Buying A Franchise Business

A significant way for someone with an entrepreneurial attentiveness and interest in supporting an established brand is buying a franchise business. Although highly beneficial, many factors should be considered by a prospective franchise purchaser to assure they are making an informed decision. The team at Fox & Moghul has ample experience helping clients navigate the complexities of franchise agreements, ensuring that their rights are protected, and that they are set up for long-term success.

Below, you’ll find information regarding the pitfalls of buying a franchise, key factors to consider when deciding to purchase a franchise, tips for understanding the terms of the franchise agreement (the “Agreement”) and how to evaluate a franchise’s financial health, and cites to Fox & Moghul’s successful relevant cases.

Factor One: Understanding the Franchise Business Model

Before acquiring any specific franchise opportunities, it is essential to form a comprehensive understanding of the franchise business model, starting with what exactly a franchise is, and its key players.

• The franchisor is the person who grants or sells a franchise.
• The franchisee is granted the right to engage in the business of offering, selling, or distributing goods or services at retail under a marketing plan prescribed in substantial part by a franchisor.
• A franchise is a written contract or agreement between the franchisor and the franchisee that allows a franchisee to act under the brand and operational framework of a franchisor. Typically, the franchisee will benefit from the use of the brand’s trademark, business systems, and marketing strategies, but will be liable under strict operational guidelines and must be prepared to pay an initial franchise fee and ongoing royalties.

There are two main franchise models to consider:

• Product Distribution Franchise: This model allows the franchisee to serve as a distributor of the franchisor’s products, such as within the automotive and beverage industries.
• Business Format Franchise: As the more commonly used franchise model, here, the franchisee adopts the franchisor’s branding, business scheme, and operational process. The most noticeable examples of this model include fast-food chains like McDonald’s.

Selecting the right model requires the parties to understand their intentions and capabilities pertaining to their investment capacity, industry preferences, and business objectives.

Factor Two: Evaluating the Franchise’s Financial Health

After developing an understanding of how Franchise Business Models work, it is then time to assess the viability of a specific franchise investment and evaluate its financial health. Prospective franchisees should thoroughly review the Franchise Disclosure Document (“FDD”), which provides information to the franchisee about how the intended business relationship with the franchisor will be conducted and the key financial details of the franchise, such as its historical performance, fees, and potential risks.

Consider the following financial aspects:

• Initial Franchise Fees: Determine the initial costs associated with acquiring the franchise; these fees vary significantly, so it is important to understand what costs the franchisee will be liable for, such as training, supplies, or equipment.
• Ongoing Royalties and Fees: Under the Agreement, franchisors will indicate what percentage of gross sales they require to collect as royalties; to be prepared, the franchisee should calculate how these fees will affect their profitability.
• Profitability of Existing Franchisees: As a prospective franchisee, you have access to pertinent information through the FDD regarding the current status of the franchise; prioritize investigating the performance of current franchisees and ask them to provide insight into the profitability and challenges of buying the franchise.

Case Cite: Helping a Virginia Retail Franchisee Secure Favorable Agreement Terms: The team at Fox & Moghul successfully assisted a client who was seeking to open multiple major retail chain locations across Northern Virginia. We were tasked with evaluating the franchise agreement and offered tactics to the client to negotiate better terms, including reduced royalty fees for the first year and more favorable profit-sharing terms. This allowed the franchisee to improve cash flow during the initial startup phase and was ultimately set up for long-term success.

Factor Three: Researching the Franchise’s Market Position and Brand Strength

A major appeal of purchasing a franchise is the franchisee’s ability to leverage an established brand. Notably, however, not all franchise brands are highly recognized or competitive in the market, so the franchisee will want to evaluate the franchise’s market position within its specific industry.

Key considerations include:

• Brand Recognition: Consider the franchise brand’s consumer recognition; A well-known brand offers an inherent advantage, whereas a lesser-known franchise may struggle with market penetration.
• Competitive Landscape: Analyze whether there are existing competitors or independent businesses offering similar products or services in your desired location.
• Franchise Support: The more reputable a franchisor is, the more comprehensive support they will offer, including marketing, training, and operational assistance; greater support leads to greater success.

