Franchise Or Business Start-Up?
Which is the right fit for you?
Options and Opportunity
The ability to work for yourself, being in control and making the big decisions appeals to many people. You may just be starting your profession and dreaming of starting your own business, or you may have had a long and successful career and are longing for something more – additional money, greater flexibility or the chance to focus on doing something you enjoy.
Taking a risk and following your dream by becoming a business owner is an aspiration shared by many Americans. The first step in determining whether starting your own business or investing your time and money into a proven franchise is more your style is to begin with a self-assessment of your strengths, weaknesses, interests, skills and work/life aspirations. Do you work well in a more structured environment, or do you require freedom to create and innovate? Are you risk-averse and like having a support system, or are you more daring and hope to blaze a trail for others to follow one day?
Countless first-time entrepreneurs have the burden of whether to start a business from scratch or buy a franchise. The allure of being your own boss can be tempting; franchises and startups each pose their own challenges and benefits. Evaluating each option can help you get closer to realizing what the right venture is for you.
What Is a Franchise?
A franchise is a type of license that an individual or group (franchisee) acquires to allow them to have access to a business’s (franchisor) proprietary knowledge, processes, and trademarks in order to allow the party to sell a product or provide a service under the business’s Brand. In exchange for gaining the franchise, the franchisee usually pays the franchisor an initial start-up and annual licensing (royalty) fees.
How Franchises Work
When a business wants to increase its market share or increase its geographical reach at a low cost, it may create a franchise for its product and brand name. A franchise is a joint venture between a franchisor and a franchisee. The franchisor is the original or existing business that sells the right to use its name and idea. The franchisee is the individual who buys into the original company by purchasing the right to sell the franchisor’s goods or services under the existing business model and trademark.
Franchises are a very popular method for people to start a business, especially for those who wish to operate in a highly competitive industry like the fast-food industry. One of the biggest advantages of purchasing a franchise is that you have access to an established company’s brand name, meaning that you do not need to spend further resources to get your name and product out to customers.
Franchise Basics and Regulations
Franchise contracts are complex and vary for each franchisor. Typically, a franchise contract agreement includes three categories of payment that must be made to the franchisor by the franchisee.
- The franchisee must purchase the controlled rights, or trademark, from the franchisor business in the form of an upfront fee.
- The franchisor often receives payment for training, equipment, or business advisory services from the franchisee.
- The franchisor receives ongoing royalties or a percentage of the business’s sales.
It is important to note that a franchise contract is temporary, like a lease or rental of a business, and does not signify business ownership by the franchisee. Depending on the franchise contract, franchise agreements typically last from 5 to 30 years, with penalties or consequences if a franchisee violates or prematurely terminates the contract.
In the U.S., franchises are regulated by law at the state level. However, there is one federal regulation established in 1979 by the Federal Trade Commission (FTC). The Franchise Rule is a legal disclosure given to a prospective purchaser of a franchise from the franchisor that outlines all the relevant information in order to fully inform the prospective purchaser of any risks, benefits, or limits of such an investment.
Such information specifically stipulates full disclosure of fees and expenses, any litigation history, a list of suppliers or approved business vendors, even estimated financial performance expectations, and more. This law has gone through various iterations and has previously been known as the Uniform Franchise Offering Circular (UFOC) before it was renamed in 2007 as the current Franchise Disclosure Document.
Brand awareness
Building a brand is no small feat and can be quite expensive and time-consuming. When you sign on with a popular franchise, the work has been done for you. We all know some of the more popular brand franchises out there, and we’ve become accustomed to a certain set of standards from these businesses. Customers will seek out establishments for their familiarity and consistency that comes from patronizing these businesses over many years.
Additionally, if you are part of a nationally recognized brand, you automatically have the power of that franchise’s marketing and advertising dollars to support you. This can inevitably result in a faster time to market and quicker ROI. However, brand awareness comes with a price tag. Buying into one of these better-proven franchises can be expensive and require more startup costs than building your own business.
Site selection
Site selection is critical for many businesses. Most franchisors pre-approve sites for outlets. This may increase the likelihood that your location will attract customers. The franchisor, however, may not approve the site you want. If there’s a specific location where you want your business to be and it doesn’t match the franchise opportunities in that area, then you will have to find a location or territory that will be acceptable to both of you.
