Washington State Department of Financial Institutions

Buying A Business Opportunity or Franchise

 Had it with the daily commute? Been downsized? Bored with your present job? Retired, but still too young to just sit on the front porch? Dream of owning your own business? Need extra money? It doesn't matter what the reason is, every day people invest in business opportunities. Whether this investment is a dream come true or a nightmare will depend a great deal on pre-purchase homework.

A business opportunity can include vending machines, distributorships, franchises, multi-level marketing arrangements and others. Before you go out and invest your hard-earned money, investigate! Consider what type of business suits your experience, the amount of money you have to invest, your interests, and your skills.

What is a Business Opportunity?

A business opportunity is legally defined as the sale or lease of any product, equipment, supply, or service which will enable the purchaser to start a business,
and:
The seller represents that he or she will provide locations or assist the buyer in finding locations, for the use or operation of vending devices, coin-operated amusement machines, or similar devices (this may include referring the buyer to a professional locating service, often one the seller has an interest in);
or
The seller represents that he or she will purchase any product made, produced, fabricated, assembled, modified, grown or bred by the purchaser using, in whole or part, any product, equipment, supply, or service sold or leased to the buyer by the seller;
or
The seller guarantees that the purchaser will earn an income greater than or equal to the price paid for the business opportunity;
or
The seller says that if the buyer pays a fee exceeding three hundred dollars directly or indirectly for the purpose of the seller providing a sales or marketing program, the seller will provide such a program which will enable the purchaser to derive income from the business opportunity which exceeds the price paid for the business opportunity.

What is a Franchise?

A franchise is a format, product, or system developed by the franchisor. By paying a franchise fee, you receive the right to use the franchisor's name and receive assistance. A franchise may cost from a few thousand dollars to several hundred thousand dollars.

One of the biggest benefits of purchasing a franchise is the name recognition. Consider carefully the following outline of a typical franchise system.

The Cost

Initial Franchise Fee and Other Expenses

In addition to your franchise fee, which may be non-refundable, you may have to rent, lease, build, advertise, and equip an outlet, including the purchase of inventory. You may have to pay license fees, or a "grand opening" fee to promote your new franchise.

You may be required to pay royalties based on a percentage of your gross income. Royalties are usually paid for the right to use the franchisor's name and may need to be paid even if you haven't earned any income or if the franchisor has failed to provide promised services.

Some franchises require that you pay into an advertising fund. A portion of the advertising fees may be for national advertising, and not to specifically target your franchise area.

Controls

Because of the name recognition, franchisors typically control how the individual franchisee runs their business. It insures uniformity but may restrict your ability to exercise your own business judgment.

Site Approval

Franchisors may require pre-approved sites for your franchise. The franchisor may not approve the site you wish.

Design or Appearance Standards

Many franchisors have a certain look that is easily recognizable and will impose that look upon you. You may have to conform to seasonal changes or periodic renovations. One of the biggest reasons for investing in a franchise is that people know what to expect no matter where they are when they come into the outlet.

Restrictions on Goods and Services Offered For Sale

Franchisors may control the goods and services you can provide. A fast food franchise can normally only sell the franchisor's menu, they cannot add or subtract items. As the franchisee of an automobile lube, you may not be able to offer additional service like brake or muffler work.

Restrictions on General Operation

You may be obliged to have your employees wear certain uniforms or to only use company advertising. You may have to run only company wide specials during specific times on specific items. This may hinder you from running your business as you see best. Some franchisors may require you to purchase supplies from approved vendors only. This may impact your profit margin if these vendors are more expensive.

Territories

Many franchisors will limit you to a certain territory. This could limit your ability to open more outlets or to move to a more profitable location.

Termination and Renewal

If you fail to comply with the franchise contract, you can lose the right to your franchise. Franchise contracts are for a limited time and there is no guarantee that you will be able to renew your franchise when the time comes.

Franchise Terminations

If your franchise is terminated, you could lose your investment. The franchisor may cancel your contract if you fail to pay royalties, or abide by sales restrictions or performance standards.

Renewals

A typical franchise agreement will run for 15 to 20 years. There is usually no provision that says that the franchisor must renew the agreement. Another thing to be aware of is that the franchisor doesn't have to renew the agreement under the same conditions as the first agreement. They may impose higher royalty fees, new sales restrictions, or may even reduce the size of your territory.

What is Multi-Level Marketing?

Multi-level marketing programs involve the sales of products or services through various levels of distributors. A distributor, also known as a sponsor, is expected to recruit other distributors. He or she is then responsible for training and motivating the new distributors. In return, he or she receives a percentage of their sales, and may receive bonuses when sales quotas are exceeded. If these distributors recruit their own distributors, the original sponsor also receives a percentage of this new downline's sales.

Multi-level marketing is a way to get in business for a very small amount of capital investment, sometimes less than one hundred dollars. Some people do very well, but the people who are very successful are few and far between. The people who are really successful are usually zealous about their product and company, and they are usually extremely good salespeople. Obviously these are attributes that will make a person successful in most any business.

