Is Buying a Franchise Wise?

Many people think that buying a franchise is a sure way to become a successful business owner. But like any business decision, there are pros and cons. While the start-up process of buying and opening a franchise is often quicker than starting from scratch, the initial costs can be steep, and the options for creative input are limited. Anyone considering becoming a franchisee needs to weigh the costs, benefits, drawbacks, and potential for profit before committing.

Kay Takeaways

• Opening a franchise comes with startup costs, and owners must pay yearly royalty fees to the franchise to stay open.
• Most franchises have suppliers that franchisees must work with to purchase raw materials and other goods to ensure brand consistency.
• Buying a franchise takes some of the guesswork out of opening a business, providing you with a proven model to follow.
• Location is a major factor in franchise success, including the proximity to other stores in the same franchise.
• The average income of franchise owners in 2023 was $102,910 per year.

Costs of Buying a Franchise

Start-up costs, royalty fees, and raw materials must be covered by every franchisee, and these can add up to significant operating costs. Franchisees must also have to consider financing costs to keep their businesses running.

Start-Up Costs and Royalty Fees

Start-up costs are paid before the business opens, and these amounts vary by franchise. For example, when opening a McDonald’s (MCD), the franchisee pays money toward the location as well as a $45,000 franchise fee for the right to operate the business for 20 years. Assuming the company agrees to renew the contract, another $45,000 franchise fee is charged after 20 years. McDonald’s generally requires an applicant to have a minimum of $700,000 of unencumbered personal resources.

In 2024, the total monetary layout to open a McDonald’s franchise can range anywhere from $1.3 million to more than $2.3 million, according to FranchiseHelp.

More costly, however, is the ongoing royalty fee. Every year, franchisees must pay the franchise a fee equivalent to a percentage of sales. These fees are paid in addition to all the business and payroll taxes that you will need to pay to the government.

Royalty fees are standard in the franchise world. Burger King charges its franchisees 4.5% of sales in addition to a $50,000 franchise fee, and Dunkin’ Donutscharges a royalty fee equal to 5.9% of sales each year in addition to a franchise fee that can range anywhere from $40,000 to $90,000, depending upon the location.

Important

Royalty fees can substantially reduce a location’s profits, especially when combined with payroll, food costs, and taxes.

Raw Material Costs

To maintain consistency among their offerings, most franchises insist that their franchisees buy raw materials directly from them or an existing supplier, meaning they often receive rebates on what the franchisees order. The prices charged for these materials, either by the company or the supplier, are often much higher than what the materials would be sold for elsewhere.

It’s not uncommon for some fast-food franchisees to pay 5% to 10% above the prevailing market value for produce, such as lettuce and tomatoes, that could easily be bought elsewhere. Some franchises have been sued for charging franchisees high markups on supplies. Over time, the premium that a franchisee may have to pay for raw materials can add up to significant costs.

Financing

Most franchises don’t provide financing. This means franchisees are on their own when it comes to the initial costs of buying and opening their franchise location. Most franchisees have to tap their savings or obtain some other source of financing, such as a small business loan.

With that in mind, some franchises, such as Lawn Doctor (which offers lawn and turf treatment services), will finance franchise fees, start-up costs, inventories, and equipment to help their franchisees get started.

Situations like these are particularly attractive because, although franchisees will probably have to put up a portion of their assets as collateral for the loan, at least they won’t have to zero out their bank accounts or tap retirement funds to set up shop.

Downsides of Buying a Franchise

Location and Territory Control

Although franchises may do a quick demographic study and gauge whether there is a good chance that a location will perform well, they rarely know an area as well as the locals. If the franchise limits or specifies where stores can operate, franchisees may be stuck with a location that won’t support the business.

Franchisees also may run into the problem of market saturation, which leads to diminishing returns. While most franchises will limit the number of stores they open in a given area, some will try to fit as many retail locations into a given area as possible.

That’s why it’s not uncommon to see five different McDonald’s locations within a five-mile area: the corporate head is trying to squeeze every last dollar out of the territory. But the individual franchisee is the one who suffers. Every new location opens within proximity, their potential market is cut.

Lack of Individual Creativity

Franchises demand uniformity. Everything from in-store decor, signage, products offered, and the uniforms the employees wear is dictated by the franchise. For a person who likes to be creative, this can be a frustrating way to operate a business.

Almost every (if not all) franchise has similar requirements. If you want to be your own boss and have detailed control over how your business is structured and run, a franchise is probably not for you.

Benefits of Buying a Franchise

Easier Business Development

Buying a franchise lets you skip over some of the early phases of business development, like creating a business plan or conducting product research. Instead, you can start your business with a market-tested product that is already familiar to your consumers. The franchise handles market research, pricing, and other major decisions.

While this eliminates some creative control, it also creates a business-in-a-box model that can make getting started quicker and easier than developing a business from the ground up would be.

Branding and Advertising

A franchise comes with a recognizable name and consistent branding, from the store sign to the menus to the employee uniforms. Major advertising is taken care of by the corporate office. While this reduces creative control, it also saves time and effort for each franchisee. Customers don’t need to be introduced to your product or business; they already know what it is and what they think of it.

Warning

Buying a franchise might seem like easy money, but those royalties and fees will quickly cut into profit margins. The majority of franchise owners earn less than $50,000 per year according to Zippia in 2024.

Potential Profits

According to a survey by Franchise Business Review in 2023, the average annual income of franchise owners is $102,910. However, many factors affect franchise income, such as neighborhood demographics and traffic.

How long your location has been open also impacts your income. The same study found that the average annual income of franchise owners beyond the two-year startup period is $115,688. Franchisees who operate more than one location see an increase in income, though not always a proportional one. The average annual income for franchisees who own two to four franchise units is $142,638.

What Should You Do Before Buying a Franchise?

The first step is to conduct thorough research. Carefully read the franchise disclosure statements and marketing materials, to understand the costs and fees associated with the business. It is also important to understand how the franchisor assists struggling franchises and the rate of franchise turnover. It may be worth meeting other franchise owners to get an idea of their experience.

What Questions Should You Ask Before Buying a Franchise?

Before buying a franchise, it’s important to talk to both the franchisor and other franchisees. Ask questions about the costs of operating the franchise (both start-up and ongoing), the expected level of commitment from franchise owners (both hours and money), and the franchise’s financial state and track record with other owners.

What Are the Top Franchises?

The top franchise in 2024 is The UPS Store, followed by Budget Blinds and Kitchen Tune-Up, according to Franchise Direct. High-ranking food franchises include Captain D’s and Teriyaki Madness.

The Bottom Line

Running a franchise is a serious decision that should be made with care. If you’re looking to buy a franchise, learn as much as you can about the company, its products, and the city or town where you are looking to set up shop. Even a great product and a great location won’t guarantee a healthy bottom line, so make sure you are aware of all the pitfalls of being a franchisee before you sign up for the job.