid incurring such a sum of money with your own start up is faulty. The mistakes you make and the time taken to learn the business would probably cost you a somewhat similar amount or even substantially more. This is especially true if the business you are venturing into is totally new in which you had little or no experience.

Suppose that you had experience in, say, managing a fast food joint or a restaurant. You could explore buying a not so well known fast food or restaurant franchise in a cuisine that you are less familiar with. The upfront fee for such a franchise is probably more affordable. This assumes that you have evaluated the franchise and thinks the food is good but the service level could be improved. With your experience, you have some ideas to raise the service level. Thus buying such a franchise makes business sense.

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