Your small business is thriving. People love your product and you’re making a consistent profit. An out-of-towner recently visited your shop and mentioned they’d love to see your store nearby. And your online following is starting to make noise about coming to their neighborhood.
Is it time to consider franchising?
If so, you’ll be in good company. Today, an average of 300 companies start franchising each year. And as of 2018, there were 750,000 active franchises throughout the U.S. alone.
This rapid growth makes sense—franchising is a growth strategy that makes expanding regionally or nationally feels a little less daunting and a lot more realistic. After all, with investments from franchisees, your brand and operations can quickly extend beyond its current home base. And that kind of expansion can yield economies of scale otherwise unavailable to single-location ventures.
In this Business Formation Guide
At Swyft Filings, we help business owners like yourself navigate the critical steps of becoming a first-time franchisor. We’ll walk you through why franchising is a smart business model, how to know if your business is ready, how to navigate legal paperwork, and how to get your first franchisee up and running.
What to Consider When Franchising Your Business
Franchising 101: What is franchising?
Franchising is essentially a model that gives business owners an alternative way to grow and expand their brand.
In a franchise business setup, franchisees gain access to the franchisor’s know-how, experience, and established business system in exchange for their money and personal labor.
This way, franchisees who want to own a business can shorten the learning curve that comes with starting a business. It’s also a way for franchisees to avoid spending a significant portion of the time and money that’s usually required to launch a new business. And for franchisors, licensing out their business model and pledging support to franchisees is an opportunity to expand without the need for extra money and manpower. In other words, it’s a win-win for both parties involved.
Why would someone consider franchising?
The primary reason that manufacturers, retailers, and service companies decide to franchise is simply a shortage of capital. Franchising gives them a means to quickly open more locations than they could on their own, using funds primarily provided by franchisees.
Franchising also solves an even more critical shortage: a lack of management and labor. In a period where every company is faced with a tight labor market, franchisees provide the local management and local recruitment of labor needed to open more locations and deliver quality service to customers.
How do you know if your business is franchisable?
Not all businesses are meant for franchising. But chances are, if you have a unique product or in-demand service, you’ll be able to replicate your business model on a greater scale.
While fast-food restaurants may be what most people associate with franchises, there are actually more than 75 industries that operate within the franchising format. This includes automotive, electronics, retail, financial services, pet services, sports and recreation, travel, construction, and so much more.
Food businesses currently make up a quarter of all ranked franchise companies, but as consumer needs and demands change and evolve, service-based businesses are starting to thrive in franchising, too.
According to the Entrepreneur Franchise 500 Ranking, here are some of the fastest-growing categories in franchising today.
- Childcare, including learning centers, daycare services, and sitters and tutors
- Fitness and health services, including gyms and physical therapy practices
- Senior care, including non-medical independent living, medical care and staffing, companion care, and transportation
Still now sure if your business has what it takes to become a franchise? Here are a few additional things to consider.
- You need a superior product or service that has enough demand to encourage other entrepreneurs to buy into it.
- Your business system must be teachable. A franchisor develops a detailed operating manual explaining every aspect of running the business while also providing training to prospective owners. If your company is dependent on your unique skill sets or knowledge, it’ll be difficult to expect others to successfully replicate your model.
- Your business concept must be easy to duplicate in multiple locations. If it can only function in specific geographic areas, it may not be franchisable on a large scale.
What kind of research should you do before getting started?
You’ll want to know what kind of competition you’re up against. It’s best to start with a competitive analysis to learn how your concept stacks up against other businesses in your industry.
A competitive analysis will identify the competition’s strengths and weaknesses. This arms you with the information you need to develop strategies that play into your distinct advantages. With a clear insight into the competitors and what makes them tick, you can also customize your sales efforts to attract prospective franchisees who might be looking for similar concepts. And, when you do start franchising, the findings from the competitive analysis will provide your franchise development staff with information to help them answer questions about competitors from franchisee prospects.
When diving into your competitive analysis, take a look at key things like:
- What is the average sales volume per unit of your competitors?
- What is the initial investment range for the competition?
- What are their gross margins and operating costs?
- What is their unit profitability?
- What does the return on their initial investment look like compared to your own?
Must-Have Documents for Starting a Franchise
What kind of legal paperwork is involved in franchising a business?
Franchising is regulated by the Federal Trade Commission (FTC) and by state laws. As a franchisor, you are required to provide accurate, detailed disclosures to prospective franchisees so they can make informed decisions about your franchise offer. These legal documents are some of your main investments in the franchise system.
