Franchising 101

I have been in franchising since the late 1900's and have led 4 franchise companies as president/CEO (Haagen-Dazs Shoppes, HoneyBaked Ham, Pure Barre and The Lash Lounge). Franchising is an excellent way for small business owners to achieve the American Dream and be in business for themselves but not by themselves. The model's strength is that it combines entrepreneurship with proven processes and systems, creating community and value for end consumers, franchisees and franchisors. Below are a few basics:

1. What is a Franchise?

Three things make a commercial business relationship a franchise:

Trademark or other intellectual property (IP) and an operating system
Significant control or assistance in operating the business
Consideration (at least $500 paid by the business owner to the IP owner)

This industry is federally regulated by the FTC, and each state has its own approach to approvals and enforcement, as the government seeks to protect the small business owner. While there are risks with any business endeavor, with only 15% of all small businesses still in business 5 years after starting, 85% of franchise businesses remain in business after 5 years of operation.

2. How Big is the Industry?

Franchising is a massive system in the US:

3,800 franchise systems across 300+ categories
Employs 8 million people and contributes ~$900 billion to US GDP
Model for many well-known brands: almost all fast food (McDonald's, Subway, Pizza Hut, KFC, Chick-fil-A), hotels (Marriott, Hilton), fitness (Orange Theory, Planet Fitness, Pure Barre, F45), and services (UPS, H&R Block, Ace Hardware, RE/MAX, Jiffy Lube, Hertz)

Franchisors provide training, coaching, on-boarding and ongoing support; in return they are paid a royalty (~5–8% of each unit's sales). Franchisees select the location, pay for the build out, hire the local employees and run the day-to-day business.

3. Key Elements of a Franchise

Franchise Fees: franchisees pay a one-time fee (typically $10–$100k) for exclusive rights to a territory
Territory: geography where a franchisee has exclusive permission to provide the service
Royalties: franchisees pay between 5–8% of their topline revenue to the franchisor
Ad Fund: franchisees typically pay 1–3% of their sales into a national brand fund
FDD: the Franchise Disclosure Document lists all aspects of a franchise system—often 200+ pages. The most important items are 5–7 (investment required), 19 (how much franchisees can make) and 20 (openings and closures)

4. Keys to Success

Each year about 300 franchise systems fail in the U.S. Only 16% of all franchise systems ever make it to 100 open units. In my experience, here are the keys to look for when buying a franchise:

Founder: the founder should have deep industry knowledge and lead strategy, brand integrity, and communication
Unit Level Economics: the most important element is ensuring that existing units make money. Best-in-class franchises return invested capital in ~3 years
Growing End Market: be in an end market where consumer demand is rising
Robust Support System: a good franchise system includes folks who have proven to scale businesses and offers marketing, branding, supply chain, IT, training and open communications

I often describe successful franchising as a river, with franchisees on one side and the franchisor on the other, and the water itself the brand. If everyone executes their role well – the brand will strengthen and grow, and there is no better way to create wealth and achieve the American Dream.