- What’s the Difference Between a Business Opportunity and a Franchise?
- Business Opportunity vs. Franchise – Which is Best?
- What Do Franchisors Look For In A Franchisee?
- What Is a UFOC?
- How Do I Evaluate a Franchisor?
- Where can I get a company’s pre-sale disclosure document?
- How can I find out about complaints against a company?
- How can I file a complaint against a company?
- How do I know what must be included in a Franchise Disclosure Document?
What’s the Difference Between a Business Opportunity and a Franchise?
When a franchise is awarded, it establishes a relationship between a seller and a buyer that continues for the duration of the buyer’s involvement in the business. The buyer operates under the franchisor’s brand name/trademarks and adheres to a set of guidelines in the operation of the 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.
|A Franchise Opportunity Provides:||A Business Opportunity Provides:|
|UFOC disclosure information
Site selection management
Security of proven processes
|No on-going royalties
Usually lower investment
Company supplied advertising
Site selection assistance
Freedom to make choices
Proven system of operation
Business Opportunity vs. 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.There are two effective ways to become a business owner without reinventing the wheel and starting from scratch: buying a business opportunity and/or 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 on-going royalties. What the buyer gets for these fees are 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.
Government Protection 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:
- Franchisor allows the buyer to use the franchisor’s trademarks.
- 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 proper disclosure information prior to finalizing the sale. This document is called a Uniform Franchise Offering Circular (UFOC) 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 UFOC 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 UFOC can also list the earnings potential for a franchise.
Q. Which is Best?
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 an added benefit of increasing the value of the investment the franchisees make in their business.
What Do Franchisors Look For In A Franchisee?
Although it may not be immediately evident, a franchise company is under no obligation to award a franchise to just anyone who can afford the franchise fee.
Like any good business, a franchise company will want to populate their system with great people. Since franchising has as its foundation a strong, consistent brand, a franchisor looks for franchisees who will present the brand in the most positive light. In the same manner, they will want to have only those people as franchisees who are able and willing to learn the system and work within the specific parameters of the business.
When researching a franchise company, you will find that they may have as many questions about you as you do about their company. A franchisor is putting their time, money and reputation on the line, so most have developed a “profile” of a successful franchisee which they use to determine if you are “right” for their business.
While this may sound exclusionary, franchisors have a very good reason to learn what works and then to stick with it. Successful franchise companies want their franchisees to excel. They have refined their systems around a set of standards they have learned franchisees need to thrive.
These are the most common items a franchisor looks for in a potential franchisee:
- Capital: This is one of the first hurdles you’ll encounter when trying to qualify for a particular franchise. Most franchisors have a minimum net worth and liquid capital requirement for their franchisees. While this may seem obvious, there are other demands on cash availability beyond the initial costs of the franchise – such as the length of time it will take your business to start making money and the living expenses you will have during that time. There are financing options available that may help you qualify if you are short of capital, however no good franchisor will want to see you start out your business heavily in debt.
- Personality: There are some personality characteristics that seem to be common in all successful franchisees. Other characteristics are specific to individual businesses. Are you willing to follow a system or are you the type who wants to do everything your own way? Do you enjoy working with people? Are you focused and decisive? Do you enjoy solving problems? Are you willing to work hard? These are some of the questions a franchisor may have for you and your answers will determine not only if you can qualify for a particular franchise but also if you will be a successful franchisee.
- Skills: Your skills are closely related to your personality. If you like working with people, chances are you will be good at it. Are you customer service focused? Can you lead a team of employees? Can you set and meet personal goals? Do you understand financial concepts? One attribute required by most franchisors is that you have business acumen and understand how the parts of a business contribute to the whole.
- Experience: Franchising is one area of business where your specific experience is less important than other factors. That’s because of the excellent training provided by most franchise companies. In truth, many franchisors prefer franchisees without industry experience because it is easier to train someone in a franchisor’s system than it is to “un-train” a franchisee that has ideas which may conflict with the way a franchise system works. Again, it is the overall business experience you’ve attained through life that will make you a “star” in a franchisor’s eyes.
