From Subway to 7-Eleven to the UPS Store to RE/MAX, franchised businesses are all around us, even though we may not always realize it. Many businesses that are commonly thought of as national chains are actually independently owned franchises, and for aspiring entrepreneurs, these brands represent the opportunity to own and operate a market-tested business in their own backyard.
Opening a franchise appeals to many entrepreneurs, even those who plan to one day build their own business from scratch. By starting with a franchise, a first-time business owner can learn how a successful, well-branded business operates from the inside out and later integrate these insights into the development of their own company.
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What is a franchise? Definition and explanation
In a technical sense, a franchise is a contractual agreement between the owner of a brand (a franchisor) and a business operator (a franchisee) that allows the business operator to own and run a branch of the franchisor’s business using the brand’s unique identity, logo, reputation, marketing materials, and proprietary business model to sell the brand’s products and services to consumers.
In other words, a franchise is a mutually beneficial joint business venture through which a brand empowers an entrepreneur to own and operate a branch of that brand’s business in exchange for a startup fee and a percentage of the branch’s revenue.
Conversationally speaking, however, the word franchise is used most often among the public to describe either a franchised business at large (e.g., Wendy’s the brand) or any given location of a franchised business (e.g., your local Wendy’s restaurant).
Each location of a franchised business is essentially an independently operated outlet that benefits from the brand recognition, marketing efforts, and established operational model of the franchisor.
Franchisor vs. Franchisee: What’s the difference?
A franchisor is the owner of an established, successful original business with some degree of brand recognition. This could be a relatively small, regional business run by a single proprietor (like a roofing company with 12 branches around the Midwest), or a well-known, multinational brand with tens of thousands of locations (like McDonald's). In either case, the franchisor represents an established brand and its products or services.
A franchisee, on the other hand, is an individual who pays for a license to operate a branch of a franchisor’s business. A franchisee invests in a franchise by paying a franchisor for the right to use its business’s name, brand, operational model, and other assets for a period of time defined in the franchise agreement. In exchange, the franchisor receives a one-time franchise payment and ongoing royalty payments from the franchisee.
Franchisor vs. franchisee at a glance
| Franchisor | Franchisee |
|---|---|
Owns brand and brand assets |
Owns the right to use brand and assets for a period of time |
Exerts influence over all branded locations |
Owns and operates one or more business locations for a set period |
Earns franchise fee and royalties from all franchisees |
Pays an initial franchise fee and ongoing royalties to the franchisor for the right to use the brand and its model |
Provides guidance, training, materials, and other assets to franchisees to help them succeed |
Receives training, guidance, and other assets from the franchisor and uses them to succeed |
How do franchises work? The franchising process from start to finish
Franchise agreements are essentially investment opportunities, both for the franchisor and the franchisee. The franchisee exchanges money for a brand’s assets (recognition, products, services, and strategy), while the franchisor exchanges brand assets for an initial lump-sum payment and an ongoing income stream. If the franchisee’s location of the business is successful in their community, the franchisor not only receives periodic, dividend-like royalty payments but also gets the added bonus of increased brand awareness and customer goodwill.
In many cases, a prospective franchisee must apply and be approved to open a franchise in their area, but since that isn’t always the case, the first real step for both parties is the signing of a franchise agreement.
The franchise agreement
A franchise agreement is a legally binding document that, once signed, grants the franchisee the right to operate their branch of the franchise for a certain number of years. This document also outlines the franchisee’s responsibilities, which can include upholding the brand’s standards, generating a certain amount of revenue, using only approved suppliers, and other provisions. If the franchisee violates the terms of the contract, the franchise agreement may be revoked by the franchisor.
The franchise agreement also details the franchise fee and royalties that must be paid to the franchisor as well as the resources and support the franchisor pledges to offer to the franchisee, both during the new branch’s opening and on an ongoing basis.
