Franchises and Business Opportunities – Understanding the Difference
For entrepreneurs seeking to hit the ground running with a new business venture, there are two main categories of opportunities out there that allow them to benefit from the experience, assets and reputation of existing business concepts. These are: (i) the franchise, and (ii) the “business opportunity”.
While they're often referred to in tandem (and the terms are occasionally used interchangeably), there are in fact important, fundamental differences between franchises and business opportunities. This article identifies those differences and highlights some of the benefits and drawbacks of both unique business concepts.
What is a Franchise?
As defined by federal law, a “franchise” is a business relationship in which one company (the franchisor) grants another independent business owner (the franchisee):
(i) The right to use the franchisor’s trademark and brand to identify and promote a business, and
(ii) The right (and obligation) to operate that business according to the franchisor’s proprietary system, guidelines and control, where
(iii) The grant is conditioned upon an initial payment of at least $500.00 within the first 6 months of the franchisee’s business operations.
If these 3 elements are present, then the business relationship is a franchise, and the franchisor must comply with all federal and state laws governing the offering and sale of franchises. In addition, many states have “relationship” laws which provide protections to franchisees once the franchise agreement is signed.
Most franchise opportunities are designed as long-term (commonly, 10-year-plus) relationships, and are governed by detailed and heavy-handed franchise agreements. Most franchise systems also have detailed Operations Manuals which become binding on franchisees and further describe the franchisees’ operational rights and obligations.
What is a “Business Opportunity”?
Generally speaking, a business opportunity consists of a marketing plan, training program and/or pre-arranged collection of goods or services that the opportunity seller offers to aspiring entrepreneurs for purposes of allowing the entrepreneurs to go into business for themselves. As compared to franchises, business opportunities often have much lower initial fees, and generally do not entail ongoing royalty payments. The buyer is free to market under its own trademark and business system, and the seller has no ongoing obligations to the buyer. Thus, once the business opportunity is sold, that is generally the end of the parties’ formal relationship.
Business opportunities are not regulated on the federal level. Many states have registration requirements for business opportunities, though the conditions for registration are typically minimal.
Benefits and Drawbacks of Franchises:
There are numerous potential benefits and drawbacks to purchasing a franchise. Some of these include:
- Potential Benefits:
- Long-term relationship with contract-mandated support structure
- Instant brand recognition and good will from the franchisor’s trademarks
- Protection under federal and state laws governing franchise sales and franchisor-franchisee relations
- With established franchisors, tried-and-true business systems with a proven record of success given the right conditions and management
- Potential Drawbacks:
- Long-term, binding relationship, often with little opportunity for exiting and the potential for ongoing payment obligations even after termination
- Generally higher initial fees plus ongoing royalty and advertising fund obligations, even after the business becomes self-sufficient
- Potentially limited growth opportunity, depending on territorial rights of other franchisees and the cost to purchase additional franchise territories
Benefits and Drawbacks of Business Opportunities:
Business opportunities have benefits and drawbacks as well:
- Potential Benefits:
- Lower initial cost as compared to franchises
- No binding commitment to the seller
- Freedom to operate under own business name and business system
- Potential Drawbacks:
- Limited (if any) support from the seller
- No affiliation with track-tested trademark or proven business system
- Revenue potential and margins are often limited
- SCAMS, SCAMS, SCAMS: Many “business opportunities” are scams, and prospective buyers need to be careful to do their homework before making a commitment
All in all, franchises and business opportunities are two very different animals. Both can represent legitimate opportunities for entrepreneurs, but both also entail their own respective sets of risks and concerns. Before committing to any franchise or business opportunity, it is crucial for the prospective buyer to perform the necessary due diligence and market research to make sure that the opportunity—whichever they may choose—has a realistic chance for success in their chosen market.
Jeff Fabian is the owner of Fabian, LLC, a boutique intellectual property and business law firm serving new and established franchisors and prospective franchisees. Contact the firm directly at 410.908.0883 or email@example.com. You can also follow Jeff on Twitter @jsfabian.
This article is provided for informational purposes only, and does not constitute legal advice. Always consult an attorney before taking any action that may affect your legal rights or liabilities.
Capital Formation Strategies For the Growing Franchise
One of the most difficult tasks faced by the leadership team of a growing franchisor is the development and maintenance of an optimal capital structure and access to the resources that the franchisor will need to stay strong and maintain its growth plans. Access to affordable debt and equity capital continues to be a problem for the growing franchisor even though franchising has matured as a viable method of business growth.
5 Steps to Getting Started in Finding the Right Franchise
Here are 5 steps to get you started off on the right foot: