Investing in a franchise? Here are the factors to consider.
Any significant financial investment warrants careful consideration, and this includes investing in a franchise. With more than 5,000 registered franchise brands in the United States, the importance of due diligence for prospective investors cannot be overstated. With so many companies and industries to choose from, finding the right fit can be daunting. That’s why we put together this guide – to help potential investors structure their research process when choosing a franchise to invest in.
Questions to Ask Yourself
Knowing what you want your investments to help you achieve is the first step in evaluating whether investing in a franchise makes sense for you. After all, you can’t get where you’re going without first being clear on your final destination.
Start with a frank and honest evaluation of your current financial situation and your goals for the future. Ask yourself these questions:
- What is my willingness to bear risk? Depending on a number of factors, people have different tolerances for the amount of financial risk they’re willing to take. The idea of watching the stock market’s daily fluctuations might make one investor queasy, while another may find the uncertainty and possibility of a huge win exciting. Knowing where you land on the risk tolerance spectrum can be an excellent guide to which assets to invest in while still maintaining your sanity.
- What is my ability to bear risk? Just because you’re comfortable sinking your life savings into a risk-bearing investment doesn’t necessarily mean you can do it without endangering your and your family’s future financial well-being. The willingness and the ability to make risky investments are two separate factors and should be considered as such. Be as objective as possible when looking at how much risk you can afford.
- What regulatory and tax requirements do I need to be aware of? Consult a financial professional to help you understand the impact your investments and any returns they generate will have on your taxes. While these tax concerns will vary from state to state, the regulatory side is less varied. Anyone considering investing in a franchise needs to factor in the guidelines established by the Federal Trade Commission (FTC), which regulates franchises on a national level.
- How much liquidity do I need? It is easier to withdraw funds from certain assets than from others. If you want to use returns from your investments to pay regular, ongoing expenses, investing in highly liquid assets will likely be a better fit for you.
- How long do I want to wait for my investment to mature? The ideal time horizon for an investment strategy often correlates with the investor’s stage of life. Young professionals who are early in their careers may want to start building a portfolio of assets that will mature later, whereas investors heading into retirement and hoping to augment their income may be better off choosing assets that achieve liquidity sooner.
- What industry do I want to be in? From fitness to pet care to printing and shipping services, there are franchise opportunities in almost every industry imaginable. Deciding which is the right fit for you can be a tough call. Consider your existing business experience in tandem with the industries you use on daily basis. Is there one that merges what you do for a living and what you do for fun? That could be an ideal fit.
Once you’ve determined where you’d like your investments to take you financially, the next step is to consider your lifestyle goals. Ask yourself questions such as:
- Am I willing and/or able to invest time as well as money?
- How much do I want to travel for business? For pleasure? Do I want to travel at all?
- What other time commitments do I have? (Family time, volunteer work, etc.)
If you’re considering investing in a franchise, these types of questions are particularly important since your desired lifestyle will dictate whether traditional franchising is a good fit for you. Becoming a franchisee is easier than starting from scratch with a single-location business, but it is still a time-consuming process. You’re responsible for implementing the management and marketing plans laid out by your franchisor, as well as standard operations such as hiring, personnel management, ordering, and scheduling, among others.
Questions to Ask About the Franchise
Part of the due diligence process includes getting to know the franchises you’re interested in. There are a few sources you can use to obtain more information about each company.
Speak with Franchisors
A conversation with your potential franchisor is a great way to start your due diligence process. Setting up a preliminary call is typically as easy as filling out an online form. This is an opportunity to get a high-level overview of the company and how it runs its franchise program.
Who you’ll end up speaking with will vary depending on the franchise. Some companies have an internal franchise development team, while others outsource this function to specialized franchise development companies (FDCs).
Regardless, some potential questions to ask on these calls include:
- What is the success rate of existing franchises?
- What methods are used to protect franchisees from poorly performing franchises?
- Is there a franchise owners association and/or franchise advisory council?
- What kind of training is provided for new franchisees? How much does it cost?
- Has the company done any consumer research? If so, what were the results?
As you get to know the team on the other end of the franchise, remember that these conversations serve a dual purpose – not only are you interviewing a potential business partner, but they are interviewing you as well.
Review the Franchise Disclosure Document (FDD)
The Franchise Disclosure Document (FDD) is a standardized document that must be provided to prospective franchisees and investors by franchisors. Created by the FTC, the FDD facilitates disclosure of critical aspects of each franchise as a business, including the franchisor’s background, a franchisee’s obligations, trademarks, any financing arrangements, and more. This document can help prospective franchise investors answer questions such as:
- What is the franchise opportunity? What type of business is being offered?