The franchise fee and other startup costs
To start a franchise, a franchisee must typically pay a franchisor a one-time franchise payment for the right to begin doing business under the franchisor’s brand. Franchise fees vary quite a bit and can depend on the length of the franchise agreement (how long the franchisor grants the franchisee the right to use its brand system), but most range between tens of thousands and hundreds of thousands of dollars.
In most cases, the franchisee also needs to purchase or lease a building and equip it to operate as a branch of the business, which often means purchasing equipment and paying for custom renovations to the space. Between a franchise fee and these startup costs, opening a franchise can require a very expensive initial investment, and since there is no guarantee of success, this investment is very risky for the franchisee.
That being said, this risk is offset to some degree by the fact that the franchisor’s brand has already proved to be profitable in other markets and the brand’s products or services likely already have a customer base. Most new businesses fail, but new franchises may be more likely to succeed because their brand is recognizable, their business model is tested, and demand for their products already exists.
Hiring, training, and grand opening
Once a franchisee secures and equips their building (if applicable) and hires a team, the franchisor typically helps them market their business in the local community, hire and train staff, host a grand opening, and begin operating.
In many cases, the franchisor (or a member of their team) may work on-site at the franchisee’s new business for a month or so in order to help establish the brand’s operational model and provide ongoing guidance and support to the franchisee and their new team of employees as they begin to do business.
Ongoing operation and royalty payments
Once the franchisee and their team get the hang of things, they are typically left to their own devices but can reach out to the franchisor for guidance and resources on an ongoing basis.
As the franchisee operates their new business, they send periodic royalty payments to the franchisor. Royalty payments are usually a percentage of either profit or revenue and may be paid monthly or quarterly — the details of a franchise’s loyalty payments can vary quite a bit and are outlined in detail in the franchise agreement.
Franchise agreement renewal, modification, or termination
Eventually, the terms of the franchise agreement come to an end, and at that point, the franchisor may offer to renew the franchise agreement, propose a modified franchise agreement (sometimes with higher royalty percentages), or simply terminate the franchisee’s right to continue doing business under their brand.
In most cases, successful franchisees are asked to sign a renewed or updated franchise agreement and continue doing business. Those who are particularly successful may even be asked if they would like to open additional branches in adjacent geographic markets.
Are franchises more likely to succeed than other new businesses?
Many in the franchising industry claim that franchises have a 95% success rate, citing a 1980s study by the Department of Commerce. The data used to produce this statistic came from a voluntary survey of 2,000 franchisees, only 5% of whom said their franchises failed within the first five years of operation, indicating a 95% rate of success (compared to the 45% five-year survival rate for new businesses at large).
The 95% figure has become so notorious in the franchising industry that it is colloquially referred to as “the Stat,” but it is widely considered inaccurate due to the fact the data was self-reported, and successful franchisees may have been more inclined to submit responses.
Interestingly, no particularly thorough research has emerged in the decades since the Department of Commerce study to replace the 95% statistic. That being said, most consider it safe to say that a new franchise of a well-known national brand with established demand and corporate operational training (like McDonald’s or Wendy’s) is more likely to succeed than a brand-new business in the same industry built from scratch.
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How does franchising vary between brands?
Every franchise is different, and they vary quite a bit in terms of startup difficulty, cost, franchisor controls, franchisee support, site selection, and other details. Some franchised businesses are very strictly controlled by the franchisor in order to uphold the brand’s standards across locations, while others give the franchisee more leeway in terms of how they run their business. These specifics are best demonstrated using real-world examples.
As far as franchised businesses go, Chick-fil-A is known for maintaining particularly rigorous franchisee selection and training processes — not only do prospective franchisees need to demonstrate their qualifications, be selected from a large group of applicants, complete an intensive multi-week training, and pledge a $10,000 initial investment; they also have to be willing to work long hours in the restaurant as a hands-on team member. Chick-fil-A’s leadership specifically notes that prospective franchisees seeking passive income via a hands-off investment opportunity should look elsewhere.
Subway, on the other hand, only requires that prospective franchisees pass a relatively simple, one-hour skills test focused on basic math and English. This means that most anyone with the requisite capital ($10,000–$15,000 plus startup costs) can open a Subway in their area without going through a rigorous application process.
