How Franchising Works

The deal

In franchising, a company, the franchisor, licenses its brand, recipes, training and systems to independent owners, the franchisees, who invest their own money to open and run locations. Franchisees usually pay an upfront fee, build-out and equipment costs, and ongoing royalties, often a percentage of sales, plus contributions to a shared marketing fund.

Why it works

For the brand, franchising allows rapid growth using other people's capital and local knowledge. For the owner, it offers a proven concept, supplier relationships and brand recognition, which can lower the risk compared with starting from scratch. Ray Kroc's McDonald's and Fred DeLuca's Subway grew this way, as our Fast Food Run sister site explains.

The disclosure document

In the US, the Federal Trade Commission's Franchise Rule requires franchisors to give prospective buyers a Franchise Disclosure Document at least 14 calendar days before they sign or pay. It covers fees, litigation history, the number of locations opened and closed, the franchisee's obligations and, in some cases, financial performance. Read it carefully and talk to current and former franchisees.

Key takeaways

Franchising lets owners buy into a proven system, but it comes with fees, royalties and rules. Read the Franchise Disclosure Document carefully. Talk to current and former franchisees about real costs and profits. Have a lawyer and an accountant review the agreement before signing. Make sure you have enough working capital to survive the first year.

Questions to ask

What is the total investment, including working capital? What royalties and fees apply? How much control do you have over prices and suppliers? How many franchisees have left recently and why? What territory protection do you get? A franchise lawyer and an accountant can review the agreement before you sign.

This page is general education, not financial, tax or legal advice. Everyone's situation is different, so check official sources and consider talking to a licensed professional before big decisions.

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