The 3 Types Of Franchises You Could Own

Quick Guide: Types Of Franchises

  • Business Format Franchises: The most common type of franchise. The franchisee not only sells a certain product, but also produces and delivers the product or service in accordance with the franchisor’s proprietary ingredients and/or practices, and with the franchisor’s assistance. Examples: Subway (fast food chain), Marriott (hotel chain), Hertz (car rental company), Nike (retail outlet), The UPS Store (mailing and shipping outlet), Great Clips (haircut salon).
  • Manufacturing Franchises: The franchisee buys the license to produce a branded product, or part of a product, in accordance with the franchisor’s practices and standards. The product is then further assembled and/or distributed to consumers via downstream channels. Common examples include automotive manufacturers (Hyundai) and beverage manufacturers (Coca Cola).
  • Product Franchises: The franchisee buys the rights to sell a certain product at their own establishment, in exchange for paying the franchisor a royalty fee and/or with certain limitations. The limitation may be that the store must sell the franchisors’ products exclusively (but this is not always the case). Common examples include gas stations (Exxon), vending machines (Coca Cola), and car dealerships (Ford Motor Company).

Business Format Franchises

A business format franchise is the most common type of franchise. A business format franchise produces and delivers not only a product or service, but also a customer experience, all in accordance with the franchisor’s specific standards. In exchange for a one-time franchise fee and ongoing royalty fees, the franchisee also receives assistance from the franchisor in terms of training, marketing, quality control systems, and other aspects of running the business. Business format franchises dominate many industries, from fast food, to retail, to hospitality, along with many others.  Some popular examples include McDonald’s, H&R Block, Starbucks, Jamba Juice, Hilton Hotels, and 7-Eleven.

Usually, it is not obvious to the consumer whether a chain establishment is company-owned or franchised because the consumer experience varies minimally or not-at-all from one location to the next, nor does it vary significantly depending on whether you’re at a company-owned vs. franchised establishment. For example, fast-casual eatery Smashburger has some corporate-owned locations and some franchise-owned locations, but they all operate pretty much the same.

Business format franchises vary significantly in how much they cost to open and operate. It may be possible to open a home-based franchise such as a travel agent franchise for just a few thousand dollars; at the other end of the spectrum, opening a popular restaurant franchise can set you back several million dollars. Business format franchisees become franchise owners either by developing a new franchise location from scratch, or sometimes by purchasing an existing franchise location. Some franchisors require prospective franchisees to agree to develop multiple franchise locations within a certain timeframe.

Pros & Cons Of Business Format Franchise

The Pros:

  • You have a certain level of autonomy, as you own and operate your own business.
  • You have a built-in base of customers who are already love your product.
  • You have the security of a proven business model.
  • You receive corporate guidance, training, and marketing.

The Cons:

  • You have very little say in how you run your business—where you purchase raw materials, how you deliver the product/service, which business management software you use, etc.
  • The franchise fee and other costs of doing business can be prohibitively expensive, with no way to control these costs, which are determined by the franchisor.
  • The profit margin is narrow (compared to running your own business), due to high operating costs and franchise fees.

Is A Business Format Franchise Right For You?

The ideal candidate for a business format franchise has the following characteristics:

  • You don’t necessarily have any specific skill-set but want to own and operate your own business.
  • You have or can access the capital necessary to pay the franchise fee and other startup costs.
  • You don’t mind following corporate practices/instructions to a tee.
  • You are willing to forfeit part of your profit in exchange for corporate guidance and the safety of a proven business model.

Manufacturing Franchises

A manufacturing franchise is a manufacturing company that produces the raw or finished product that a franchisor ultimately sells. Sometimes, these operations are also called “suppliers” or “partners.” They are often located in countries outside the U.S. where the cost of production is cheaper. Some examples include automobile and automotive parts manufacturers, computer manufacturers, clothing manufacturers, and food and beverage manufacturers. Not all consumer product use manufacturing franchises; some trademarked products are manufactured by company-owned facilities.

