Your Ultimate Guide to Investing in a Restaurant Franchise

One of the more popular ways to go about starting a restaurant is to purchase a restaurant franchise.

A restaurant franchise offers you the opportunity to start a restaurant using an existing brand name, menu and operating system. In exchange you will pay a franchise fee in addition to the cost of starting a restaurant as well as an ongoing royalty based on your gross sales which usually runs from 4 to 8%. You also agree to abide by the rules of the franchise which generally means you can't make changes to the menu and when the franchise system itself decides to make changes to the way it operates you must follow suit whether you agree with the changes are not.

Check out all of our restaurant franchise articles here after you finish reading this one:

When you're considering whether or not to get started in the restaurant business via the franchise route there are several points to keep in mind both in selecting a specific franchise and also determining whether or not you want to be involved with a franchise at all. In order to determine this you have to understand the trade-offs you're making for becoming part of a franchise system and whether or not the value you receive is equal to the value you will give. The value will receive comes in two basic parts.

The first part is the planning and decision-making is partly done for you. By becoming part of the franchise won't have to figure out a menu or the ingredients required or the equipment you'll need or pick a name for the restaurant and lots of other decisions you would normally be required to make on your own.

This first part also includes the training you will receive and how successfully operate your business and you'll get lots of viable information about your target food cost of your target labor costs and how to run things efficiently which will save you a lot of time learning these things on your own and that time translates into money. The cost of this part of the franchise is encompassed in the franchise fee that you pay the beginning.

The second part of the value that you receive being part of a franchise is the association with the brand. The value of the brand is basically the difference between the amount of business you attract using the brand name as opposed to the amount of business you would attract if you had an identical set up in terms of location, menu etc. but you are using your own name. For example, if you found a location that would work as a Subway restaurant and the cost to outfit it to be a Subway was exactly what you would spend to outfit it to be a regular sandwich shop, What difference if any would result in your sales volume from being one or the other?

Selecting a Franchise Brand

The value proposition of a franchise is that by being associated with the franchise you automatically win more business more consistently than if you're an independent restaurant. In exchange for this additional business you pay them a royalty. Your job is to determine whether or not you really will get additional business and then whether or not that additional business will more than make up for the royalty payment.

This may sound like a difficult task but in fact it isn't that complicated. While there are well over 400 different restaurant franchise concepts available there only a dozen or so which could be considered a household name around the country and maybe a dozen or more in various regions with enough name recognition to provide the brand value that is a no-brainer. These are franchises run large and consistent marketing campaigns and where she said the name most people would be very familiar with the restaurants and probably have been a customer at some point. These restaurants are also generally at the top of their market in the category that they compete in which means is an independent could be very difficult to displace them. If you were comparing opening Joe's burgers versus opening a McDonald's, for example, you can be almost certain that the McDonald's will do significantly more business than Joe's assuming they offer about the same menu at the same prices. That's the value you're paying for becoming part of one of the major brands.

This still doesn't mean necessarily that for your specific location and situation that you be better off running a franchise than an independent restaurant. The only way to know for sure is to run your financial software through both scenarios and see which one works out better. The royalty you pay, while sounding like a small number, comes from your gross sales. When you work out the actual impact on your profit it becomes a much larger number- in some cases 50% or more of what you would otherwise keep yourself.

The mid tier brands may or may not be a good fit. While the name may not be a household word yet concept itself may be attractive and quickly growing. You could in fact be getting in on the ground floor of a concept that soon becomes the next McDonald's or Subway. On the other hand, you may end up paying hefty share of the profits to the company that has little or no value for those payments once you've benefited from the initial startup help. The only way to determine whether or not the brand it could fit in worth the money in your area is to do your market research to figure out if this is something that will resonate with customers in your area who would be the target market.

The brand-new concepts that are offering franchises are in many ways the most risky bet. They've had the least amount of operating history on which to base their system that you are paying money to copy. They are also likely to have the least thorough training program in the least amount of marketing support and help. They will also, by virtue of the fact that they simply haven't been around very long, and little brand equity to offer. If you are an experienced restaurant manager or owner already and you'll be locating your franchise near to where there are already existing operations so that what brand equity there is has a chance of reaching you then this could still work. On the other hand if you're brand-new to restaurants in your location will be in a different city or even a different region from the current units that it will be hard to justify the additional cost of owning a franchise compared to simply opening a similar but independent concept instead.

