Should You Sell Franchises Or Build A Chain?

How to decide which expansion plan is right for you

The owner of an actively growing business may be contemplating on whether to franchise it or build it up to a giant business. When making decision on whether to franchise your business or to expand your business yourself, you need to consider if it favors you or not. You need to determine if the business will thrive well in your care or go worse. There are three groups of talents when it comes to expanding a business:

  • The first are those who are talented in growing a business to a certain level. Beyond this level, they might be declared bankrupt. In few years, this set of people can easily develop their business up to the level that they are matured to be franchised, but they can’t go beyond that.
  • The second sets of talents are not creative enough to start up a business from the scratch but they can handle bigger ones. They are the “big players” in the business. I called them big players because they have the money to buy franchises.
  • The last are those that have all it takes to build a business from scratch to big business, and even take it public. These set of people are usually those who are in love with their products or services and have all it takes to build it to a very large business. Apart from the profit they generate from the business, they have sound knowledge about their business and are inseparable from their business due to the passion they have for it.

Notwithstanding, the above are also factors to consider when deciding on whether to franchise a business or expand it yourself. Of course, there are other factors that you need to consider when it comes to franchising or expanding a business yourself.

The Advantages of Franchising
There are many advantages attached to franchising over a company-owned expansion. Many business owners resort to franchising for four main reasons which include:

  • Capital: Expanding a business requires large capital. A business that is being operated with low capital will certainly take far more years to develop than the one that is funded with huge capital. The advantage is that the franchisor watches the business as it grow without spending any part of his money.
  • Motivated management: It’s a common truth that a business that is managed by motivated staff will surely do well. The franchisees will do everything necessary to see that the business expands. They see to the welfare of their staff. They also train their staff to become professionals in their jobs. The staff are trained to work towards the goals of the business. While the franchisee works eminently to expand the business, you are relaxed and yet, still get compensated.
  • Speed of growth: The franchisee invests huge capital into the business. A business filled with motivated staff and funded with huge capital is expected to do well. This makes the business to expand rapidly if properly managed.
  • Reduced risk: Since the business is franchised, most of the risk goes to the franchisee. The most interesting part here is that, despite not spending any of your capital in the business, you are still compensated. You grow by using other people’s money and at the same time, you are operating without risks.

Debunking the Myths
There are some wide held beliefs about franchising which are far from the truth. One of them is that, franchising is a system of dealing with franchisors legally. The reason for this belief is that America is a litigious society in which someone can sue anybody just for anything.

Franchising is actually less prone to litigation. The reason is that a franchise contracts is a one-sided document. You can be protected if it is being handled by a professional attorney that specializes in law.

Many litigation practices such as cases involving the proper use of advertising funds and that of territorial encroachment have been bypassed. There are now much fewer lawsuits than they were in the past couple of decades.

The major issues that often lead to lawsuit are actually violations of franchise law and fraud in the document of selling a franchise. In order to prevent the former from happening, it’s important that you hire a professional franchise attorney and train all your staff on franchise law. Make sure that each and every one of your staff is honest with the company. Use a written checklist or better still, video tape to interview every franchisee concerning his or her sales process and the representation made.

Franchising is a great tool that helps you to avoid liabilities. However, as a franchisor, each time any contract is signed by you, you are obligated to operate according to the terms of that document.

Let’s consider the company-owned operations.
If you are the operating the company yourself, you will be responsible for everything. You will have the liability for every lease you execute – ranging from equipment, vehicles, buildings. The liability also extends to all wrong operations in the business as well as customers and employees liabilities such as breach of contract, sexual harassment, personal injuries and so many others. However, in franchising, these liabilities are solely that of the franchisee.

Nevertheless, this doesn’t mean that you cannot be sued. But with a good written contract, the liability will be that of the franchisee. In addition, you are also insured by the franchisee against any damage, harm and wrong operations resulting from the business.
The second big myth in franchising is the control and the improved unit-level performance that some argue comes with it. Another belief is that, the ability to hire and fire an employee at any given time is a big advantage, where as with company operations, it’s difficult to do this. However, franchisors have a great deal of control in unit operations.

Studies have shown that similar franchise-operated sites are better managed than their company-owned counterparts. As a result of this, the franchised-operated sites outperform the company-operated sites in almost every aspect.

Reasons
There are two reasons for this. First is that, franchisees are highly motivated by their money and take pride of ownership. Secondly, franchisees usually stay put in their business for generation. They pass their business to members of their families. They develop an easy-to-follow system that can be easily understood and followed by anyone. They then, make sure that the system is thoroughly followed by their staff. This easy-to-follow system prevents them from spending money unnecessarily in training their staff from time to time.

However, if a franchisee is not performing up to your expectation or standard, you have the right to terminate the contract. But if the franchisee is operating to the standard of the contract, there is absolutely no reason why you should consider terminating the contract.

Choosing a franchisee has always been a big problem. When choosing a franchisee, it’s important to assess the franchisee critically before making any decision. In order to prevent any lawsuit against any franchisee, it’s advisable to choose the right franchisee.

Risk attached to franchising
Just like company-owned operation, franchising has its own limitation. There are some benefits that you will no longer be entitled to.

As a franchisor, you will no longer be entitled to all your profits. You will only receive royalty which is a percentage of gross revenue. Instead of being entitled to 100% of your revenue as the business owner, you will only be limited to only about 4 to 10% and probably some product sales, rebates and advertising fees.

In the same vein, if the operating units generates only about 20% profit and your royalty is just 6 percent, you will need to sell about four to five franchises or even more to achieve the same level of profit a company would have fetched you if you owned the company. This means that if you have enough capital to run your business yourself, you would be entitled to 100 percent of the profit. However, your ROI would be higher through franchising.

Although franchisors are also highly compensated with growth in revenue, it is important that the franchisor possess certain leadership style which are better suited to franchising. As stated earlier, it is not all business owners that have the quality of taking a business public. If you find out that you are better off with developing business to a certain level after which you cannot handle it anymore, it’s better to put it in the hand of a right person – the franchisee.

Should You Do Both?
Lastly, for the company trying to choose a growth strategy, it is important to recognize that it does not have to be a tradeoff between building assets and speed of growth. Most franchisors use both company-owned strategy and franchised strategy to run their businesses.

They choose to operate the best location while they franchise secondary and tertiary markets. This means that they operate their businesses in units where they make more profits while they sell off less profitable units. However, others may choose to treat company growth and franchise growth equally. This means taking advantage of any positive conditions that promotes progress of any of them.

Combining the franchise and company-owned growth, is the best for most companies. Even if the best strategy is used in either of these two, it still does not contribute to the success of the business as combining the two would.

This article first appeared on entrepreneur.com and is reproduced here with permission.

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