Subway is also unique in that the brand holds the leases for all of its franchised branches and then subleases the locations to the franchisees. It also requires all franchisees to source their supplies and ingredients from the brand’s approved distributors in order to maintain quality across all locations.
Many franchised businesses, like Subway, are fairly lax about franchisee selection (so long as investors have enough capital to open a branch), offering plenty of initial and ongoing support when requested by the franchisee but requiring little of them but their initial and ongoing financial investments and adherence to the brand’s standards.
In some cases, franchisees of these sorts of businesses can hire an on-site manager to run the business’s day-to-day operations so that they can collect passive income without working on-site all that often.
12 top-rated U.S. franchises & their franchise fees
| Company | Industry | Initial franchise fee |
|---|---|---|
Chick-fil-A |
Fast food |
$10,000 |
The UPS Store |
Shipping/retail |
$9,950–$29,950 |
Ace Hardware |
Retail |
$5,000 |
McDonald’s |
Fast food |
$0–$45,000 |
Wendy’s |
Fast food |
$5,000 |
Snap-on Tools |
B2B automotive tool sales |
$8,000–$16,000 |
Matco Tools |
B2B automotive tool sales |
$8,000 |
RE/MAX |
Real estate |
$17,500–$37,500 |
Express Employment Professionals |
Employment & staffing |
$0–$40,000 |
Wild Birds Unlimited |
Retail |
$40,000 |
Century 21 |
Real estate |
$0–$25,000 |
Minuteman Press |
Printing |
$32,500–48,500 |
What other expenses do franchisees incur besides the franchise fee and royalty payments?
The initial franchise fee and periodic royalty payments are just two of the expenses that come with operating a franchise. Every situation is different, but many other fees and expenses can come into play. Some larger franchisors charge all franchisees a mandatory fee for the brand’s ongoing advertising efforts, which may take place on a national scale but benefit all franchise locations.
Some franchisees purchase or lease their own equipment, but in many cases, specific equipment and supplies must be leased directly from the franchisor for a monthly or annual fee. Other common expenses franchisees may incur include payments for mandatory insurance or IT/network support provided by the franchisor.
Every franchise opportunity is different, and the best way to get a full sense of the expenses associated with operating a specific franchise is to look the brand up on Franchise Direct, which aggregates specific information and data about virtually all common franchises.
Frequently asked questions (FAQ)
Below are answers to some of the most common questions investors and entrepreneurs have about franchises and the franchising process.
How do existing business owners franchise their businesses?
Turning an established business into a franchise is a complicated process, but some of the most important steps include creating a franchise disclosure document (FDD) for prospective franchisees as required by the Federal Trade Commission (FTC), distilling the company’s business model and proprietary knowledge into a cohesive and accessible operations manual, registering the brand’s trademarks, establishing a new franchising company, and registering the FDD with the states in which the franchisor wishes to operate.
Can franchised businesses be publicly traded?
Many well-known franchises are also publicly traded companies, including McDonald’s (MCD) -), Wingstop (WING) -), Domino’s (DPZ) -), Valvoline (VVV) -), Goosehead Insurance (GSHD) -), Planet Fitness (PLNT) -), The Vitamin Shoppe (VSI) -), and other well-known national and international brands.
What are the best franchises for passive income?
According to the International Franchise Professionals Group, a networking organization used by franchisors and franchisees, the best brands for “semi-absentee franchises” — those where the franchisee can typically hire a manager to run day-to-day operations after the startup process is complete — include the following:
- Gameday Men’s Health
- Everline Coatings
- Temporary Wall Systems
- DonutNV
- Fastest Labs
Are there work-from-home franchise opportunities?
According to Franchise Direct, an online franchise information aggregator, the following franchises represent the best opportunities for franchisees who want to do most of their work remotely, from home or elsewhere:
- Healthier 4U Vending
- Ideal Directories
- Cruise Planners
- Hommati
- SiteSwan Website Builder
