For many people, the dream of independent business ownership leads to exploring franchise businesses. These tried-and-true, service-based companies seem to offer all the benefits of starting a business while cutting out some of the uncertainty.
So … is that true? Are franchises actually a good investment?
The fact is, it depends on whom you partner with.
In this article, we take a look at franchising as an investment opportunity by exploring:
We will also answer the question: Can a franchise be a passive investment?
Let’s get started.
Franchises are businesses that license their brand and systems to independent entrepreneurs (franchisees). Franchise owners then run the business according to the business model and systems provided by the franchisor.
In the United States, the earliest forms of franchising were developed by the sewing machine pioneer, I.M. Singer, whose company documented its production process for licensing to independent franchisors. Over the following years, franchising’s popularity and prevalence soared.
Today, franchising represents a $788B market segment, with more than 5,000 brands offering franchise opportunities to entrepreneurs and investors. Although the businesses span every industry and vertical, the franchise opportunity follows a predictable and repeatable process.
Wealthy investors have long understood the value and potential returns of building franchising networks as part of their investment portfolio.
The initial investment for a franchise location varies widely, depending on the type and location you choose. Costs for starting a franchise are one of the main barriers to entry for the everyday investor. Various factors influence the range of initial investment, including (but not limited to) the cost of building out the location, the price of systems to run the business, and the brand recognition of the franchise partner in question.
The costs break down into three main areas: franchise fees and start-up costs.
Depending on the brand and the industry, franchise fees typically start in the $20,000 to $50,000 range. Some brands market themselves as “low-cost” franchises with investments beginning at $15,000.
There is a caveat, however. Part of the success of the franchise model comes from the support a franchisee receives from the parent brand. In the case of low-investment franchises, this support may not compare to the services, systems, and back-office support received from higher-fee brand partners.
After obtaining the right to franchise, a significant portion of your investment will go to building out your physical location, purchasing systems and equipment, and hiring and training staff to support daily operations. If you plan to run the franchise semi-passively, this cost will include hiring a manager to oversee the location.
For perspective, here are some typical initial investment prices for popular franchise industries:
Building a foodservice franchise is a costly endeavor. In addition to the franchise licensing fees, owners must invest in equipment, point of sale systems, ingredients, and supplies. Foodservice franchise owners can expect to invest between $325k to $678k in starting up a new location.
Automotive services franchises enjoy high rates of return, depending on market factors – but start-up costs for a location range from $300k to nearly $600k on average. Factors such as materials, equipment, employees, and environmental services contribute to the high initial costs in this industry segment.
Many home service brands are franchised opportunities. These in-demand, service-based businesses offer a high potential return, but wage and equipment expenses drive up the cost of the investment. Expect to pay anywhere from $200k to $300k or more to start and scale an automotive services franchise.
In-demand personal services such as fitness, hair and beauty care, and massage command big returns for their investment. That considerable rate of return comes alongside a high initial investment cost – anywhere from $300k to $700k invested in equipment, supplies, employees, and liability insurance.
People who invest in personal care often spend similar discretionary income on their pets. For this reason, the pet care industry blossomed to more than $260B in 2022. Pet care services such as veterinary care, grooming, boarding, and social boarding (aka, “doggie daycare”) are in high demand and offer a robust return on investment. Investors in this industry can expect to pay $265k to almost $500k per location for build-out, systems, and instance costs.
The financial considerations of personal and pet care franchises also apply to childcare and education start-ups. Franchise locations for child care services, enrichment, tutoring, and daycare average $151k for first-year costs
Despite the dependability and expected returns for these businesses, the initial investment becomes a barrier to entry for many investors.
Aside from the initial licensing fees paid to participate in the franchise, owners also pay royalties calculated as a percentage of revenue. These fees are akin to marketing fees. Depending on the type of business and your franchisor, royalties may range from 4-12% of monthly revenue.
As with the amount of initial investment, the profitability of franchise businesses is wide-ranging. Many factors influence the profit you can expect to generate from your business in year one and beyond, including:
Franchise businesses boast impressive returns – far above the expected return from investment vehicles like venture capital or the public markets. Within a few years of opening a location, some franchises see investment returns of more than 100 percent.
Franchise owners can offer a general perspective on the experience, and you will get a good idea of the earning potential of a specific franchise location by talking to the owner.
To get a more in-depth understanding of the individual investment and the potential returns for a brand location, investors should read its franchise disclosure document (FDD). The FDD contains all the relevant financial information available from a franchise brand, including:
The information contained in the FDD is the most comprehensive road map to the investment and returns possible with a franchise location.
It helps to have a professional such as an accountant, attorney, or franchise broker help in reviewing the FDDs. They can break down the wealth of information contained in the documents, and how it will impact your investment decision.
Franchising can be a lucrative and stable investment with the right brands and under the right conditions. Traditionally, franchises are active or semi-passive investment vehicles.
Unlike other investment models – stocks, bonds, venture capital, or asset investments like wine or art – a franchise requires the participation of a willing and capable entrepreneur to build and scale the business using the systems and marketing resources provided by the franchisor.
Some franchise owners grow their business into a multi-unit enterprise, either by expanding into multiple locations of a single brand or by launching networks of complementary businesses under one management structure. In these cases, the owner’s time and attention are directed to “managing the managers” who run the individual locations.
Well-funded, high-net-worth investors often build passive or semi-passive franchise businesses using a third-party management company. These professional franchise firms specialize in launching, staffing, training, and scaling franchise locations for multi-unit owners. Although the owner must still engage with the business, this is still considered a passive model of franchise investment.
While this method works great for large-scale investors, it is out of reach for most beginning franchisors. Even those with sufficient capital may find the learning curve of franchising too steep or the time investment too significant for them to undertake.
Fortunately, there is an alternative.
The expense and learning curve involved in starting a franchise prevent many everyday investors from taking advantage of this important alternative asset class. The requirements for net worth and initial investment capital are simply too high (and perceived as too risky) for the average investor.
That’s why FranShares is the ideal solution for any investor.
FranShares allows accredited and non-accredited investors to participate in a fractionalized fund of start-up franchises. Investors can start with as little as $500 and enjoy returns on investment from 16 percent to more than 21 percent.
This provides an entirely passive way for investors to participate in the franchise asset class – without needing heavy investment, specialized training, or major changes to their personal or professional lives.
To learn more about the FranShares model of franchise investment or get information about participating in a future fund, join our waitlist here.
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(1) Portfolio IRR projections are calculated using all cash flows, including the initial investment of $25,000,000 of offering proceeds, annual earnings before interest, depreciation and amortization (“EBITDA”), less estimated corporate taxes, and the sale of the entire portfolio at the end of the fifth year at 5x EBITDA.
(2) Cash Yield projections are calculated as the arithmetic mean (average) of five years of annual cash flows (including EBITDA, less estimated corporate taxes) divided by the initial investment of $25,000,000 of offering proceeds.
(3) Equity IRR projections are calculated using the initial investment of $25,000,000 of offering proceeds and the sale of the entire portfolio at the end of the fifth year at 5x EBITDA.