The goal for every franchisor is successful franchisees. As much as you may want to qualify for a franchise opportunity that interests you, remember that the franchisor has the background and experience to know what type of person makes a good franchisee in their system.
If you encounter a franchise that doesn’t discriminate when choosing franchisees – look out. They’re just going for volume and hoping some of the businesses succeed. Stay clear of these companies as they will not be vested in helping you achieve your long term goals.
What Is a UFOC?
Prior to the 60s, there was little franchising momentum in the US. However after the success of McDonald’s, many other companies began to franchise their concepts and the franchise industry expanded rapidly. In 1979 the Federal Trade Commission’s FTC Rule became effective. This rule required all franchisors submit to all potential franchisees a document called the Uniform Franchise Offering Circular (UFOC). The purpose of the FTC Rule (manifested in the UFOC) was to provide enough information so the prospective franchisee could make an informed decision about purchasing the franchise.
The UFOC serves as a protection for the individual against making a decision based on information not supported by fact. The FTC Rule requires franchisors provide the UFOC to the prospective franchisee at the earlier of the first personal meeting or 10 business days before the franchisee signs an agreement or pays any money. It also provides that the franchise agreement must be given to the prospective franchisee at least five business days before the franchisee signs any agreement or pays any money. A franchisor’s UFOC must be updated on an annual basis, or sooner if certain conditions are met.
Here are some of the items a UFOC must contain:
- History and Experience. The franchisor must provide you with a history of their past activities, especially as it may relate to potentially negative information. This information must be provided not only for the company itself but also for the officers and directors. The information includes factors like the business experience of the company and its principles and any fairly recent litigation or bankruptcy history for either.
- Financial Factors. The company must disclose to you the relevant financial terms of the franchise opportunity. This would include the initial franchise fees, other startup costs, and an investment range estimate for your total cost to get into the business. The UFOC must also disclose any other fees, such as the royalty, marketing and renewal fees that the franchisee will have to pay throughout the life of their franchise.
- Obligations and Restrictions. The company must disclose the obligations of both you and the company under the terms of the franchise agreement. They must also spell out any mandated restrictions that you will operate under in terms of your purchasing options and behavior as a franchisee.
- Other Considerations. The company must also disclose relevant information on a number of other factors such as financing programs, territory, trademarks and patents, renewal or transfer provisions and public figures.
- Exhibits. The company must also provide other data including audited financial statements, current franchisee lists with contact information, contracts and receipts.
- Earnings Claims. FTC rules leave it up to the franchisor whether they want to supply information about the earnings that can be achieved in their business. If a franchisor does want to provide earnings claims, they must follow stringent rules on how this information can be given to a prospective franchisee. It is essential for the franchisor to make sure that the data provided is as accurate and representative as possible and they must also clearly label any assumptions or qualifications on the data provided. As a result, earnings claims can take a variety of angles and approaches, so reviewing the background information is vital.
Individual State Requirements
In addition to the laws that mandate disclosure, there are also some states that have passed specific laws to further protect franchisees in that state. These laws may add additional disclosures or rules about franchise agreement terms. As an example of this, there are a number of states that require that the legal venue for any dispute must be in their state rather than in the state where the franchise company is located. These types of additional requirements vary from state to state but any that are appropriate to your situation in your state should be disclosed in the UFOC you receive.
The following “filing states” currently have additional requirements above and beyond the requirements of the FTC:
The most important point to remember regarding the UFOC is that you need to read and understand the material that the franchisor is disclosing to you. The FTC has a requirement that these documents must be presented in understandable English so that the material should be clear. It won’t make any difference, however, if you don’t carefully review the material.
Make sure you take the time to study the information supplied to you and you’ll have a much better chance of making sure that these legal requirements actually serve their purpose of protecting or safeguarding your interests.