In addition, franchisors may impose design or appearance standards to ensure customers receive the same experience in each outlet. If you are passionate about creating a unique look and feel for your business, you may have a hard time following the guidelines set forth by the franchisor.
Training and support services
Perhaps one of the biggest advantages to buying a franchise is the training and ongoing support you receive from a franchisor. They can help with managing the day-to-day business, from hiring and training employees to overseeing the finances. Franchisors can help you learn to run a business rather than doing it on your own, which can lead to mistakes that affect your business’s bottom line – whether through the cost of time, money or both.
Costs, fees and contracts
Depending on the system, startup costs for a franchise can be steep. Many franchise owners find it necessary to secure financing to purchase their business. In addition, most franchisors require franchisees to pay ongoing royalty and/or advertising fees. The fees are attributed to training, support and marketing, of which a certain percentage of your profits will be allocated to the franchisor. Finally, when you buy a franchise, you sign an agreement that locks you in for a specified amount of time, anywhere from 5 to 30 years. Breaking a franchise agreement can be difficult and costly.
Financing
Owning any new business, start-up costs can be high and require infusions of capital if they encounter hardship. A business needs a good business plan, healthy cash flow, and solid financing to succeed. Most franchisees will have to apply for a business loan at some point, such as a loan backed by the SBA (Small Business Administration). But bank loans and SBA loans are still not easy to get even for franchise businesses, and the application and approval process can be prohibitively long for a lot of franchisees in need of quick capital. Some franchisors offer their own financing programs, but the practice is far from widespread, so you can’t necessarily depend on funding from your franchise brand.
For these reasons, many prospective business owners are turning to alternative funding for better financing options. DRDA BORSA™ Plan, a self-directed 401(k) plan which allows an individual access to their qualifying retirement funds TAX and PENALTY FREE to be used as equity for a business start-up, acquisition, or as capital for an existing business. The Plan offers a much faster time to funding than traditional bank loans, often receiving funds in your account within 30 days of initiating the plan. The Funds then can be used as a down payment for an SBA loan.
Autonomy
Buying into a franchise system requires you to run your business as dictated by the franchisor with little leeway for business decisions, including the look and feel, purchasing equipment and overall operating procedures. You may control your franchise unit’s culture and who you hire and fire, but you still must follow a prescribed set of guidelines.
To maintain uniformity and ensure future success within a franchise system, franchisors can be very diligent about enforcing policies and procedures. The franchise system they created is their most valuable asset. If following and adhering to a prescribed set of operating instructions to run your business is not something you are envisioning, then franchising may not be the path for you.
Purchasing power
Having brand-name backing allows you to benefit from the collective buying power of the franchise when it comes to purchasing equipment and supplies. This can be critical for finding the right supplier and negotiating deals. Franchisors can also help you with determining what equipment you need, the right size and the supplies you’ll need.
At the same time, a franchisor’s requirement for you to purchase equipment and inventory only from approved suppliers will limit what you can purchase as well as your ability to purchase something at a discounted price from another dealer.
Challenges & Advantages
There are many advantages to investing in a franchise, as there are advantages in starting your own business. Widely recognized benefits to buying a franchise include a ready-made business operation. A franchise comes with a built-in business formula including products, services, even employee uniforms and well-established brand recognition. Depending on the franchise, the franchisor company may offer support in training and financial planning, or even with approved suppliers. Whether this is a formula for success is no guarantee.
Business owners, by definition, may not have any ongoing costs to an investor in the form of a percentage of sales or revenue, but they do have to expense their marketing, training, processes, and systems in place. Thich can equate to the same percentage range of 4% to 8% royalty fees required by the franchisee. Other equivalents would be location control or creativity with an owned business. Territories are defined by the Franchisor and approved based on area and region of similar brands within the geographical distance. The business owner must conduct market research and competitive analysis in order to establish a consensus of where to locate, and how to promote their brand. Other factors that affect all businesses, such as poor location or management, are also possibilities.
Franchise or Startup
As a franchisee, you will be signing a long-term contract with your franchisor and creating a relationship through which you will need each other to succeed. It’s critical you do your research and ensure your core values and goals align with those of the franchisor.