Coca Cola is an example of a company that partners with manufacturing franchises to manufacture the syrup that goes into their soft drinks. The syrup is then sold to a bottling company that adds water and carbonation, and then bottles and distributes the drinks.

Manufacturing franchises must pay the franchisor a fee in for the license to produce the raw materials or finished product with the company’s trademarked name. The product must be manufactured within strict specifications so that it meets the franchisor’s quality standards and is indistinguishable from the products produced by the company’s other manufacturers. These are significant operations and require not only owning the means to production, but also experience, expertise, and a lot of legal help to ensure that all relevant laws and policies are being adhered to.

Pros & Cons Of A Manufacturing Franchise

The Pros:

  • With an efficient production system, you can potentially make a substantial amount of money.
  • You may have a certain amount of autonomy as to how you run your operations, as long as you produce the product to the franchisor’s specifications.
  • You do not have to worry about sales, marketing, or any other customer-facing aspect of the business.

The Cons:

  • Startup and overhead costs are both substantial.
  • Fluctuations in raw material and energy costs can cut into your profit margin.
  • You need to meet a number of strict codes and specifications, adhering to the company’s policies and all relevant laws.

Is A Manufacturing Franchise Right For You?

You might consider a manufacturing franchise if you fit the following profile:

  • You already own manufacturing facilities or have the capital to obtain or build them.
  • You have experience mass-producing products for other franchisors or can partner with someone who has this experience.
  • Your operations meet or can meet all of a franchisor’s supplier requirements; for example, here are the requirements to become a Coca Cola supplier.

Product Franchises

A product franchise, also sometimes called a “product distributor” franchise, is a business model in which a company agrees to sell a trademarked product, either exclusively or not. Some examples include car dealerships, auto parts suppliers, tire stores, and convenience store inventory. The car dealership may sell a franchisor’s product exclusively, while a convenience store may agree to purchase a certain number of units, or agree to sell the franchisor’s products to the exclusion of certain competing products. Vending machines can also be considered a type of product franchise. Many gas stations, including Exxon, follow a product franchise model as well.

Depending on the agreement, the franchisee may or may not have to pay fees to the franchisor to buy the license to sell the trademarked product.

With a product franchise, the product itself is the only aspect of the business distributed per the franchisor’s terms. The consumer experience can vary a lot from one business to the next, as the distributor (franchisee) maintains control over most aspects of their business, and the franchisor does not offer any assistance in terms of sales processes, employee training, etc.

Pros & Cons Of A Product Franchise

The Pros:

  • You benefit from the reputation of name-brand product, without having to produce it.
  • You have very few upfront costs, apart from the cost to purchase the wholesale products from the franchisor.
  • You have the flexibility to run your business how you see fit.

The Cons:

  • You could find yourself stuck with a surplus of an unpopular product, possibly forcing you to sell the product at a loss.
  • You receive no or minimal support/assistance from the franchisor.
  • You need to own your storefront where you can distribute the product.

Is A Product Franchise Right For You?

You could be the ideal candidate for a product franchise if you have the following attributes:

  • You already own your own sales channel (usually a storefront establishment but could also include eCommerce) or can access the capital to do so.
  • Your customers ask for a certain (franchised) product, or you have reason to believe your customers would buy said product.
  • You want to maintain control of your own business without having to deal with franchisor oversight.

Final Thoughts

There are three main types of franchising relationships, each of which represents a different segment of a franchised company’s supply chain. Depending on factors such as the level of control you want over your business, your business experience/skill-set, and the amount of capital you can access, you might decide to open a business format franchise, product franchise, or a manufacturing franchise. Or, you might just decide to go into business for yourself! For more information on franchise ownership, check out some more franchise resources we’ve put together for you:

  • The Step-By-Step Guide To Buying A Franchise
  • Franchise Financing: The 7 Best Places To Get A Franchise Loan
  • How Franchises Work: The Complete Guide For Entrepreneurs

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7 Ways To Buy A Franchise When You’re Short On Funds

Franchisor Financing

One of the most appealing benefits of buying a franchise is that sometimes you don’t have to look very far to get financing. In fact, many franchisors across various industries offer financing options for new and existing franchisees. Franchisor financing is a win-win for everyone: the franchisee gets needed capital while the franchise continues to grow with the addition of new locations.