Q. How Do I Evaluate a Franchisor?
After you’ve taken a look at a franchisor’s overall concept and business model, and evaluated their UFOC, there are a number of ways to help determine if the company is going to be able to support you, both initially and down the road.
- A company must provide you with their Uniform Franchise Offering Circular. The UFOC will tell you if there is any litigation against the company and the number of franchisees who have left the organization. These items are red flags, particularly if the numbers seem large compared to the size of the system.
- Make sure you personally meet the franchise staff with whom you will be working. You will evaluate their style, professionalism and competence. If they seem hurried or stressed out, the franchisor probably doesn’t have sufficient staff to handle further growth.
- An important measurement of the health of any given franchise company is the rate of growth of their system. Specifically, the franchise system should be growing at a rate that shows it is healthy and vital and is able to attract a number of new people to the system but should not be adding new franchisees so quickly that it will have problems managing this growth. When doing your research on a franchise opportunity, you will find a variety of ways to evaluate a franchise’s growth. The following may assist you in your examination.
1. Determine the number of new franchisees added each year : This information is not usually available in the UFOC so you will have to ask the franchisor for these numbers. Ask also about the number of operational support people devoted to new franchisees.
It is obvious that if a franchise system has been franchising for a number of years but has added very few franchisees, there may be problems in their system. It could be that current franchisees don’t validate well due to problems with the business model so potential franchisees are rejecting them. Or the problem may be that the franchisor has insufficient staff to handle all the elements associated with getting a new franchisee up and running and must reject a number of qualified applicants. Either way, lack of new franchisees may mean this isn’t a healthy company.
A good number to look for would be when the percentage of new franchisees falls somewhere between 10% and 35% of the total number of franchisees. A company currently with 100 franchisees should have the infrastructure to add up to 35 new franchisees in the coming year.
This formula will not work for very large or very small companies, however. Therefore, another number to look at is the ratio of operational support personnel compared to new franchisees. A ratio of one support person for every 10-20 new franchisees tells you that new franchisees are likely getting adequate preparation and support to develop their businesses.
2. Talk to existing franchisees: You will be contacting a number of existing franchisees from any system you are serious about joining. Besides asking them about such items as marketing effectiveness and earnings potential, spend a sufficient amount of time covering such areas as the training they received as well as initial and ongoing support. Pay particular attention to the answers from those franchisees that have recently joined the system as their answers will most likely reflect the type of support you would receive.
3. Meet the support staff : Once you’ve spent time evaluating the numbers and talking to existing franchisees, there’s a final step to take before giving a franchise company thumbs up as a potential purchase. If everything looks good up to this point, you will want to personally meet the franchise staff with whom you will be working. You will evaluate their style, professionalism and competence.
Make a note of the impressions you get during this visit. Does the staff seem warm, friendly, knowledgeable and helpful? Are they able to spend time answering your questions or do they seem rushed, distracted and overwhelmed by their busy schedule? Will the staff be there for you, both at the beginning and also years down the road? Will you enjoy working with them or be frustrated by the lack of clear direction and slow response time?
There are many important elements to consider when researching a franchise business that will meet your needs and desires. A system that is successful and expanding should be right near the top of your checklist. If you’ve done your research and you are happy with all of the results of the interaction you’ve had with the franchisor, you can be confident that you are investigating a growing, healthy franchise system, one which will provide you an opportunity to make your personal and professional dreams come true.
The Franchise Rule requires franchise and business opportunity sellers to provide to prospective purchasers with a Franchise Disclosure Document. The FTC does not require filings of these documents, so the FTC cannot provide copies to consumers. As of October 2008, a total of 13 states keep franchise offering circulars on file, and 26 states require business opportunity disclosure filings. Most states provide copies of these disclosures, usually by allowing visitors to their offices by appointment to review or copy the documents.
