Rather than carrying out a company formation to start a new limited company, people often buy into an established franchise to get started in business. But what are the advantages and disadvantages of a franchise?
Advantages of a Franchise
As a business structure, a franchise can certainly be an appealing option. With a number of advantages, it is often the choice of those looking to start a new business without the risks associated with going out on their own.
An Established Business
A franchise offers the advantage of operating under the banner of an already established business. The ideas, the brand, the operating techniques and much more are already tried and tested and in place ready to be implemented again and again at a new location as each franchisee takes up the mantle.
A Known Brand
Operating under the banner of a franchise allows a franchisee to take advantage of the previously established brand of the business. This means there will (in theory) be far less work (and cost) involved in trying to establish and build on the brand of the business. It will already be known and trusted by the market and therefore should produced a steady stream of brand-loyal customers. Adopting a franchise means the advantage of the franchises trademark and the benefits of a registered trademark.
Simpler Business Financing
Yet another advantage of franchises is the fact that acquiring business finance is generally easier. Investors are far more willing to invest in a business with an established network, secure brand and effective support structure. In some instances, finance may be acquired from the franchisor, making life even simpler for the new business.
The franchisee can also take advantage of the numerous business relationships already established by the franchisor. In all likelihood, relationships with suppliers (and perhaps distributors) will already be in place and easy to manage. The advantages of already established relationships with advertisers and marketing teams may also be of benefit to the new business start-up.
Support and Security
Franchises offer the advantage of a support and security system. Often franchisors will offer training schemes and support with things like the management of accounts, sales, advertising and more. These sorts of things may well be included in the price of the franchise fee.
Less Likely To Fail
The old myth is that 95% of businesses fail within the first 5 years – this (false) point is often championed by franchisors who are trying to encourage new people into their network. The security offered by the franchise can give the impression that the business will be less likely to fail.
You’ll Make More Money?
People often think that another advantage of starting a franchise is that they will make more money. With the backing of a big name and a big brand, they think they’ll get more customers and thus more profits. In truth, this isn’t always the case. The fees that a franchisee pays to the franchisor often means a big cut in profit and due to the limits imposed by the rules of the franchise it is often less easy to invest the profits in a tax-efficient way as you could by forming a new limited company. A franchisee might benefit from higher profits in the beginning, but in the long term, they will often find that starting their own business would have been more profitable.
Disadvantages of a Franchise
Just as with any business model, there are disadvantages to setting up a franchise. Quite often people are under the mistaken belief that the advantages outweigh the disadvantages, but this is because they are commonly blinded by the potential risks of starting a new business from scratch. The formalities of setting up a limited company under which the franchise operates will be the same as if you were starting your own business.
The first and most significant disadvantage of a franchise is the fact that the franchisee has no control of the business or how it is run (or very limited control). The rules of the business are already established and part of the franchise agreement. How the business operates is set out by the brand of the franchise and it is very rare that a new franchisee will be able to operate outside of these borders.
Tied To Suppliers
Operating a business, you’d probably like to keep costs down. Finding the cheapest suppliers to minimise your overheads and maximise your profits. But being part of a franchise means you’ll be required to use the franchise supply network. You will be tied to the suppliers dictated to you by the franchise agreement. The obviously disadvantage for a franchisee here is not only the lack of control, but the reduction in potential profits.
Risks From Others
Another serious disadvantage of a franchise is the risk that others might damage the reputation of your business. As a franchisee you would rely on the brand of the business to bring you customers. If other franchisees did something to damage the reputation of the brand, this would have a knock on effect on your own business. Potentially this could damage your sales and overall profits.
This is a big disadvantage for most franchises – the costs. A franchisee will often be expected to pay an initial cost to buy into the franchise agreement. As part of the continuing franchise agreement, they will then be paying on-going fees for the support and training provided by the franchisor. In the long term, this means a restriction to the amount of profit (and money in your pocket) that you can make as a franchisee. Completing a company formation to start your own limited company will often be the better choice, as there will be fewer restrictions on how you operate your business and more potential avenues for profit, without the overheads.
Cut Of Your Profit
The franchisor will expect a cut of your profit. These are usually taken by way of “franchise fees“.
It is important to understand how the franchise fees work. Often these will be fixed periodic fees (often annually) plus a percentage of the turnover the franchise business makes.
You do all the hard work and still have to pay them for the privilege of using their name (and support). When times are hard, this might mean a further reduction in already low profits and a struggle for your business.
Difficult to exit business
Selling a business can be challenging. Selling a franchise business can have potentially more pitfalls as any buyer is bound by the terms that have been negotiated with the franchisor when a franchise was granted. The initial franchise agreement will probably have been negotiated for a fixed period, so even if the business has been successful, the terms of the franchise will have to be re-negotiated on renewal and any potential buyer may be deterred by the uncertainty of the terms the franchisor may seek to introduce on renewal.
As with the other legal forms of business, the advantages and disadvantages of a franchise need to be balanced and considered before starting your new business. The main advantage is clearly the security, but the disadvantage of the costs and reduced profit and control might put people off. Certainly, the majority of people would choose to start their own business rather than get tied in with a franchise agreement. That is not to say that setting up a franchise is not worth consideration.
Starting Your Own Franchise Enterprise
A number of people have come to us looking to setup a franchise for their own business; forming a series of limited companies to sell onto other people looking to start their own business, but looking for the advantages and safety net of a franchise scheme. If you’re interested in doing something similar, contact our company formation team for more information and guidance on 0800 0828 727.