# Understanding Franchises: How They Work and Their Benefits

> **Definition**
>
> A franchise is a business model in which a franchisee pays a franchisor for the right to use its brand, business processes, and proprietary knowledge to do business under the franchisor's name.

## What Is a Franchise?

A franchise is a business model where the owner licenses operations, products, branding, and knowledge for a fee.

The franchisee sells a product or service under the franchisor's business name. In exchange for acquiring the franchise, the franchisee usually pays the franchisor an initial startup fee and annual [licensing fees](https://www.investopedia.com/terms/l/licensing-fee.asp). A typical franchise agreement includes three types of payments to the franchisor: an upfront fee for the controlled rights, or trademark; payment for training, equipment, or business advisory services; and ongoing royalties or a percentage of the operation's sales.

The franchise business model dates to the mid-19th century in the United States, followed by the first food and hospitality franchises in the 1920s and ’30s that still define the American fast-food industry.

Franchise advantages include a ready-made business formula and support systems. Disadvantages include control and creativity limits, ongoing fees, and major startup costs.

Franchises are regulated at the state level, with the exception of the Federal Trade Commission's Franchise Rule. It's a legal disclosure in which a franchisor must fully disclose any benefits, limits, or risks to a propsective franchise investment.

### Key Takeaways

*   Franchising allows a business owner (franchisor) to expand their business by granting licenses to others (franchisees) to operate under their brand and business model, which can lead to increased market reach without the costs of direct management.
*   The franchise business model provides entrepreneurs access to established business processes, brand recognition, and support, making it an attractive option for those entering competitive industries.
*   While franchises offer advantages like a ready-made business formula and support systems, they involve significant startup costs, ongoing fees, and limits on creativity and control, which potential franchisees must carefully consider.
*   It's crucial for potential franchisees to thoroughly review the Franchise Disclosure Document to understand the financial implications and operational responsibilities involved before committing to a franchise.
*   Franchises contribute significantly to the economy, with hundreds of thousands of establishments in operation and billions of dollars generated annually, spanning various industries from fast food to hospitality.

![Franchise](https://www.investopedia.com/thmb/7swO3RaSCTJJU11kIB8Oi1eW4wg=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Term-Definitions_Franchise-1fe8a59aefa649fa8a994897ef843919.jpg)

*Franchises are effective for starting a business, especially in a highly competitive industry or an established industry that requires time to develop operating processes from scratch. — Mira Norian / Investopedia*

## Exploring the Franchise Business Model

When a business wants to increase its [market share](https://www.investopedia.com/terms/m/marketshare.asp) or geographical reach at a low cost, it may franchise its product and brand name. A franchise is a joint venture between a franchisor and a franchisee. The franchisor is the original business. It sells the right to use its name and idea. The franchisee buys this right to sell the franchisor's goods or services under an existing business model and [trademark](https://www.investopedia.com/terms/t/trademark.asp).

Franchises are an effective way for entrepreneurs to start a business, especially when entering a highly competitive industry such as fast food, or an industry that is established and requires time to develop its operating processes from scratch. One big advantage to [purchasing a franchise](https://www.investopedia.com/articles/insights/072516/cost-buying-mcdonalds-franchise-mcd.asp) is you have access to an established company's [brand](https://www.investopedia.com/terms/b/brand.asp) name, management knowledge, processes and procedures, financial toolbox, and metrics. You won't need to spend time and resources building them and getting your name and product out to customers.

The franchise business model has a storied history in the United States. The concept dates to the mid-19th century when two companies—McCormick Harvesting Machine Co. and I.M. Singer Co.—developed organizational, marketing, and distribution systems recognized as the forerunners to franchising. These novel business structures were developed in response to high-volume production and allowed McCormick and Singer to sell their reapers and sewing machines to an expanding domestic market.

> **Important**
>
> Before buying into a franchise, investors should carefully read the Franchise Disclosure Document, which franchisors are required to provide. This document contains information about franchise fees, expenses, performance expectations, and other key operating details.

The earliest food and hospitality franchises were developed in the 1920s and 1930s. A&W Root Beer launched franchise operations in 1925. [Howard Johnson Restaurants](https://www.investopedia.com/company-profiles-4689825) opened its first outlet in 1935, expanding rapidly and paving the way for the restaurant chains and franchises that define the American fast-food industry to this day.

There were an estimated 830,876 franchise establishments in 2024 that supported the U.S. economy, with an expected 851,402 for 2025. These franchises contributed almost $900 billion to the economy. In the food sector, franchises included recognizable brands such as McDonald's, Taco Bell, Dairy Queen, Denny's, Jimmy John's, and Dunkin'. Other popular franchises include Hampton by Hilton and Days Inn, as well as 7-Eleven and Anytime Fitness.

## Key Regulations and Fundamentals of Franchising

Franchise contracts can be complex and differ for each franchisor. A typical franchise agreement includes three types of payments to the franchisor. First, the franchisee must purchase the controlled rights, or [trademark](https://www.investopedia.com/terms/t/trademark.asp), from the franchisor in the form of an upfront fee. Second, the franchisor often receives payment for providing training, equipment, or business advisory services. Finally, the franchisor receives ongoing [royalties](https://www.investopedia.com/terms/r/royalty.asp) or a percentage of the operation's sales.

A franchise contract is temporary, akin to a lease or rental of a business. It does not signify business ownership by the franchisee. Franchise agreements usually last between five and 30 years, with penalties for violations or early termination.