If you don’t want to carry on somebody else’s idea for a business, with a host of regulations, procedures, systems in place and rules you must follow as part of your agreement, you can start your own. While founding your own company has plenty of potential rewards, both monetary and personal, it is also at greater risk. When you start your own business, you are on your own, and much is unknown. Will the product sell? Will customers like it? Will I make enough money to survive?
If you choose to build your own business, then you won’t be as constrained by the franchisor/franchisee relationship, but you also will not receive the support you may need down the road. If your business is going to survive, you alone will have to make that happen. To turn your dream into a reality, you can expect to work long, hard hours with no support or expert training. If you try this on your own without any experience, the deck is stacked against you. If this sounds like too big a burden to bear, the franchise route may be a better choice.
People purchase a franchise because the model often works. It offers careful entrepreneurs a stable, tested model for running a successful business. It also requires them to operate on someone else’s business model. For those with a big idea and a solid understanding of how to run a business, launching your own startup presents an opportunity for personal and financial freedom.
So, startup or franchise? As you can tell the decision is very dependent on the professional and personal experience you want to gain through this next venture. There are merits and perils with each, but at the end of the day, only you can make the right choice for yourself.
Are you interested in learning more about DRDA’s ROBS structure, the BORSA™ Plan? Give Bryan Uecker a call today at 281-954-6004 for a free consultation.
- Published in ROBS 401(k), ROBS 401k Provider, Small Business, Tax
Clearing Myths about ROBS with DRDA’s BORSA® Plan:
Using 401(k)/IRA Funds to Start or Buy a Business
By Jay Barrera, MFA. MS.
Using Rollovers for Business Start-ups (ROBS) such as DRDA’s BORSA® Plan to finance a business isn’t new, but it is unfamiliar to many. As a result, there are a lot of myths swirling around about the use of ROBS structures that may be stopping would-be entrepreneurs from chasing their dreams.
BORSA® Plans involve using money from an eligible retirement account to finance the purchase of a business or franchise. To summarize, a corporation is formed, and that corporation then sponsors a 401(k) plan. Funds are rolled from an existing retirement account into the new 401(k) without triggering a taxable distribution. This new 401(k) purchases (or invests in) shares of the corporation, which can then purchase a business or franchise.
In essence, a BORSA® Plan allows you to invest in your own business where you have control rather than investing in the market where you have no control. Here’s the truth behind the most common ROBS myths:
It’s not tax avoidance.
Using a BORSA® Plan isn’t a way to evade taxes by any means. The Employee Retirement Income Security Act of 1974 (ERISA) was set up explicitly to encourage investment in small businesses – businesses that pay taxes.
BORSA® Plan is an investment, not a loan.
With a BORSA® Plan, you’re investing in your new business or franchise, not taking on debt. This means you won’t have to make monthly loan payments or incur interest.
You can use a BORSA® Plan to diversify your nest egg.
You don’t have to take every penny from your existing retirement fund for a BORSA® Plan to work. Many people only use a portion of their retirement assets, and this arrangement can be used in conjunction with a small business loan or other financing option. So, you can diversify your investments.
Getting funded using a BORSA® Plan can take as little as four weeks.
Depending on the state in which you’re filing, and how fast you’re able to file the necessary paperwork, funding can take as little as a few weeks. Most are completed in less than 30 days.
BORSA® Plans are not the same as Self-directed IRAs.
While it’s possible to finance a business with both self-directed IRAs and a BORSA® Plan, there are some major differences between the two. If you use an SDIRA, the owner may not work for the business or take a salary. The investment amount is also potentially liable for the unrelated business income tax (UBIT), which can get very expensive. With the BORSA® Plan, the 401(k) owner must work for the new business, and UBIT doesn’t apply.
A BORSA® Plan can be used to fund start-ups.
A BORSA® Plan is a great option to finance not only start-ups, but also purchases of existing businesses and franchises.
To some, the BORSA® process can appear to have complex rules and regulations. But if you have a qualified retirement plan with a balance that’s sufficient for your start-up needs and work with an experienced company to support its formation, it can be a great option to start or re-capitalize your business debt-free.
Please visit “BORSA® Plan in ACTION” to learn more about the structure and strategic steps to the solution of the BORSA® Plan.
Are you interested in learning more about DRDA’s ROBS structure, the BORSA® Plan? Give our experienced team a call today 281-488-2022 or email bryan.uecker@drdacpa.com for a free consultation.
- Published in Job Posting
