The Benefits and Risks of Franchising Your Business The flexibility, speed-of-growth and payoff possibilities of this sector are more robust than ever, but there are also pitfalls to consider: How to know if becoming a franchisor is the right move.
By Emiliano Jöcker Edited by Maria Bailey
Key Takeaways
- The benefits of franchising include speed of growth and protecting your own cash by using other people's money (franchisees') to open units.
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Imagine that you own a uniquely appealing local food service concept that routinely has lines out the door. The first unit was so successful that you opened a second across town, which is doing equally well.
The question then becomes, how can that concept further grow? Do you take all the risk — max out credit cards and/or knock on bankers' doors in an attempt to raise capital for expansion? Do you take on partners and dilute ownership stake and decision-making power? Or do you investigate franchising?
If your business has strong unit economics and a system that's easily duplicated (but not so simple that people can do it without your help), that last move may be the right one. And, of course, it's a model that has the potential to work in any number of industries, not just food. Dermatologists and dentists are franchising offices, along with pet-centric services, eye-lash extension boutiques and music lesson venues. The franchise sector actually outpaces growth in the broader economy, according to the International Franchise Association's 2024 Franchising Economic Outlook.
Related: Franchise Your Business in 7 Steps
There are numerous advantages to expanding in this way, two key ones being speed of growth and protecting your own cash by using other people's money (franchisees') to open units. Although you will need to invest time and money in developing the legal contracts and other documents for a franchise offer, once you have the paperwork completed and legal obligations nailed down, you can sign on single- or multi-unit operators much more quickly than customizing each deal individually.
A word of caution: Don't go cheap in this formative stage (or any stage, for that matter). Hire a knowledgeable attorney and accountant with expertise in franchising and a reputable consulting firm to ensure that you have the essentials locked down. This type of business is regulated, so you want to have everything both legally sound and fair to the franchisor and franchisee alike. After all, this will be a relationship you will ideally be in for a long stretch.
At least for the moment, the Fed has yet to act on interest rates, so it's likely that the low rates seen prior to the pandemic won't be back in the foreseeable future. Rather than using your (possibly borrowed) capital for expansion, the franchise model fuels growth with others' capital. Your focus can then turn to upgrades to systems (such as technology, marketing/advertising and training) to make the company attractive to both customers and franchisees.
Related: How Investing in a Multi-Unit Franchise Can Positively Diversify Your Portfolio
Another plus: When a new unit is opened, franchisor resources are not tasked with unit-level details such as staffing, training new employees, sending out press releases to local press or paying taxes. Nor do they have to work with real estate agents to find the perfect site, pay rent and CAM (common area maintenance) or make payroll. All of those are handled by the franchisee. There is also limited liability in the case of employees' or customers' legal complaints since you are not involved in their day-to-day operations. You're free to focus on the big picture (which can include company-owned units), while unit owner/operators handle their sites.
And since franchisees have their own money invested, they are more likely than hired staff to keep an eagle eye on profitability and customer service. They can also be a franchisor's eyes and ears on what customers want in the way of new products or services. For instance, it was a franchisee who came up with Subway's wildly successful $5 Footlong campaign and another who invented Dairy Queen's signature item: the Blizzard. They have also been multiply credited with streamlining systems and coming up with ideas for add-on profit centers. All innovations will need to be approved by you, but this is research and development that you don't have to pay a consultant for.
The process might also take the company into neighborhoods you wouldn't normally consider. While many franchisors try to keep expansion regional at first, doing further-flung development deals with experienced operators can help get a jump on the competition, particularly if national expansion is the goal. These local partners will likely better identify the "A" locations from the "B" ones and might be able to help establish better supply chains with local vendors. Better still, as a franchisor of numerous units, you will be able to establish buying power that will help both your bottom line and those of your franchisees. Lastly, if international expansion is desirable, having local partners doing deals in other countries helps solve problems like coping with different languages, laws and cultures.
Finally, if growing your company and then selling it is the long-range goal, all these benefits (speed of growth, dedicated management with a personal and financial interest in the business, and better-than-average profitability) will help generate higher multiples when it's time to field offers.
The mantra for franchisees has long been, "You're in business for yourself, but not by yourself." The same rubric can be applied to the franchisor. As the company founder, you are the one who knows the brand best. But in welcoming other qualified business people into the system, you're able to accomplish goals faster and with all the traditional benefits of tapping a variety of individuals' experiences and insights.
There are challenges to franchising. Selecting the right unit buyers is paramount to a good experience, and you can't be a dictator — must be willing to listen to partners and make sure they are provided with value. As with everything worthwhile, it is not for the faint of heart, nor the unprepared.
