There are two effective ways to become a business owner without reinventing the wheel and starting your own business from scratch: buying a business opportunity and being awarded a franchise business. Each has advantages and disadvantages so knowing how each works and how you would fit their model is important before you begin your search for a particular business.
With a business opportunity, you buy and own a business outright and operate it under a name you choose. The seller makes his money by delivering the business system, training, equipment, or service method to the buyer. In some cases, the seller may also make residual income for the ongoing sale of products or services, but for the most part, the relationship is over once the purchase is final.
While a business opportunity is not federally regulated, some states will encourage a general form of disclosure prior to purchase, but most do not require it. If a business opportunity does offer a disclosure document, it may provide only general information. The lack of regulation can speed up the purchase process, but it also leaves the buyer responsible for completing a thorough investigation of the business.
Some advantages to a business opportunity are that there are no ongoing royalty payments and the buyer is given complete freedom to run the business as he chooses. On the downside, there is no vested interest by the seller to ensure that the buyer succeeds in the business so they are less likely to offer ongoing support, marketing help, etc.
Income expectations for a business opportunity may be lower than for a franchise opportunity, but they typically are available at a lower overall investment than most franchises. A business opportunity may not require costly leasehold improvements or large working capital reserves, making it an option for many people who may not have the capital available to purchase a franchise. For many buyers, a business opportunity provides the flexibility to start out as a supplemental income or home-based business but has the potential to support their lifestyle and meet their financial goals in the future.
A franchise opportunity is a relationship between a seller and a buyer that continues for the duration of the buyer’s involvement in the business. A franchise differs from a business opportunity in two important ways.
First, a franchisor generally collects a franchisee fee up front from the buyer and also collects ongoing royalties. What the buyer gets for these fees is access to a brand, a proven business model, comprehensive training, and ongoing support.
The second difference is that in a franchise, the franchisor will require the franchisee to adhere to strict guidelines in the operation of the business. This is done because it is the franchisor’s name on the business. The brand must be protected for the benefit of all franchisees in the system and the service or product provided must be consistent from store to store and state to state.
The Federal Trade Commission (FTC) regulates franchising at the federal level. In order for a business to be labeled a franchise, three elements must be in place:
- The franchisor allows the buyer to use the franchisor’s trademarks.
- The franchisor collects a fee (of at least $500) from the buyer within the first six months of operation.
- Franchisor exercises “significant control” over the buyer’s operation on an ongoing basis.
The most critical FTC guideline requires franchisors to provide buyers with proper disclosure information prior to finalizing the sale. This document is called a Franchise Disclosure Document (FDD) and will assist a buyer in completing the due diligence (the process of investigation into the details of a potential investment and the verification of material facts) before purchasing the franchise. In many cases, individual states have additional guidelines a franchisor must meet to sell franchises in that state.
The FDD is of enormous value to a prospective franchisee and is the best way to differentiate the good franchisors from the bad. Franchisors must disclose any litigation they have faced, list all franchisees in the system, and address turnover, terminations, etc. Although not required, the FDD can also list the earnings potential for a franchise.
Which is Best?
The answer, obviously, is that it depends on the buyer. An entrepreneurial individual may find the confines of a franchise opportunity limiting and thrive in a business opportunity where he makes all the decisions. Another person may find the brand recognition, ongoing assistance, and company-wide marketing programs associated with a franchise just the safety net he needs to feel confident when starting a new career.
If you’ve never owned a business, you may find that franchising offers a significant advantage to you over a business opportunity. A good franchisor is continuously working on refining the product or service and building the brand. As the marketplace or technology changes, your franchisor will be there for you, providing new products, upgraded equipment, and training as needed. As a franchisee, you have the benefit of learning from your peer groups – other franchisees in your area, region, state, and even across the country. You may also have such advantages as group buying power and national advertising.
A franchisor has a vested interest in seeing each franchisee succeed for many reasons, including the royalty it receives. The royalty revenue makes it possible for the franchisor to have a strong corporate staff and to provide a superior level of ongoing support to the franchisees. Finally, franchising offers one exceptional benefit over a business opportunity and that’s the power of the brand. A consistent, recognizable, and everywhere brand is important to customers with the added benefit of increasing the value of the investment the franchisees make in their business.