The two primary documents you’ll create are the Franchise Agreement and the Franchise Disclosure Document (FDD).
The Franchise Agreement
The franchise agreement is a binding contract between you and your franchisee. It explains all rights and obligations for both parties and protects the integrity of your franchise system. This is one of the first documents you will send to a prospective franchisee.
Your franchise agreement will include:
- Initial and ongoing franchise fees
- Timelines for opening the franchise for business
- Franchise territory protections (if applicable)
- Specifications for equipment, supplies, and inventory
- The term of the agreement and conditions for its renewal
- Rules regarding the transfer of the franchise to a third party
- Conditions for termination of the agreement
- Post-termination obligations
- Non-compete covenants
- Minimum sales requirements (if applicable)
The Franchise Disclosure Document
A Franchise Disclosure Document (FDD) must be prepared in strict compliance with FTC rules. By law, you can’t sell a franchise until you’ve given the prospective franchisee an FDD. In fact, 15 states require franchisors to register their FDDs with the state or to notify them that they will offer franchises before they even begin any franchising activity in the state.
The FDD discloses extensive information about you and your business, and with a total of 23 categories, it can turn into a pretty hefty document that can be hundreds of pages long.
Here are some of the main items included in an FDD:
- The franchisor: How long you’ve been in business, likely competition, and any special laws that pertain to your industry, such as license or permit requirements.
- Key persons: The identity and experience of executives and key management personnel.
- Litigation history: A discussion of all litigation involving your company and other franchisees or customers, and disclosure of any allegations of fraud or violations of franchise laws.
- Bankruptcy: If you or any of your executives have filed for bankruptcy, it must be disclosed here.
- Initial franchise fee: Lists the costs in starting and operating the franchise, including any non-refundable deposits or fees, along with any other ongoing fees.
- Training: Describes the training programs you will provide to the franchisee.
- Restrictions: Lists any restrictions on sources of products or services and the suppliers that must be used.
- Financing: Discusses any financing help you may provide to the franchisee.
- Obligations: Lists the obligations and expectations of both you and the franchisee in the daily operation of the business.
- Financial performance: This section is optional, and many franchisors choose to omit any information or projections about sales or revenues. This is known as the Item 19, and while it is optional, it’s also one of the critical—and often looked at—line items in the FDD (more on this next).
- Financial statements: You must provide information about your financial status, including audited financials, so a franchisee can determine if your company is profitable and sustainable.
- Current franchisee contacts: Names and contact information of current franchisees so the prospective franchisee can get a firsthand account of the franchise system, the support it offers, and the revenue opportunities.
So what’s up with Item 19 in the FDD?
Item 19 in the FDD covers any statement that would inform a prospect about the financial performance of existing franchised units, or how a particular franchise might perform in the future.
Under FTC rules, no information about the financial performance of a franchise can be given to franchisees unless it is listed in Item 19. However, franchisors have complete freedom in choosing the type of Item 19 disclosure that makes sense for their businesses.
Hotel systems, for example, may want to include occupancy rates; restaurants may include gross sales figures and key percentages reflecting food costs; pet daycare companies may want to include daily animal counts and the average length of stay. Some franchisors include complete profit and loss statements; others include average gross sales figures or even gross sales of every unit in the system.
What is a franchise model document?
Compiling your legal documents is just one step in franchising your business. You’ll also need to build your franchise model, which includes all the details about how your franchise will operate, what it’ll cost, what you look for in a franchisee, what regions you’ll explore, and more. This serves as a guide for you as you start ramping up for your first franchisee.
Your franchise model will include things like:
- Franchise fee and annual royalty percentage
- Your franchise agreement term and renewal conditions
- The geographic areas you will go into and the specific territory rights for each franchisee
- The amount of start-up and ongoing training you will provide
- Whether franchisees must buy products or equipment from your company
- The qualifications, experience, and financial standing you want in a franchisee
- How you will market and sell your franchises
All of these details carry a lot of weight, and they have a big effect on your long-term profit potential. The difference between a 6% and 7% royalty fee, for example, may not seem like much in the beginning. But over time and with multiple franchises bringing in revenue, that one percent difference can make a big difference in your profitability.
What is an operations manual and why do you need one?
If the franchise model is the guide you follow to succeed, then consider the operations model the guide your franchisees need to follow to succeed. Consider it a playbook that you hand to your team, and it’s filled with all the things they need to know, do, say, and follow to ensure long-term success. After all, the point of a franchise is to provide franchisees with a business model that is practically turnkey. This means you’ll need to develop a replicable system that anyone can easily follow.
