What is a franchise? How franchising works for small businesses

Published Tuesday 4 November 2025

Table of contents

• What is a franchise?
• Types of franchise models
• How do franchises work?
• Advantages and disadvantages of franchising
• Franchise costs and fees
• What will a franchise do for you?
• Due diligence is key
• Getting started with your franchise finances
• FAQs on franchises

Key takeaways

• Evaluate franchise opportunities by requesting specific financial data from franchisors, including sales reports, break-even timelines, and common problems faced by new franchisees to make an informed investment decision.

• Budget for comprehensive franchise costs beyond the initial fee, including ongoing royalties (typically around 5-6% of revenue), marketing fund contributions, and higher startup expenses that can range from $160,000 to over $326,000.

• Prioritize franchisors that offer exclusive territory rights, comprehensive training programs, and documented operational systems to maximize your chances of success and protect your investment.

• Recognize that franchise ownership involves trading business flexibility for proven systems, meaning you'll follow strict brand standards and operational procedures while gaining access to established business models and ongoing support.

What is a franchise?

A franchise is a business model where an established company (the franchisor) grants others (franchisees) the right to operate under its brand name and proven systems in exchange for fees.

Key players:

• Franchisor: The parent company that owns the brand and business model
• Franchisee: The individual or entity that purchases the right to operate the franchise

Unlike businesses with multiple locations owned by one company, each franchisee is a separate business and legal entity from the franchisor. This means the franchisee manages their own financial outcomes, while the franchisor continues to operate the brand. A franchise system includes many independent businesses operating under the same brand.

So what is a franchisor?

Besides providing the brand, the franchisor generally hooks the franchisee into their supply chain and passes along processes, systems, management advice, and marketing insights to help make the business a success.

And what about the franchisee?

The franchisee will run their franchise as a separate business, which may require them to form a company. They pay franchise fees and will be expected to adhere to certain standards of operation and reporting. You may need to meet other legal obligations outlined in the franchise contract.

Types of franchise models

You can find franchise opportunities in many industries, not just restaurants.

Franchises are available in a range of industries. Here are some common categories:

• Food and beverage: Restaurants, coffee shops, food trucks
• Retail: Clothing stores, convenience stores, specialty shops
• Services:Cleaning, landscaping, automotive repair, fitness centers
• Professional services: Accounting, legal, marketing, IT support
• Healthcare: Dental practices, physical therapy, senior care
• Education: Tutoring centers, language schools, test preparation

How do franchises work?

The franchise process involves several key steps from initial contact to profitable operations:

Step 1: Initial application

• Contact the franchisor to express interest
• Meet their requirements for skills, experience, and financial capacity

Step 2: Legal review

• Review the franchise disclosure document (FDD), which government analysis notes can be several hundred pages long and hard to understand, reinforcing the need for professional advice.
• Get independent legal and financial advice
• Negotiate terms if possible

Step 3: Business setup

• Establish your legal business entity
• Complete franchisor training programs
• Set up operations according to brand standards

Step 4: Ongoing operations

• Pay regular franchise fees and royalties
• Follow brand guidelines and operational procedures
• Build revenue to cover costs and generate profit

Advantages and disadvantages of franchising

Franchise ownership gives you a proven business model with established systems and brand recognition. You will need to meet certain costs and follow operational guidelines.

Here are some things to keep in mind when considering a franchise:

• Proven concept: You get access to tested business models and products
• Higher startup costs: You pay franchise fees and meet brand requirements, which increases your initial investment
• Ongoing support: You receive training, marketing, and operational guidance from the franchisor
• Limited control: You must follow brand standards and operational procedures

Advantages of a franchise

Proven business concept: Most franchises are based on successful, market-tested business models that generate profit, with some franchisors estimating franchisees can earn an average cash-on-cash return on initial investment of over 25% in their second year.

What this means for you:

• Access to established systems and processes
• Reduced risk compared to starting from scratch
• Track record of success in similar markets

While many franchises are successful, it's important to research both successful and unsuccessful locations. Ask franchisors about franchisees who have not met their goals during your evaluation.

• You will sell market-tested products or services: If a business has succeeded in other markets, you can feel confident the products or services are in demand. A growing franchise often means customers value what it offers.
• You will likely get support through setup and planning: A franchise often comes with a business plan and a manual to help you get started. Pricing is set, key supplies are arranged, and you may receive marketing strategies.
• You receive training: Some franchisors will provide training for owners and their staff; for example, one franchise agreement specifies an initial training program that lasts for approximately three days at a designated corporate location.
• You get help troubleshooting problems: Some franchises offer support during your first few months. They can help you solve early challenges and guide you through any issues.
• You receive guidance on day-to-day operations: Well-organized franchisors document the tasks you need to complete and offer advice on efficient ways to do them. They may provide or recommend software to automate some tasks. Job sheets, checklists, and tools can help you start your business smoothly.
• You receive growth plans: Experienced franchisors have clear plans for growth. They have helped many franchisees grow their businesses. They can guide you step by step toward sustainable growth.