Know the difference between a multi-level marketing program and a pyramid scheme. Bona fide multi-level marketing programs allow a distributor to sell the product or service if they do not wish to recruit others. Pyramid schemes make their money by recruiting other people to invest. If there is a product or service, it is incidental to the recruiting effort. Pyramid schemes always collapse with only the promoters and/or the very first investors making any money.

Before You Buy

Before you invest, whether it is in a franchise, multi-level marketing program or other business opportunity, there are many things you should consider. The following is a guide to some of the questions you should ask yourself. Go over these questions carefully to help make your decision.

Your Investment

Your Knowledge and Skills

Your Goals

Making Your Selection

Investing in a Business Opportunity is like any other investment, there are risks. As you narrow down your possibilities, carefully consider these factors.

Demand

Competition

Your Ability to Operate a Business

Name Recognition (Franchises or Multi-level Marketing)

The main reason for purchasing a franchise or multi-level marketing program is the right to use the company's name. The more successful the franchisor or multi-level program, the more the name will be recognized.

Company Reputation

Training and Support Services

Promoter's Experience

Many franchises and business opportunities have been in business for many years. Many franchisors operate well-established companies with years of either selling goods or services and in managing a franchise system. Some franchises and business opportunities started out operating their own business. Just because a business may be successful doesn't mean that you will be successful. Carefully consider how long the business has been in business. If the promoter seems to have little experience, perhaps their promises of guidance, training, and other support may be unreliable.

Growth

A growing franchise or business may increase the name recognition or enable you to attract customers. Growth alone doesn't ensure a successful business. Will the promoter be able to support rapid growth? Do they have sufficient assets and staff? Does your background compare?

Shopping a Franchise/Business Opportunity Show

Attending a Franchise/Business Opportunity Show will offer you an opportunity to see a wide variety of businesses in one place. Remember, however, that the exhibitors are there to sell their product. Their idea of the perfect business for you and your idea may not even be close. Do not let a salesperson tell you what you should be investing in.

How Much Can You Invest?

Have your investment figures firmly in mind because there will be exhibitors that will tell you that you can't afford to pass up this opportunity even if it is much more than you feel you should invest.

Know The Type Of Business That Is Right For You

Only you know what your interests, skills, and desires are. Perhaps the area you are interested in stems from a hobby. Maybe you have lost your job, but due to your years of experience, feel you would like to stay in that field. Only you can make that determination. Don't allow a salesperson to sell you something you are not interested in. Focus on the businesses that are of interest to you.

Comparison Shop

Walk the floor once to see what is available and what you may be interested in. Listen to several exhibitors as they talk to other interested persons. Get the answers to the following questions:

Exhibitors may offer you prizes, free samples, or free dinners to entice you to attend a promotional meeting later on in the day or sometime during the next week. Don't feel obligated to purchase anything. These meetings should be another way to acquire more information and ask more questions. Walk away if you feel that the product doesn't suit your needs.

Substantiate All Earnings

Some exhibitors may tell you how much you can earn or how much current owners are earning. Be Careful. Any exhibitor that makes such claims must provide you with written substantiation. Ask for and obtain this written substantiation. If the exhibitor cannot or will not provide it to you, consider the claims to be suspect.

Question all charts or claims such as: "You need only make X sales per day with X number of sites to make X amount of money." "Every time you pull this lever, you make $X." Ask what else is involved?

Take Notes

It will be difficult to remember what each exhibitor said. Bring a pad and pen and take notes. Take any promotional literature so that you can review them. Get business cards so you can contact them later with additional questions.

Avoid High Pressure Sales Tactics

The promoter may tell you that the offering is for a limited time only, that only one territory is left, or that the price has been reduced for this show only. Don't allow yourself to be pressured to make a commitment. Legitimate franchisors and business opportunity promoters expect you to comparison shop. If it is a good deal today it should be a good deal tomorrow. It is better to wait and lose a good deal than to jump in and lose everything.

Before You Purchase Checklist

Before you purchase, make sure you thoroughly read the disclosure document and contract. Consult an attorney or accountant, preferably one with experience in this area, before you invest any money or sign any documents. Even the most experienced business people never enter into an important business relationship without consulting a team of professional advisers.

Warning Signs

Any of the above are serious red flags and when they occur, close your checkbook and look elsewhere.

Take your time when investing in a business opportunity. Scams and frauds can be hard to spot, do your homework and investigate thoroughly.

Remember, making money almost always requires hard work, and lots of it.

To check to see if a business opportunity is registered or if any complaints have been filed against it, call or write:

Department of Financial Institutions
Securities Division
PO Box 9033
Olympia WA 98507-9033

360-902-8760
or
1-877-RING DFI (1-877-746-4334)

If you want to come to the office, we are located at:

Department of Financial Institutions
Securities Division
150 Israel Rd. SW
Tumwater, WA 98501

Visit the FTC's Web Site @ www.ftc.gov