A few private companies may make franchise disclosure documents filed in one or more states available for a fee. We do NOT support or endorse these companies:
1665 North Fort Meyer Dr., Suite 410
Arlington, VA 22209
101 Executive Boulevard, 2d Floor
Elmsford, NY 10523
745 Campbell Way,
Herndon, Va 20170
Also, consumers searching for franchise documents may wish to check an online database maintained by the California Department of Corporations, known as Cal-EASI: http://184.108.40.206/caleasi/pub/exsearch.htm
No federal or state agency or private organization can tell you whether a company is legitimate or operates in good faith. The FTC or the Better Business Bureau can report on whether consumers have complained about a company. But, operators of fly-by-night franchise and business opportunity scams know this, and may change the name and location of their company every few months to avoid a record of consumer complaints.
There is no substitute for checking the track record of a franchisor or business opportunity seller by personally talking to at least 100 prior purchasers. That’s why the Franchise Rule requires companies to give consumers a list of the names, addresses and telephone numbers of at least 100 prior purchasers who are geographically closest to you. Interview these prior purchasers about their experiences. Ask questions to verify that they have purchased the franchise or business opportunity and that they are not being paid to provide a favorable review. A scheming promoter of a bogus business opportunity may line up “singers” who provide phony testimonials. Visit their business locations in person.
If you want information about consumer complaints from the FTC, request it in writing. Address your request to:
Freedom of Information Act Request
Federal Trade Commission
Washington, D.C. 20580.
Please identify your letter as a “FOIA Request” and include (1) your name, address and daytime phone number, and (2) the name and address of the company you are asking about.
In most cases, the FTC does not charge the public for searching, reviewing documents, or copying. Still, it is a good idea to state the maximum you are willing to pay in writing, so that the FTC can contact you in the unusual event that any applicable fees for these services will be higher than your limit.
You can also request information from the Better Business Bureau and look up information about the franchise or business opportunity seller online at: www.bbb.org
If you are having a problem with a franchisor or business opportunity seller, consider talking with a private attorney about bringing a lawsuit, or taking other action that may help resolve the problem.
Consumer complaints help the FTC identify companies and practices that affect a broad segment of the public, and are useful for law enforcement purposes.
You can file your complaint online using the FTC’s Complaint Assistant at: https://www.ftccomplaintassistant.gov, or by telephone at 1-866-382-4357.
The FTC also accepts complaints in writing, but postal mail to federal agencies may be subject to delays for security reasons. Please describe your problem or concern writing. Tell the FTC what you think was misleading or deceptive in the company’s promotional materials, disclosure document or offering circular. If you want your letter kept confidential, please print the words, “Privileged and Confidential,” on the top of each page. Include your name, address, and a daytime telephone number where the FTC can reach you. It will help if you can send the FTC copies of any written claims in promotional materials or elsewhere that you believe are false. Send copies, not originals, of any documents you think the FTC should have.
Please address your complaint to:
Consumer Response Center
Federal Trade Commission – Rm. 130
600 Pennsylvania Ave., NW
Washington, D.C. 20580.
The amended Franchise Rule states what must be disclosed. It is published in the Code of Federal Regulations, Volume 16, Part 436 (16 CFR § 436). The Franchise Rule Compliance Guide, which is designed to assist franchisors in complying with the amended Rule are available at: www.ftc.gov/bcp/edu/pubs/business/franchise/bus70.pdf.
There are franchise registration and disclosure laws in a number of states that require a filing of a franchisor’s Franchise Disclosure Document (“FDD”) with a state agency. In most of those states, it is unlawful to offer or sell a franchise until the agency has registered the franchisor’s FDD after reviewing the filing. Information about these state law requirements can be obtained from:
North American Securities Administrators Association
750 First Street, Suite 710
Washington, DC 20002
You can also find the current state and federal guidelines in the Business Franchise Guide, published by Commerce Clearing House, Inc., in many law libraries.
Last Modified: December 5th, 2009