Here are a few things to keep in mind when building out your operations manual:
Setting the Groundwork
You want your franchisees to feel invested in and connected to your business. That’s why it’s so important to include your business’ story. This means introducing yourself and the rest of the management team, your background, and your company mission.
Outlining What The Business Does And How It Does It
Your operations manual should educate franchisees on the products and services you provide. But it gets even more detailed from there: You’ll want to explain (in a lot of detail) how to deliver these services and products. This includes how to develop, prepare, and provide the products; how to price your services or products; customer service guidelines; how franchisees should manage their employees; how to utilize a point of sale system; and how to report revenues and performance data.
How to Market and Develop The Business
You’ll want to show franchisees how they can promote their business and drive traffic on a local level. This includes everything from marketing strategies you’ve designed and approved for wide-scale use, to outlining approved marketing channels like social media, email marketing, or websites to promote their local unit.
Listing Out Approved Suppliers and Products
To ensure consistency across all of your franchisees, you’ll need to create a comprehensive list of requirements, restrictions, and approved plans. This includes things like approved buildout and construction plans, so you can control the look and feel of new locations. It might also include a list of approved suppliers, so you can guarantee consistency across all of your store’s shelves and safeguard your brand’s integrity.
You’ve Completed All Of Your Paperwork, So Now What?
The answer to that completely depends on where you plan on selling franchises.
Before offering or selling a franchise within a particular state, franchisors must distinguish between franchise registration states, filing states, and non-registration states.
Before selling a franchise within a registration state, you must first register your FDD with the state’s designated regulatory agency. In filing states, you must file a notice with the state regulator advising of your franchise offering. In non-registration states, you aren’t required to register your FDD or make a filing with any state agency.
Filing in a registration state
Each registration state designates a particular entity to regulate and oversee the franchise registration process and requires annual FDD registration.
These states include:
- California: your FDD must be registered with the California Department of Corporations;
- Hawaii: your FDD must be registered with the Business Registration Division of the Department of Commerce and Consumer Affairs;
- Illinois: your FDD must be registered with the Franchise Bureau of the Illinois Attorney General;
- Indiana: your FDD must be registered with the Securities Division of the Indiana Secretary of State;
- Maryland: your FDD must be registered with the Maryland Attorney General;
- Michigan: you must file a notice and register with the Michigan Secretary of State;
- Minnesota: your FDD must be registered with the Securities Division of the Minnesota Department of Commerce;
- New York: your FDD must be registered with the New York Attorney General;
- North Dakota: your FDD must be registered with the North Dakota Securities Department;
- Rhode Island: your FDD must be registered with the Rhode Island Department of Business Regulation;
- Virginia: your FDD must be registered with Virginia Corporation Commission;
- Washington: your FDD must be registered with the Securities Division of the Washington State Department of Financial Institutions; and
- Wisconsin: your FDD must be registered with the Securities Division of the Wisconsin Department of Financial Institutions.
Franchise filing states
Beyond the franchise registration states, there are a number of states that require a franchisor to file its FDD with the state before operating. Franchise filing is a step below FDD registration. In states with a filing versus registration status, there is usually some kind of specific law governing how business opportunities are offered and sold within the state, but not franchise-specific rules.
These states include:
- Florida: an annual franchise exemption must be filed with the Florida Department of Agriculture and Consumer Services;
- South Dakota: an annual notice must be filed with the South Dakota Dept. of Labor & Regulation;
- Utah: an annual notice must be filed with the Utah Division of Consumer protection;
- Connecticut: a one-time exemption notice must be filed with the Connecticut Department of Banking;
- Kentucky: a one-time exemption notice must be filed with the Office of the Kentucky Attorney General;
- Nebraska: a one-time exemption notice must be filed with the Nebraska Department of Banking and Finance;
- North Carolina: a one-time exemption notice must be filed with the North Carolina Secretary of State;
- South Carolina: a one-time exemption notice should be filed with the South Carolina Secretary of State;
- Texas: a one-time exemption notice must be filed with the Texas Secretary of State.
What kind of support should you consider hiring?
It takes a lot of time and effort to build, market, and sell your first franchise—all while keeping your own business up and running. That’s why it’s a good idea to add a few staff members who are brought on to focus solely on managing the franchise work. You may need a salesperson who can also interface with franchisees and answer questions, or even a marketing and advertising specialist. If your franchisees will be buying supplies from your company, it’s a good idea to hire someone to process and ship those orders, too.