The amount of money and type of financing offered vary by franchise. For example, Weed Man provides up to $40,000 to franchisees that may not qualify for a bank loan. The UPS Store also offers a low-interest financing program to qualified borrowers. Marco’s Pizza offers personal guarantees and assists franchisees in finding funding through sources including traditional and SBA loans.

Like other types of financing, you must be qualified to receive financial assistance through your chosen franchisor. Borrower requirements vary by franchise, but you should expect to have some funds to put into the business and meet any credit requirements.

SBA Loans

If you want long repayment terms and low interest rates, a conventional loan fits the bill. Unfortunately, qualifying for this type of loan is difficult for any business owner — especially one that’s new to the game. The good news, though, is that the Small Business Administration (SBA) makes it easier for people like you to get business loans with competitive rates and terms.

The SBA itself does not distribute loans. Instead, this government organization provides a guarantee on loans provided by banks, credit union, and other lenders, known as intermediaries. Because a large percentage of each loan is backed by the SBA, it’s easier for franchisees and other small business owners to be approved.

There are several types of SBA loans for franchisees, but one of the best is the SBA 7(a) loan. With this loan, you may receive up to $5 million with repayment terms starting at 7 years and going up to 25 years. Funds can be used for a variety of purposes including commercial real estate, equipment, franchise fees, and other startup costs. Interest rates are extremely competitive and are based on the prime rate plus up to 4.75%. Rates are based on the amount and duration of the loan. Learn more about SBA 7(a) loans.

Another SBA loan option is the CDC/504 loan. With this option, a nonprofit Certified Development Company (CDC) provides up to 40% of the amount needed by the franchisee. A traditional lender, such as your bank or credit union, provides up to 50% of the amount. With this option, you could contribute as little as 10% to receive the funding you need.

There are more limitations on how CDC/504 funds can be used. While you can’t use funds to pay franchising fees, you can use this loan to purchase, expand, or update commercial real estate for your franchise. You can also use funds to purchase equipment for your business. CDCs can loan a maximum of $5.5 million with terms up to 25 years. Like SBA 7(a) loans, CDC/504 loans have very competitive interest rates based on the prime rate plus a markup. Learn more about CDC/504 loans.

Although qualifying for an SBA loan is easier than getting a conventional loan, the process can be time-consuming, taking anywhere from weeks to months for approval and funding of the loan. You must also meet all of the requirements for 7(a) loans and CDC/504 loans, including but not limited to having a solid personal credit score, putting up collateral, and meeting the guidelines of a small business as defined by the SBA. You should also be prepared to pay any fees required by the lender, including appraisal fees, service fees, and closing fees.

Home Equity Loans & HELOCs

If you own your own home, you could use your equity as collateral for a startup loan for your franchise. Equity is the difference between what is owed on the property and the value of the property. For example, if your home is appraised at $500,000 and you owe $300,000 on your mortgage, you have $200,000 worth of equity in the property that you could potentially leverage for your business venture. Equity is built up if your home value increases as well as when you pay down your mortgage.

With a home equity loan, you won’t be able to borrow the full amount of equity, though. Most lenders will only give you 80% of the value of your home, less what is still owed. Funds can be used for any purpose, including covering startup costs and franchising fees for your new business.

You may also consider a home equity line of credit, or HELOC. Instead of a lump sum, you have access to a flexible line of credit that is backed by the equity in your home. You’ll be able to withdraw funds as needed up to your set credit limit for a certain period of time. This is known as the draw period and usually lasts one year. After the draw period ends, you enter the repayment period. Since HELOCs are a form of revolving credit, you can reenter the draw period once you’ve repaid borrowed funds.