Case Cite: Assisting a Virginia Restaurant Franchisee with Market Analysis: Through a comprehensive market analysis, Fox & Moghul’s team assessed local competitors, customer demographics, and brand positioning for a Virginia-based restaurant entrepreneur seeking to buy a franchise with an established brand throughout the Northern Virginia region. These efforts leveraged the client to choose the most advantageous location and structure the Agreement to include an additional territorial exclusivity provision to prevent nearby franchisees from entering the same market.

Factor Four: Understand the Franchise Agreement

After establishing that the franchise purchase is aligned with your goals, capabilities, and preferences, the next step is to form the agreement. The franchise agreement is a legally binding contract between the franchisor and franchisee that outlines the terms of the franchise relationship. Before signing, it is crucial for both parties to understand the terms and expectations provided for by the Agreement and the parties’ intentions regarding the contents of the Agreement. This document will dictate how the business operates and what obligations the franchisee owes to the franchisor.

Key elements of the franchise agreement:

• Territorial Rights: Determine whether the Agreement grants you exclusive territory or if the franchisor is permitted to open additional franchise locations in your region. Establishing territorial rights protects the franchisee from internal competition within the brand.
• Franchise Term and Renewal: Understand the length of the franchise agreement term and what renewal conditions are implemented.
• Franchise Fees and Royalties: Ensure that the Agreement clearly outlines all fees, including initial franchise fees, royalties, and any marketing fees.
• Operational Requirements: Recognize the requirements set out in the Agreement regarding how the business will be operated, including hours of operation and product sourcing.

Case Cite: Securing Favorable Renewal Terms for a Virginia Fitness Franchisee: Fox & Moghul has extensive experience negotiating franchise agreements and prioritizes establishing terms that are most favorable to our clients. This is demonstrated by our successful negotiation of an Agreement for a client in the fitness industry. This client was seeking to open a gym in Fairfax, VA and our team negotiated a longer franchise term and favorable renewal conditions, which allowed the client to build a profitable business before the expiration and renewal of the Agreement. Additionally, we included a territorial exclusivity clause to protect the franchisee from internal competition within their area.

Factor Five: Assessing Your Financial and Operational Capabilities

Successfully purchasing and operating a franchise requires significant financial and operational commitment. It is important for a prospective franchisee to assess their financial resources and business capabilities to guarantee they are fully equipped to meet the demands of running a franchise.

Key considerations include:

• Initial Investment: Ensure you have sufficient funds to satisfy the franchise’s initial investment, and the working capital required for the early stages of running the franchise.
• Business Management Skills: Although the franchisees will be trained, as provided by the franchisor, a successful franchisee goes into the business relationship with strong management skills and at least a baseline knowledge in finance, customer service, and operations.
• Time Commitment: Keep in mind that purchasing and operating a franchise often demands a significant time commitment, especially during the developing stages.

Factor Six: Engaging with Current and Former Franchisees

It is important for a prospective franchisee to engage with current and former franchisees to assess the merits of the franchise. Contact information for these individuals is easily accessible, typically through the FDD. Keep in mind that many are willing to share their experiences.

Consider asking:

• How supportive has the franchisor been?
• What challenges have you encountered?
• How long did it take to become profitable?

Engaging with former or current franchisees offers valuable and realistic insights into the franchise’s day-to-day operations.

Conclusion

Buying a franchise business is an excellent opportunity for someone to expand their knowledge and entrepreneurial interests by supporting and engaging with an established brand. Although advisable, this endeavor also requires careful consideration of several key factors, including the financial health of the franchise, the strength of the brand, and the terms of the franchise agreement. Fox & Moghul has an enthusiastic team with extensive experience in assisting clients in navigating the complexities of buying a franchise, ensuring that your investment is protected, and your business is set up for success.

If you’re considering purchasing a franchise, contact us today at 703-652-5506 to schedule a consultation with one of our experienced business attorneys, or visit our website to learn more about how we can assist you.