Are franchises a good choice for new entrepreneurs?

It starts like this: one day you receive a flash of inspiration for a brilliant business idea.

“If only the world had {insert product or service idea here}, our lives would be so much easier. How has nobody thought of this??”

You then start working on bringing your idea to live, but you encounter challenge after challenge. Sure, it’s a good idea (as far as you can tell), but how are you going to acquire customers? How much does it cost you to acquire a customer? Where can you even find them?

As the questions pile up, and the answers remain elusive, you start to think about how nice it would be to have some structure in your business. Of course, you don’t want a JOB. You started this to escape cubicle hell in the first place. But a little bit of structure wouldn’t hurt.

As entrepreneurs ourselves here at Rambling Soul, we decided to take a look at a common business model that many first time business owners opt for.

Enter the Franchise…

You start exploring franchises, and you are struck by the predictability that they seem to offer. And they look potentially lucrative, with the franchise sector outpacing the S&P 500 in recent years. Sure, the upside is lower than if you had 100% ownership, but they also seem to mitigate risk. All it takes is an upfront investment and a monthly licensing fee, and you are on your way. Or are you?

The purpose of this post is to explore the franchise model, who they are good for, and who they are not good for.

What is a franchise? Here is one easy-to-understand example…

A franchise is a business model in which you buy the rights to use a company’s brand name and business model in exchange for paying them monthly royalties. One of the most common industries in which you’ll find franchises is the fast food industry. Let’s take a look at a hypothetical franchising scenario for McDonalds.

Let’s say McDonalds has aspirations to enter the market in Tonga. They see it as a as potentially a very lucrative market, but they lack market knowledge. And their legal team is focused primarily on minimizing global taxes, not on Tongan law.

How can a multi-billion dollar multinational organization peddle its food in an impoverished third world country with a high obesity rate? The franchise of course.

While McDonalds lacks local market knowledge, they do have a well-known brand that they have spent decades building. During this time, they have invested literally billions of dollars into building the McDonalds name into a brand that everyone recognizes.

Let’s say McDonalds is able to connect with a well-t0-do Tongan businessman. He is interested in bringing their product into the market, and he has the connections to deal with pesky local regulations. In exchange for the support of McDonalds and its brand cachet, this businessman is willing to pay a monthly percentage fee to McDonalds.

For the specifics of franchising deals with McDonalds, we’ll look at the structure as it pertains to franchising in a US market like Los Angeles, as international franchising specifics differ. The principles, however, are the same.

In the US, to become a franchisee of a McDonalds, you would first need to make a down payment. The amount varies, but in some franchises it can reach up to 50% of the total cost of opening the restaurant. Most franchises stipulate that this money must not come from borrowed funds.

From there, you will pay an ongoing licensing fee to McDonalds, which is generally a percentage of total sales. In the case of McDonalds US, it is 4% of monthly sales plus a monthly base rent, which is also a percentage of sales.

Another example of franchising…

For another example, we can look at Homewatch Caregivers, who have a model of homecare that can be used in US markets ranging from Santa Barbara, California to Nashville, Tennessee. This is a much smaller company than McDonalds and thus provides an interesting counterpoint to look at.

Homecare is an industry in which caregivers visit elderly, disabled, or rehabilitating patients to provide training and ongoing support. As the baby boomer generation continues to retire and grow old, now is a great time to enter the industry.

If you were to sign up to be a franchisee of Homewatch, you would be given training and ongoing support in setting up your franchise. You also get to use their brand equity right out the gate, and might not need to spend as much time establishing yourself in the market as if you were launching your own brand. However, it is important to try to quantify the value of their brand name as much as possible. After all, this brand doesn’t come with the recognizable name that say a McDonalds has, so it might make more sense to build a brand yourself in exchange for higher upside.

So who are franchises for?

-Those looking for a proven model and who are willing to minimize upside in exchange for also minimizing downside

-Those with capital that they are able to invest upfront

-Those who are willing to pay a monthly licensing fee

-Those who are interested in being business owners, not entrepreneurs

Who are franchises NOT for?

-Those are want unlimited upside

-Those without cash to invest upfront

-Those who value freedom and flexibility above predictability

-Purebred entrepreneurs who are interested in building and selling multiple business, not maintaining the same business over a period of time

The bottom line is that, when you lease a franchise, you are paying for predictability and a proven model. The value of this varies from person to person. If you are interested in being a business owner more than you are an entrepreneur, a franchise just might be the right thing for you.

Next post we’ll take a look at how you can evaluate the many opportunities in the marketplace to find a specific franchise opportunity that meets your needs.

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