Realizing the American dream means different things to different people. For many, the ultimate career goal is to be your own boss and create a successful business. In most cases, these endeavors take a significant amount of time, money and hard work.
However, you don’t always need to develop a unique idea or product to achieve success or the satisfaction of owning your own company. Two of the most efficient and effective ways to start a business are franchises and business opportunities.
Aren’t they the same thing?
They are not the same thing. A lot of people think of a business opportunity only in a general sense; meaning any private, independent business. However, “business opportunity” is also a legal term for a pre-packaged business investment offered by a seller; some refer to it as a “business in a box.”
More people are familiar with franchises, such as McDonald’s, Burger King and 7-Eleven. In these arrangements, the investor (franchisee) pays a franchise fee, plus ongoing royalties and other fees, in exchange for a license to operate the business using the company’s trademarks, products, expertise and marketing tools.
While there are similarities, another way to think about these enterprises is that all franchises are technically business opportunities, but not all business opportunities are franchises. Let’s look at each of these investments in more depth.
Business opportunities: What do they entail?
While franchisors require franchisees to pay initial and ongoing licensing fees, business opportunities are usually a one-and-done purchase. One major advantage is that buying a so-called “biz opp” generally requires much less upfront capital than a franchise. With most business opportunities, you pay for a package of equipment and materials for a readymade business. These opportunities include a myriad of business types, such as:
- Medical billing
- Envelope stuffing
- Craft assembly
- Digital products
- Vendor products
- Printing services
- Certain home-based businesses
The most common business opportunities are distributorships, vending machine sales and rack jobbing, which involve selling another company’s products displayed on racks located in local retail stores and supermarkets. Franchisees must generally follow strict rules and specifications set by the franchise. Business opportunities are attractive to many entrepreneurs not just because they cost less, but also because owners have the freedom to manage the business as they see fit.
Regulations seek to protect business opportunity buyers
Franchises and business opportunities are both regulated under state and federal laws. In 2012, the Federal Trade Commission (FTC) implemented the Business Opportunity Rule. Under the provision, sellers must disclose specific information to prospective buyers to assess the risks. The one-page document (plus a few attachments) must include the following information:
- The seller’s contact information, including the salesperson’s name and the date the disclosure information was provided to the buyer
- Whether the seller has had any legal action taken against them
- If the seller has a refund or cancellation policy
- Any specific claims made about the buyer’s projected earnings
- Contact information for at least 10 other investors in the same business closest to the purchaser’s location
The investor must receive the disclosure document at least seven days prior to signing the acquisition documents or paying any money to the seller. The FTC does not allow buyers to waive these disclosures. Sellers who fail to provide the information face civil penalties.
Franchises: Pros and cons
Franchises typically cost much more to license and operate, and franchisees must pay ongoing fees and comply with strict franchisor rules. However, a distinct advantage is having a well-known brand name offering a substantial client base and immediate revenue opportunities for a proven model.
Franchisees must operate the business according to the franchisor’s terms, but they also receive more assistance. While you must sell only the franchisor’s products, you generally receive a protected or exclusive territory and support for training, products, services and marketing.
In most cases, you must accept higher expenses, stricter rules and more restrictions to operate a franchise. However, you oversee an entity that has an established business model that can reap substantial benefits in the marketplace.
High startup costs and ongoing royalties are significant drawbacks for many. Franchise fees vary widely according to the type of business you pursue. It’s estimated that the costs to start a McDonald’s restaurant range anywhere from $1 million to $2.5 million. Ongoing royalties can run from 4% of yearly revenue and up, depending on the industry.
Franchise agreement basics
Franchise contracts are complex. The franchisor makes money by selling you the right to use their business model and brand. These agreements typically contain these types of payments:
- The initial franchise fee which gives the franchisee the right to use the company’s trademark and other intellectual property
- Fees for providing training, equipment and business advice may be part of the franchise fee or charged separately
- Ongoing annual royalties or a percentage of the franchise’s sales
- Ongoing marketing fund and other miscellaneous fees like software license fees.
Franchise agreements are temporary, generally lasting between five and 30 years. These contracts are comparable to lease agreements in the sense that they expire and the franchisee typically does not own any equity in the brand or trademarks. What a franchisee typically owns when he or she is ready to sell the business are the assets of the business (physical equipment, furniture, leasehold improvements) and the goodwill and customer lists that the franchisee acquired during its ownership. A franchisee does not own any goodwill in the brand or name; that belongs to the franchisor.
The FTC Franchise Rule
Franchises are also regulated under state and federal laws. The FTC established the Franchise Rule in 1979, requiring a legal disclosure that franchisors must supply to prospective buyers. The FTC Rule was substantially amended in 2007 and the current Franchise Disclosure Document (FDD) and guidelines to its contents were established.
The FDD requires franchisors to alert buyers to risks, benefits and limits to the investment. The document also includes all upfront and ongoing expenses and fees the prospective franchisee will likely have to pay, a full list of all current and former franchisees with their contact information so a prospective franchisee can contact them, a listing of all relevant prior and current litigation and bankruptcy cases and threats against the franchisor, whether a franchisee must only purchase from certain suppliers and vendors, revenues of other franchisees in the system and other important information that a prospective franchisee should know before making the decision to invest in the opportunity. These documents are substantially more in-depth (often 100 to 400 pages long) than the one-page business opportunity disclosure form and provide a prospective franchisee with a great deal of information that is helpful in making the decision to become a franchisee of a franchise system.
A comparison between franchises and business opportunities
If you are considering a business opportunity or franchise, here is a brief look at some major differences between them:
- Franchise: On average, the initial franchise fee is $25,000 to $50,000. Your total investment can run from $75,000 to $500,000 or much higher.
- Biz opp: Typically the total investment runs from around five hundred to several thousand dollars.
- Franchise: Franchisees may face monthly, quarterly or yearly fees or royalties.
- Biz opp: Ongoing fees are usually not required.
- Franchise: Many retail franchises are well-known to consumers.
- Biz opp: These brand names usually are not well known to consumers and may be business to business ventures.
- Franchise: Franchisors generally offer ongoing support during the term of the contract.
- Biz opp: Buyers usually receive little to no help from the seller after purchasing.
- Franchise: Franchisees must follow strict rules. Failure to do so can result in penalties or losing the franchise.
- Biz opp: Sellers usually exercise no control after the sale, and the buyer can operate the business on their own terms.
Factors to consider for selecting franchise and business opportunities
If you are considering these two ventures, here are questions to ask yourself:
- How much capital do I have for an initial investment?
- Do I want a long-term contractual relationship?
- Am I comfortable following franchisor rules, or do I want to do things my way?
- Is the cost of ongoing support acceptable, or can I go it alone?
- Is it important to partner with a franchisor to be successful?
- What is the earning potential?
- What is the return on my investment?
- Can a business opportunity help me reach my financial and lifestyle goals?
- Will I enjoy it and be able to achieve my dreams?
- Do I want to have the information that a franchise provides in an FDD before investing?
Neither venture assures success, but both can be rewarding. Due to the complex nature of these arrangements, it’s critical to receive experienced legal advice from attorneys who focus on business and franchise law. Whether it is a franchise or a business opportunity, your investment is a tremendous commitment of time and money. Having an attorney advise you and be on your team is crucial to identifying potential risks and ensuring that the seller or franchisor has complied with all applicable laws.