Franchise or Business Opportunity: What is the Difference?
If you're looking to become a business owner, but have ruled out starting from scratch or buying a business, then opening a franchise unit or business opportunity may be an option. Both options offer a ready-made business model that is already proven to work, but the similarities end there. These business models carry their distinct features, each of which may appeal to a different set of entrepreneurs.
Here's what you need to know about the differences between a franchise and a business opportunity, so you can decide which path to business ownership best fits your lifestyle needs and financial goals.
Franchises
A franchise refers to a business that grants a franchisee (the individual business owner) the right or licenses to market its products or services in a specific location in return for a franchising fee. The franchisee operates the business per the terms of the franchise agreement.
Franchises allow companies to expand their reach into different territories without tapping into their own financial resources. Basically, as a franchisee, you bring a well-known brand name into your community, working as a team with your franchisor to distribute the goods and services it's known for.
Becoming a franchisee allows you to leverage known name, such as McDonald's or Crumbl, as well as a time-tested business model, brand recognition, customer base, products, techniques, and procedures.
As a franchisee, it will be your responsibility to ensure your customers receive the high-quality products and services associated with the brand. You'll also own the right to:
- The company's trademarked materials, including logos and slogans
- The system of doing business
- Marketing materials
- Software
- All proprietary materials
The franchisor still maintains control over the operation of your business. That means you'll have to follow certain guidelines for running the business, which will be underlined in your franchising agreement. You're responsible, after all, for providing a consistent customer experience and upholding the standards of the brand name. You'll maintain an ongoing relationship with the franchisor.
In addition to start-up costs, you'll also pay ongoing royalty fees that make up a percentage of sales or revenue. Standard royalty fees typically range from 4-8 percent of gross sales.
Franchises come with their own set of legal requirements. The Federal Trade Commission (FTC) mandates that all franchisees receive a Franchise Disclosure Document (FDD), which discloses extensive information about the business, including:
- The history of the franchisor
- Identity of key personnel
- Litigation and bankruptcy history
- Initial franchise fee
- Description of required training programs
- Any restrictions
- Financing arrangements
- Financial performance and statements
In addition to reviewing the extensive disclosures, you'll also receive a franchise agreement that details the entire scope of your relationship with the franchisor. That includes the initial and ongoing fees, timelines for opening the business, specifications for equipment, terms of the agreement, sales requirements, dispute resolution, and non-compete covenants. You'll also find a section on penalties for violating or terminating the contract early, which can be expensive and severe.
When you're interested in buying a franchise, you will have to agree to an interview. Topics may include background, goals, existing experience in the industry, and your future plans for building the customer base. You may discuss a plan for financing, which the franchisor can help you navigate with lender recommendations.
The interview should also be a chance for you to find out about the level of support and training you'll receive, especially in the early months as you get up to speed. You may also want to find out how the franchisor can guide you to a suitable franchise location. If you feel confident in your ability to run the business and the franchisor's promise of ongoing support and guidance along the way, the franchise may be a good fit.
In exchange for the franchise fees, extensive documentation, and input from the franchisor, you'll enjoy the built-in structure of a successful business model along with ongoing support on topics such as marketing, employee hiring and training, and other aspects of business operations. The franchisor will have a vested interest in ensuring your location lives up to the brand name's expectations.
Because you have the support of a franchise behind you, your business is likely to become profitable in a faster window of time than if you were launching a solo venture.
Business owners must adhere tightly to the franchisor's terms throughout the length of the contract – and for some, that level of outside control can be burdensome.
Business Opportunities
Similar to a franchise, a business opportunity allows you to start a business using a prepackaged model. You can choose to continue selling the products or services that the previous seller used. Or you can decide to operate the business in a completely different way to suit your needs.
Essentially, when you purchase a business opportunity, you're buying the right to a business system that may include training, products, and equipment that the seller has developed and turned into a profitable arrangement.
Unlike a franchise, you enjoy a great deal more freedom to run the business as you choose. After you complete the sale, you're likely to have little to no interaction with the seller, and you aren't required to operate under the same brand. In some cases, the seller may provide some guidance and support, but that's not a requirement.
Because you're figuring out how to run the business mostly by yourself, you're likely to encounter some roadblocks along the way. Many small businesses fail as their owners try to get up to speed. Also, as a business opportunity owner, you'll lack the support of a franchise company that offers you support and structure. However, if you're creative and prefer to build a business using your own ingenuity and talents, a business opportunity may be the ideal choice for you.
These are the main types of business opportunities you're likely to encounter:
- Rack Jobber. You'll enter into an agreement with a company to market their products in certain store racks. As the rack jobber, you'll maintain the rack inventory, appealingly arrange the merchandise, and perform the bookkeeping.
- Distributorship. In this type of arrangement, you may agree to sell someone else's product but cannot use the manufacturer's trade name. You may be required to sell only the products provided by the seller, or you may be allowed to expand the products or services as you see fit.
- License. In a licensing arrangement, you'll pay the seller for the right to use the seller's trade name as well as the products, services, or technologies they developed.
- Vending machines. You'll pay for the machine and the products it offers and pay the location owner a percentage based on sales.