The main considerations when trying to determine whether or not franchises the right move is to weigh the following factors:

There is no question that there are pros to joining a franchise even if you aren't necessarily buying into the strongest top tier brand. The pros include:

There are also obviously cons to starting a restaurant franchise including:

Some people see getting involved with a franchise as a sure thing business opportunity. It is a business like any other however and comes with its own risks. The reason franchises tend to do better than independent restaurants has more to do with their requirements that whether or not they are actually better businesses.

For example, by requiring a certain level of net worth of liquid capital franchises are trying to ensure that undercapitalized restaurants aren't being launched. If there was a similar requirement for independent restaurants their failure rates also go down. In addition, much of the planning is required to be successful has been done by the franchise and independent owners performed a similar level of planning they would likely achieve a similar level of success but likely with greater profitability because they wouldn't have the expense of the franchise fee or the ongoing cost of royalty payments.

Whether or not a restaurant franchises a good idea for you particularly hinges on a few important questions that depend on you knowing yourself well in answering these questions honestly:

Restaurant Franchise Investigation

If the answers come down on the side of a restaurant franchise or you are still in the consideration phase then the next step is to thoroughly investigate whatever franchise systems are considering. The first step is to request a legal document called a Franchise Offering Circular. This is a document prepared by lawyers for the franchise which must disclose certain facts about the franchise and is legally required to be prepared and presented to any potential franchisee before they become a franchise owner.

The most important thing you can do with this document is to locate the names of current franchise owners and give them a call to discuss the business. Unfortunately this is a step that many potential franchisees skip. The franchise obviously wants to put their restaurants on their system and the best possible light and so the story here from them tends to be all positive about successes. The best information however comes from the owners of the actual franchises who can tell you what it's like operating the day-to-day.

Your best bet is to call and talk to as many as you possibly can. You should aim to talk to both newer franchise owners who can give you a good feel for what the startup process is like as well as what the most current training and support is like. You should also speak with veteran franchise owners who can give you feedback on the ups and downs of being a business owner and how the investment has worked out for them over the long term.

Realize that when you speak with these owners you are going to see two kinds of bias. Most of the new owners are still going to be upbeat about things because they are still hopeful about earning their investment back and being new to things they are going to still feel that the franchise system has been very worthwhile in getting them going. The older franchisees are going to be more biased against the franchise because they will have long forgotten the startup phase and everything they got from it and they will be more cognizant of the royalty payments they have to make which they may not feel like the franchise is still "earning".

Of course these are generalizations and some new owners will be bitter and some older owners will still be very loyal to the system. Just keep in mind each person is going to have some bias and you have to factor that in to what they are saying as you consider their answers.

You most definitely want to speak with owners in your same region and preferably as close to where you expect to have your own location is possible. It will be much less helpful to hear the experiences of someone Who is located in the northeast when your restaurant is going to be located in the southwest. Even from state to state that can be significant variations in how restaurants operate.

Here are some questions you can ask of the franchise owners to speak with:

Also be sure to give them plenty of opportunity to ramble- they will often end up answering some of the questions before you have asked them and they will also often drop important pieces of information about things that you weren't going to ask or wouldn't have thought of asking.

Another thing to carefully investigate is how many of the unit's in this particular franchise have either closed or been sold by the original owner or been taken back over by the parent company. This can be an indication of how well the franchise is actually doing how profitable it is for the owners. You can also take a look and see if any of the franchises are listed for sale on business for sale websites. Often times these listings will show a gross sales number and a net profit number which can again give you an indication of how all these businesses perform in the real world.

The franchise offering circular will not disclose the specific profits of any location or make income earnings claims. What you can do is determine the gross sales of the average sized unit in your area along with some of the largest expense numbers such as the percentage of labor cost and the percentage of food costs and add in your own figures for the cost of the lease and some of the other large expenses and then use financial software to determine about what you can expect your profits to be. Some of the franchise owners to speak with the very honest and giving you the results and others will only hint around about it but through a combination of these methods you can generally get a pretty accurate picture of what you can expect to make.It is then your job to determine whether or not based on the overall considerations a restaurant franchise is the right way to go terms of the risk and the reward of owning this type of restaurant.

When a Franchise Might Not Be the Best Choice

One final thought- if you are considering a franchise you may also want to consider buying an independent restaurant for sale. Why? You get many of the benefits of buying a franchise: concept already established, existing goodwill, operating history, etc. but there are even more benefits that a franchise doesn't offer:

It depends what you want. If you are looking for a single location in your area that can make you a good living, buying an existing proven business in your area may cost less, profit more and be less risky than buying into a restaurant franchise system. On the other hand, if you have visions of multiple units, a large investment fund and extensive expansion plans, buying into an existing chain make work out better. Just something to think about!

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