The Disadvantages of Buying a Franchise

Loss of Independence

Although most franchisees invest in a franchise because they want the guidance of the franchisor, some franchisees view the loss of independence that comes with a franchise as a negative.  One of the greatest strengths of franchising is consistency and with consistency comes compliance. You should think twice about entering into a franchise relationship if you are not capable of working within a system and accepting some regimentation.

Franchisor’s Failure to Perform

For several reasons, some franchisors don’t deliver what they promise. A common reason for failure is the franchisor’s shortage of available capital. This shortage of capital can be caused by:

a. Unrealistic franchise sales projections by the franchisor;

b. Underestimating the expenses of the development of the franchise system;

c. The franchisor’s failure to meet franchise sales projections, or

d. High franchisee attrition.

In other cases, the franchisor is not capable of providing support and assistance and he or she does not have the ability to operate a franchise organization.

Misunderstanding the Franchise Agreement

Problems can arise when either the franchisor or the franchisee becomes confused or does not understand the interpretation of certain aspects of the franchise agreement. Many potential franchisee have likely never encountered a document that is similar to a franchise agreement. It is important to remember that a franchise agreement requires careful explanation and scrutiny. Failing to do so can result in a conflict that could end up in court.

Misrepresentation by the Franchisor

Misrepresentation by the franchisor can be intentional or unintentional. Projections of income and expenses are often good faith, but it may end up that they are inappropriate for the location. In many cases, this is due to the franchisor’s inexperience or unfamiliarity with the area’s demographics.  However, in some cases, the figures may be total fabrications simply to get the franchisee to sign the agreement and hand over the initial franchise fee.

Caveat Emptor (let the buyer beware) applies to franchising as it does to any consumer purchase or investment. However, consumers often choose to ignore cautionary advice and warning signals. This happens when a consumer primarily bases their investment decision on emotion without balancing it with logic.

Payment of Fees

The franchisee typically pays an initial fee for being granted the franchise, using the system, and receiving initial training. Typically, these single-unit franchise fees range between $25,000 and $35,000. The initial fee is paid only once during the term of the agreement. However, some franchisors may charge a renewal fee at the commencement of each new term of the agreement. The typical term for a franchise agreement is 5 or 10 years but this may vary in order to match with the terms of a lease. Franchisors sometimes charge a site selection fee in addition to the initial fee. This fee is generally $5,000 or more and is charged in order to offset their costs of site selection and lease negotiation.  In addition to the initial fee, an ongoing royalty is paid by the franchisee to the franchisor. In most
instances, the royalty is based on a percentage of the franchisee’s gross sales. This can vary from 1% to 10%,
(or higher) with a median range of 3% to 6%. It is important to note that units with high sales volumes often pay 1% or 2% less.  Franchisees are also required to contribute to a national or regional advertising fund. These costs are in
addition to any requirement that the franchisee invest a minimum amount on local advertising.

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