Staffing can be a huge piece of your franchise overhead costs. But it’s an investment that’s totally worth it. The last thing you want while ramping up your franchise is for your own business to struggle during the process.
Selling Your Franchise: What You Need to Know
Tips for Selling Your First Franchise
You have your business model mapped out and your paperwork filed—now you just need to find your first franchisee.
Selling the first franchise is the hardest because, without any prior success stories or references, you’re asking someone to take a pretty big leap of faith. But even more than that, there’s a bigger obstacle standing in the way: How do you even get people to hear about your franchise in the first place?
Fortunately, you have a handful of avenues to explore that’ll help validate and promote your franchise to the right prospects at the right time.
Promoting franchise opportunities in your original location
Yes, this is obvious. But you’d be surprised to hear how many franchisors overlook this. Do you have signs that say “franchises available” on your business’ front door? Do you promote your franchise on every piece of printed collateral in your main location? This is an easy way to get initial exposure for your new franchise opportunity.
Using broker networks is a great way to supplement your own efforts. However, it’s vital you spend time developing relationships with these people if you want to get meaningful results. They have hundreds of options they can choose to offer their clients, so you’ll want to think of this as any other kind of relationship—it takes some effort to build respect and trust. Consider exploring places like The Entrepreneur’s Source, FranNet, or FranChoice.
There are a ton of franchise trade shows out there (you’ll discover that immediately after doing a quick Google search), and it’s a good opportunity to get some exposure, meet prospects, or even mingle with like-minded franchisors.
Internet referral sources
Just do a search for “franchise opportunities” or “franchise leads” and you’ll be amazed at the number of lead source portals. Some of these portals offer monthly agreements while others have pay-per-lead programs.
Are you taking full advantage of your website? Is it optimized for your franchise offering or is it still just directed to your main business? Are you just talking with customers or are you also trying to engage franchise prospects? Websites for franchise development are a completely different beast than your normal business page. It’ll need to clearly tell prospects why they should invest in your business, what the investment looks like, and what kind of support they’ll receive.
How much will it cost to franchise my business?
Although franchising allows you to grow very quickly, it still requires you to spend money to make money. So how much can you expect to spend to get your business ready for franchising? It’s not an exact science, but you can expect to pay anywhere from $18,500 to $84,500 for the franchise development stage (this includes legal costs for your FDD, franchise license agreement and registration fees, and the cost of hiring a support staff). During the franchise sales stage you can expect to pay $22,500 to $75,000 to market your business, work with brokers, and attend conferences.
How long does the entire process take?
Once you’ve made the decision to franchise, it’ll take around four to five months to complete the paperwork and get it filed. Depending on where you’re selling franchises, you’ll also need to register your franchise with the state franchise regulator. This can take an additional month.
Once your paperwork is filed and your business has met the legal requirements, it’s time to wait for the prospects to trickle in. Assuming you have a queue of people who are ready, willing, and able to become franchisees, you will first need to provide them with that FDD you built. If your franchise offering is compelling, and these prospective franchisees are people that you want as franchisees, you can expect to close your first franchise sale within 120 days.
But wait, there’s more! If your concept requires the franchisee to find an appropriate location and develop new construction based on your specifications, that process can take approximately 180 to 210 days. During that period of time, you can count on working alongside your new franchisee to offer site selection assistance, opening assistance, and any other support they might need.
All told, the process can be lengthy, and getting your first franchisee up and running and bringing in revenue can take as long as a year.
What kind of resources are available for help?
Franchisees often decide to start a franchise because of the ongoing support they know they’ll receive. And the same can be said for franchisors: You’ll have a ton of resources available to help you out along the way.
The International Franchise Association is a good place to start. The IFA is the ultimate resource when it comes to the legal issues surrounding franchising. They compile information on franchises, lobby for legislation favorable to franchises, and provide resources and aid to businesses looking to franchise. The association also publishes reports on the legalities involved in franchising (check out their resources page to get started).
A franchise lawyer is another huge resource that could save you from some nasty legal troubles down the road. A good franchise lawyer will help you through each phase of the franchise development process (especially with your FDD) and provide insights and strategies that have worked for other brands.
Let us know if you need help franchising your business!
With the right business model, growth strategy, and marketing plan in place, you’ve already made your first step toward franchising your business. If you need help with the incorporation and compliance aspects of your business, contact the business experts at Swyft Filings for assistance. That way you can spend more time growing your dream business while we handle the paperwork.