Since different states carry their own legal definitions of business opportunities, you'll have to consult with the particular laws of your state of operation. In general, however, a business opportunity has to comply with the following guidelines:
- A business opportunity involves the sale or lease of any product, service, or equipment that allows the purchaser to start a business.
- The seller agrees to help the buyer find a location or provide a product to run the business.
- The seller guarantees an income higher than or equal to the price that the buyer pays for the business opportunity.
- The initial fee to start the business opportunity must exceed $500.
- The buyer will purchase any products or services developed by the seller.
The Federal Trade Commission has mandated that the sellers of business opportunities provide a short disclosure statement outlining their contact information, any legal action was taken against the seller, the existence of a cancellation or refund policy, any earnings claims, and references for the seller. You must receive this disclosure ten days before the sale of the business takes place.
Unfortunately, business opportunity scams can be quite common. The promise of earning large amounts of cash quickly tends to be a red flag. You might also be left with very little training or educational materials to help you operate your business effectively.
To make sure the business opportunity is legitimate, and the seller isn't misrepresenting its prior success, the FTC recommends:
- Studying the disclosure statement and earnings claim statement thoroughly
- Asking the seller for proof of earnings
- Checking any references from the seller
- Asking the current business opportunity owners questions about the earnings claim statement and how it matches up with the actual performance of the business opportunity
- Vetting the seller with your local consumer protection agency and the Better Business Bureau
Advantages and Disadvantages of Each
When deciding between a franchise or business opportunity, you'll want to consider each venture's various advantages and disadvantages. Remember that the right choice for you can depend on your management style, work history, interests, and personality traits.
Advantages of a Franchise
- Access to ongoing training and support
- Built-in infrastructure that's already been a proven success in the industry
- Easier to market to the surrounding area, with established advertising and marketing campaigns
- Instant brand recognition that comes with running a well-known, respected business
- Chance for higher earning potential
Disadvantages of a Franchise
- A commitment to pay the franchisor ongoing royalties in exchange for the right to use the brand and operating model
- More expensive in the long term than a business opportunity
- More intense regulations and scrutiny that govern the legal operation of a franchise
- Must undergo a more extensive process before being accepted as a franchisee
- Limited (or no) ability to use your own creativity and innovative ideas to improve the business
- You might lose the right to operate the franchise if you don't comply with the terms of the franchising agreement
- Restrictions on operating methods and locations where you can open
- You'll be locked into a contractual agreement for a longer time (such as ten years)
Advantages of a Business Opportunity
- No ongoing payment commitment other than your upfront payment – which can be as little as $500
- Flexibility to run the business as you choose as long as it meets state guidelines
- The ability to use your own brand and operating system
- You can customize the advertising campaign and develop the brand as you choose
Disadvantages of a Business Opportunity
- Will have to meet state requirements for a business opportunity, which may be more stringent or relaxed depending on your location
- The seller is not obligated to offer you any support or direction in running your business
- More informal than a franchise
- Usually, very little to no brand recognition
How to Choose Between a Franchise or a Business Opportunity
As an aspiring entrepreneur, it's important to consider your own needs, interests, and personal and career goals when deciding whether to pursue a franchise or a business opportunity. You're making a significant business investment, in either case, so you want to be sure that it is a good fit.
A franchise might be the better option for you if:
- You want a known brand and the marketing behind it to help build your customer base
- You want to be able to reach out to the franchisor for ongoing assistance and feedback
- You are prepared to cover the higher upfront investment and ongoing royalty fees and have additional income to live on until the franchise becomes profitable
- You're willing to stick to the franchisors “playbook”
- You are comfortable with a long contractual agreement
- You prefer to follow a prescribed business model with predictable orders and methods that have stood the test of time
A business opportunity might work better in your situation if:
- You want the independence to run your business without any input or guidance from others
- You prefer to set your policies, procedures, pricing, and control the type of products and services offered
- You want a lower upfront investment
- You don't want a long contractual arrangement
- You have a creative, innovative spirit best suited for a more flexible business model
- You want to devise the methods to grow the business
When you commit to a franchise, you're tapping into a ready-made support structure that is proven to work. However, you'll need to have sufficient cash to cover the franchising and royalty fees.
On the other hand, a business opportunity offers a great deal of operational latitude for a lower investment. You're able to “be your own boss” in the traditional sense. However, you should have strong business sense and a solid plan for building the business since you likely won't benefit from the support system of a franchise model.
It's important to also consider how much time and money you want to invest and your expected length and level of involvement. Review different options available to you in both franchises and business opportunities. What appeals to you? What will help you meet your personal and professional goals? Would you appreciate the rules and instruction of franchising, or are you interested in flexing your creative muscle in a business opportunity?
Even though both franchises and business opportunities are easier than starting a business from scratch, it's still hard work — and success is not a guarantee. Consider the financial, legal, and logistical elements of each option, so you're fully prepared.
Choosing a franchise or business opportunity is a big commitment. Be sure you consider and research your options, so you can be confident in taking the next step to business ownership.
In addition to existing businesses for sale, BizBuySell also has a directory of franchises and business opportunities. Start by browsing the available options, and reach out to get more detailed information to start researching your options.