Competitive interest rates, long repayment terms, and flexible use of funds make home equity loans and HELOCs a good choice for covering the costs associated with buying and operating a franchise. On the flip side, though, your personal property is at risk if you default on your loan.

In addition to having equity in your home, you must also meet the other requirements of your lender. This includes having a high personal credit score, a low debt-to-income ratio, and a solid repayment history.

Rollovers As Business Startups (ROBS)

Another way to get the money you need to buy a franchise is by using funds you already have in your retirement account. Normally, drawing from your account early results in penalties. However, you can avoid these penalties and access your funds in just weeks with a Rollovers for Business Startups plan, also known as ROBS.

Instead of borrowing from a lender, a ROBS plan allows you to use your own retirement funds to start your own business. A new C-corp is established, and a new retirement fund is created. Funds from the existing retirement account are rolled over into the new retirement account. These funds are used to purchase stock in the C-corp, giving you access to the cash you need to build your business.

Qualifying for a ROBS plan is easy — you simply need a qualifying retirement account, such as a 401(k), 403(b), or IRA. You don’t have to worry about having a high credit score, a certain amount of income, or any other requirements needed for other types of funding. Because this isn’t a loan, you also don’t have to worry about paying interest to a lender. The downside, though, is that if your business fails, you risk losing your retirement funds.

While you won’t have to pay interest to a lender or penalties for the early withdrawal of funds, you will need to work with a ROBS provider. For a one-time setup fee, a ROBS provider can help you set up your C-corp and retirement account. You may also need to pay a monthly fee to cover maintenance and reporting on your account.

Ready to leverage your retirement funds to buy a franchise? Learn more about how ROBS can help you launch your new business.

Online Loans

The internet has made it easier than ever to shop for loans to purchase a franchise. Unfortunately, as a startup, you might find it difficult to find a competitive business loan. Lenders evaluate risk by looking at factors such as your personal and business credit profiles, annual revenues, and time in business. If you haven’t yet launched your business or you’re in the very early stages, finding funds with favorable rates and terms can be a challenge.

One option you do have, though, is to take out a personal loan for business. When you apply, you use your personal information — personal credit score and history and annual income, for example — to qualify for funding. That loan can then be used to purchase your franchise or fund other startup costs.

Partnerships

If you don’t have the funds to purchase a franchise, consider bringing on someone who does and forming a partnership. A friend, family member, colleague, or anyone with money to invest can become a partner. Be aware, however, that forming a partnership means that you will be handing over partial ownership of your business. This means that you won’t be the only one making the decisions … or taking the profits.

When you find a business partner, make sure that you work with an attorney to draft all documents and agreements. Having the right documentation doesn’t just protect each partner; it also ensures you remain compliant with Securities and Exchange Commission regulations.

Low-Cost Franchises

If you have some money in savings or another source of funding, shop around for lower-cost franchising opportunities. The big players — think, McDonald’s, Chic-Fil-A, and other established franchises — are typically the most expensive to purchase and operate. Instead, focus your sights on more affordable opportunities that will allow you to break into business ownership.

In addition to finding low-cost startups, you can also look for franchises that offer discounts to new owners. For instance, some franchisors offer discounts on franchising fees to women, minorities, or military service members and veterans. You can kick off your research by checking out our picks for low-cost franchises.

Final Thoughts

Even though buying a franchise is one of the easiest ways to dive into business ownership, finding the right source of funding to get your business off the ground can be a challenge. However, as you can see from the methods above, affordable funding is out there. The important thing is to research all of your options, get creative with your funding if you have to, and choose the option that’s best for your business over the long term.

Interested in learning more about owning a franchise? Check out The Step-By-Step Guide To Buying A Franchise for more information to help you get started.

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