updated 4/14/2005 4:50:59 PM ET 2005-04-14T20:50:59

Oh, the allure of starting a franchise! For relatively modest upfront fees, a new franchisee gets a proven business idea, a designated market, and savvy management and marketing support. Presto, you can step off the corporate treadmill and launch a growth business. Suddenly, you're your own boss.

It always sounds easy, but opening a franchise is far from foolproof. At best, "You're given a model that is successful in other markets that you can replicate," says Steven Bergenholtz, president of Franchising Ventures Group, a venture capital firm in Plano, Texas, that helps entrepreneurs build franchises in return for a share of the royalties. But, while the industry has cleaned up a lot from the 1970s, when it was rife with fraud, there are still a lot of businesses available for franchise that are not — and will never be — great opportunities. "People really have to do their due diligence," he says.

So before you quit your day job, make sure you understand what opening a franchise entails and are aware of some pitfalls to avoid. The following are six steps to get you started:

Make sure running a franchise is right for you. If it's running your own business you're after, you might be better off opening your own donut shop, rather than, say, a Dunkin' Donuts or Krispy Kreme.

"You're supposed to follow the method of doing business described by the franchisor," says David Kaufmann, senior partner at Kaufmann, Feiner, Yamin, Gildin & Robbins, a New York law firm that represents franchisors. He suggests asking yourself, "Can you follow orders and follow the system religiously?"

If you can't, you may chafe as a franchisee, and you may not even get the opportunity to start one. Steve Greenbaum, co-founder of PostNet, a Henderson, Nev., packaging and shipping franchise, says he gets between 400 and 600 inquiries a month, but only adds about 100 stores a year. He's looking for people who will follow the business system he designed.

"You have to make sure they are entrepreneurial, but not let them veer too far from the business," Greenbaum says. "We're rejecting a lot of potentially qualified people." Keep in mind that at the end of the day, a franchise is about creating a uniform experience for customers and building a brand that matches that experience, he says.

Investigate opportunities. This is the fun part. Read up about available franchises in your area, attend a franchising exposition, check out the Web sites of businesses you like for more information. "Step one is to figure out what you're interested in," Kaufmann says. There are a lot of options out there. "Hotels, real estate, janitorial — half the stores in the malls are franchises."

When you decide on an industry you like, consider the market for that store or service in your area. Is there competition? Is there likely to be demand? Choose three or four franchise opportunities to study in more depth.

Don't ignore the option of buying an existing franchise, which has some inherent advantages over starting your own from scratch, including immediate cash flow and easier financing. "The franchisee is buying a working, living territory," says Sheila Bangs, director of franchise sales at Palm Springs, (Calif.)-based American Leak Detection. "They don't have to go out and start from scratch."

Review the documentation. Each business available for franchise is required to give you a current Uniform Franchise Offering Circular [UFOC], which includes information about the franchisor's history and business model, terms of the agreement, and, often, audited financial statements. The documents easily run 200 pages. "Prospective franchisees get a wealth of information before they sign on a dotted line or pay so much as a nickel," Kaufmann says.

Best of all, it lists all recent litigation, all franchises, and any franchise agreements that were terminated in the past three years. "By all means, pick up the phone," Kaufmann says. Call franchisees and find out if they are successful and getting the support and services they were promised. Some franchises are growing so fast, they can't always deliver. Call the franchisees that were terminated and find out why. Litigation will crop up even in the best of businesses, but a lot of litigation is a red flag.

Figure out the costs. Franchise fees can vary widely, and you only want in if it is a fair deal. Royalties can run between 4 percent and 9 percent of your weekly or monthly gross. Then there's an upfront franchise fee, usually between $10,000 for a new startup to six figures for one of the biggest and best operations. Finally, there's an advertising fee, ranging from $250 a month to 2 percent of sales.

That doesn't include what may be substantial costs of getting up and running. You will need to find a location, renovate, and purchase inventory. In terms of upfront cash, you'll need as little as $40,000 for a one-person business you can run out of a truck (such as a plumbing franchise) to $300,000 to $400,000 to open a fast-food restaurant, Bergenholtz estimates. Don't forget, you should also have a year's worth of savings to live off.

Consult some professionals. At the very least, you'll need to hire an attorney to go over the franchise's documentation and give you an idea if it's a good deal. You may also want to hire an accountant to assess the finances and business consultant to help you sort through options. With their help, you should be able to find out how much control you're giving up, and if the franchisor is asking for too much money relative to the value of the name recognition, training, and support offered. Attorneys can charge $2,500 to $10,000 for a review and negotiate the contract, Kaufmann says.

Watch out for deals with high franchise fees — that could be an indication the parent company is trying to make profits from selling franchises, not from building a strong network of partners. The franchisor should be making most of its money from royalties, so it has an incentive to help you succeed, he says.

Find financing. This is the hardest part of all. Very few franchisors offer financing, but most can give you some direction in finding it. You may find it hard to get a loan from a bank if you don't have a major chunk of cash and aren't willing to pledge your personal assets [such as your house] as collateral. The Small Business Administration has a guarantee program to insure banks against risk of default [see resource box]. It also has a registry of franchises it has already approved loans for, which streamlines the application process.

If you can't get a loan from a bank, you may need to turn to friends and family members for help or use your personal lines of credit.

Once you've purchased the franchise, in the best cases, you'll be part of a team that will help you along the way. The parent company will not only show you how to operate the business, but also teach you the basics of finance and cash management. American Leak Detection learned the hard way that some of the best business operators don't know how to manage cash coming in with the cash going out, and has since instituted a financial responsibility course.

Buying a franchise isn't always the fast track to success that it seems. But for the kind of entrepreneur -- someone who does their homework, follows the rules, and craves independence -- it has a lot of advantages. As Bergenholtz puts it: "You get to be in business for yourself, not by yourself." Just keep in mind, seeing the appeal of franchising is often the easiest part of getting started.

Copyright © 2012 Bloomberg L.P.All rights reserved.


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