Disadvantages of a franchise

• You'll have higher startup costs: Upfront franchise fees add substantially to your startup costs, with one franchise disclosure document estimating the total initial investment required to begin operations can range from $160,000 to over $326,000.
• You'll need to hire staff from the start: Many small businesses start as sole proprietors and add staff over time. Many franchises require you to hire staff from the beginning, so you need to manage payroll and human resources right away.
• You'll have more fixed costs: You pay regular franchise fees and wages. You may also need to repay a large startup loan. These extra fixed costs mean you need more revenue to break even. You also need to manage cash flow carefully.
• You will have demanding sales targets: Many franchises succeed by offering products or services at low cost. These low-margin, high-volume business models have tight budgets. If sales drop, your earnings can change quickly.
• You'll have limited control: Part of the beauty of a franchise is that it gives you tight guide rails to destress business ownership. But that can also be a downside. You will be locked into very specific products, services, pricing, brand standards, business values and sales targets. It may prevent you from taking the business in the direction you'd like.

Franchise costs and fees

It's important to understand all the costs of a franchise before you decide. Your investment includes more than just the initial purchase price. Most franchise agreements include several common types of fees.

The initial franchise fee is a one-time payment to the franchisor for the right to use their brand and systems. You'll also have ongoing costs, like royalty fees, which are typically a percentage of your revenue.

For instance, one major franchisor reported its average royalty rate was 5.61% in 2018. Many franchisors also require you to contribute to a shared marketing or advertising fund.

What will a franchise do for you?

A key benefit of a franchise is the support you receive. Franchises are designed to make business setup, ownership, and growth easier. However, each franchise offers different levels of support.

Some franchisors document each step you need to take, provide training, offer systems, and share key performance indicators. Others may offer less support. Make sure you research the level of support before you commit.

Ask franchisors direct questions, such as:

• Can you share sales, revenue and growth reports for the whole business?
• What do new franchisees spend in their first year and when do they break even?
• Do you (the franchisor) have models for predicting sales in new locations?
• What are the 10 most common problems for new franchisees?
• What are the three most important KPIs for franchisees?
• Do you provide systems for things like inventory management, accounting, payroll, health and safety, training, or anything else?
• Will you commit to giving me (the franchisee) exclusive access to my local market?

Exclusive access to your local market is important. If the franchisor sets up another business in your area, it can create competition. Look for a franchisor who is fully invested in your success.

Due diligence is key

When you evaluate a franchise, analyze the costs, benefits, and support the franchisor offers to make sure the opportunity is right for you.

A quality franchisor will offer the following:

• Comprehensive operational and marketing support
• Exclusive or protected territory rights
• Transparent financial performance data
• Ongoing training and business development

When you invest in a franchise, consider these factors:

• Higher startup costs than independent businesses
• Ongoing franchise fees and royalties
• Compliance costs for brand standards
• Potential restrictions on business decisions

Getting started with your franchise finances

To manage your franchise finances, track your fees, compliance costs, and performance metrics to stay profitable.

Keep these financial points in mind:

• Track franchise fees, royalties, and marketing contributions
• Monitor performance against franchisor benchmarks
• Maintain cash flow for ongoing operational requirements
• Plan for territory expansion or additional locations

When you evaluate franchise opportunities or manage your franchise, clear financial visibility helps you succeed. Try Xero for free to streamline your franchise accounting and stay on top of your numbers.

FAQs on franchises

Here are common questions small business owners may have about franchises.

Is McDonald's a franchise?

Yes, McDonald's is one of the world's most well-known franchise systems. Most of its restaurants are owned and operated by independent local business owners.

Is Chick-fil-A a franchise?

Yes, Chick-fil-A uses a franchise model, but it is unique. You need a smaller initial financial commitment, but Chick-fil-A keeps more ownership and control than most franchises.

What's the difference between a franchise and a chain store?

The main difference is ownership. In a franchise, you own and operate your location under the parent company's brand. In a chain, the parent company owns and operates all locations.

How long do franchise agreements typically last?

Franchise agreements usually last between five and 20 years. The agreement will specify the initial term and any renewal options. Review these terms with your legal advisor before you sign.