- Is the franchisor involved in any lawsuits or another type of litigation?
- What is the anticipated initial investment? What fees can I expect?
- What are the obligations of the franchisee? Is the franchisee required to participate in the daily operations of the franchise location?
- What assistance will the franchisor provide?
- Are any public figures involved in the franchise system? If so, what is the extent of their involvement?
- What financing options are available? Does the franchisor receive any consideration for referring a prospective franchisee to a lender?
- What provisions are in place for ownership transfer? For termination? For dispute resolution?
Each FDD has 23 sections and provides even more detailed information than outlined by the questions above. It should be reviewed carefully by each prospective investor along with their legal counsel.
Speak with Existing Franchise Owners
Once you have the FDD in hand and the franchisor has validated your intentions (i.e., ensured that you’re serious), you’ll likely receive a list of current and past franchisees. You should speak with at least five people from the list to get the best idea of what day-to-day life is like running a franchise. Here are some questions you might ask:
- What made you choose this franchise over others you considered?
- How was your experience with initial and ongoing training?
- Can you describe a typical day as a franchise owner?
Keep in mind that some franchisees may assume their franchisor is monitoring their conversations with potential investors and may be evasive or noncommittal with certain questions. That’s okay – it tells you something all on its own. Be sure to strike a balance between collecting good information and being respectful.
Making Franchise Investing Passive
If the process of answering all the questions we’ve discussed so far seems like a significant time investment, that’s because it is. Investing in a franchise as an individual is not a decision to be taken lightly and can involve an initial outlay of $100,000 or more. With such a significant investment, you cannot afford to cut corners when it comes to research.
But what if there was a better way?
Add Franchise Investing to Your Portfolio with FranShares
At FranShares, we’ve taken the fractionalized model of investing (previously used for pricey luxuries such as vacation homes and private jets) and applied it to franchises. This approach allows investors from all walks of life to invest in a portfolio of pre-vetted, managed franchises – and do so completely passively.
FranShares pursues every franchise opportunity using a systematic due diligence process. Investment teams evaluate franchise businesses for potential fund inclusion using specific metrics and a meticulous screening process. You can learn more about this topic by reading our blog post, How FranShares Selects Franchises. The bottom line is that we take care of the due diligence so our investors don’t have to.
Our novel investment model comes with additional benefits:
- Passive Income
Our best-in-class franchise management team ensures that our investors enjoy truly passive income through quarterly distributions without having to manage the franchise. In other words, we do the legwork while you sit back and enjoy the returns.
- Flexible Capital Commitment
We offer accredited and non-accredited investors the opportunity to invest for as little as $500, although our model also appeals to ultra-high-net-worth investors. Our platform allows people of all walks of life to become fractional franchise owners with the ability to invest the right amount of capital for their own personal circumstances.
- High-Yield Diversification
Franchises are real assets with little or no correlation to the overall stock market; thus, they act as a hedge against inflation and are not subject to the same level of volatility. Furthermore, our fractionalized ownership approach allows investors to fully diversify their franchise holdings. Owning a portfolio of franchises across different geographies and industries creates an effective buffer against challenges that may shut down a single franchise or location, such as service franchises closing temporarily during pandemic lockdowns.
- Low Risk
To minimize volatility and give our investors peace of mind, FranShares only invests in recession-resistant franchises with a track record of success. We perform all due diligence and thoroughly vet each franchise partner for strong brand recognition and market positioning.
The franchise industry is regulated by the FTC; along with that, as a registered investment vehicle, FranShares is also regulated by the SEC. The FTC requires full disclosure of each franchisee’s background, financials, and performance. In addition, we provide our investors with reporting and regulatory compliance documentation above and beyond what those regulators require.
- Zero Fees
Traditional investment vehicles charge an asset management fee of at least 1 to 2 percent, and that can significantly cut into your returns as an investor. But because FranShares participates in every fund, we are able to waive all platform fees and pass along those benefits to our investors. Our profits come from co-investment in franchise locations as well as brokerage commissions from the franchisor, not the fund. This approach preserves capital for our investors and also creates parity in the investment opportunity.
To learn more about how we’re opening the door to a new chapter in wealth-building for our investors, click here to sign up for our mailing list and review our offerings.