In the U.S., franchises are regulated at the state level; however, the [Federal Trade Commission (FTC)](https://www.investopedia.com/terms/f/ftc.asp) established one federal regulation in 1979. The Franchise Rule is a legal disclosure that a franchisor must give to prospective buyers. The franchisor must fully disclose any risks, benefits, or limits to a franchise investment.

This includes fees, expenses, litigation history, approved vendors, estimated financial performance, and other key details. This disclosure requirement was previously known as the Uniform Franchise Offering Circular before it was renamed the [Franchise Disclosure Document](https://www.investopedia.com/terms/f/franchise-disclosure-document.asp) in 2007.

## Weighing the Pros and Cons of Franchising

### Advantages

There are many advantages to investing in a franchise, and also drawbacks. Widely recognized benefits include a ready-made business formula to follow. A franchise comes with market-tested products and services, and in many cases established [brand recognition](https://www.investopedia.com/terms/b/brand-recognition.asp).

As a McDonald's franchisee, choices about products, store layout, and employee uniforms are already decided for you. Some franchisors offer training and financial planning or approved supplier lists, but success is never guaranteed.

### Disadvantages

Disadvantages include heavy startup costs as well as ongoing royalty costs. For a McDonald's franchise, startup costs range from $1.3 million to $2.3 million, plus $500,000 in liquid capital.

By definition, franchises have ongoing fees that must be paid to the franchisor in the form of a percentage of sales or revenue. This percentage can range between 4.6% and 12.5%, depending on the industry.

For uprising brands, there are those who publicize inaccurate information and boast about ratings, rankings, and awards that are not required to be proven. So, franchisees might pay high dollar amounts for no or low franchise value.

Franchisees also lack control over territory or creativity with their business. [Financing](https://www.investopedia.com/terms/f/financing.asp) from the franchisor or elsewhere may be difficult to come by. Other factors that impact all businesses, such as poor location or management, are also possibilities.

Pros

*   Ready-made business formula
    
*   Market-tested products and services
    
*   Established brand recognition
    
*   Large decisions already made
    
*   List of approved suppliers
    
*   Training and financial planning provided
    

Cons

*   Success not guaranteed
    
*   Large startup costs
    
*   Ongoing fees
    
*   Lack of territory choice
    
*   Lack of creative control
    

## Comparing Franchises and Startups: Which Suits You?

If you want to run your own business instead of relying on someone else's idea, consider starting your own. But starting your own company is risky, though it offers rewards both monetary and personal. When you start your own business, you're on your own. Much is unknown, like whether your product will sell, if customers will like it, or if you will make enough to survive.

The failure rate for new businesses is high. Two-thirds of businesses survive just two years, and 50% survive just five years. If your business is going to beat the odds, you alone can make that happen.

To turn your dream into reality, expect to work long and hard hours with no support or expert training. If you venture out solo with little or no experience, the deck is stacked against you. If this sounds like too big a burden, the franchise route may be a wiser choice.

People typically purchase a franchise because they see other franchisees' success stories. Franchises offer careful entrepreneurs a stable, tested model for running a successful business. On the other hand, for entrepreneurs 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. Deciding which model is right for you is a choice only you can make.

## What Are the Advantages of Franchises?

Some of the widely recognized advantages of franchises include a ready-made business formula to follow, market-tested products and services, and, in many cases, established brand recognition. For example, if you're a McDonald's franchisee, decisions about what products to sell, how to layout your store, or even how to design your employee uniforms have already been made. Some franchisors offer training and financial planning, or lists of approved suppliers; however, despite these benefits, success is never guaranteed.

## What Are the Risks of Franchises?

Disadvantages include heavy startup costs as well as ongoing royalty costs. By definition, franchises have ongoing fees that must be paid to the franchisor in the form of a percentage of sales or revenue. This percentage can range between 4.6% and 12.5%, depending on the industry.  

There is also the risk of a franchisee being duped by inaccurate information and paying high dollar amounts for no or low franchise value. Franchisees also lack control over territory or creativity with their business. Financing from the franchisor or elsewhere may be difficult to come by, and franchisees could be adversely affected by poor location or management.

## How Does the Franchisor Make Money?

Typically, a franchise agreement includes three categories of payment to the franchisor. First, the franchisee must purchase the controlled rights, or trademark, from the franchisor in the form of an upfront fee. Second, the franchisor often receives payment for providing training, equipment, or business advisory services. Finally, the franchisor receives ongoing royalties or a percentage of the operation's sales.

## The Bottom Line

Franchising allows individuals to enter entrepreneurship by leveraging established brands with proven business models. Key structures of franchise fees are an upfront fee, ongoing royalties, and potential additional costs for training and proprietary processes.

The advantages of franchising include access to market-tested products and services and established brand recognition. The disadvantages include high startup costs, ongoing royalty fees, and limited creative or territorial control.

In franchising, franchisors benefit by increasing their market share or geographical reach at a minor expense.

Prospective franchisees should thoroughly review the Franchise Disclosure Document to understand fees, expectations, and contractual obligations.  

While [franchises provide a formula for success](https://www.investopedia.com/articles/financialcareers/11/alternatives-to-starting-your-own-business.asp), profit and viability depend on your diligent effort and management.

> **Article Sources**
>
> 1.  Thomas S. Dicke. "[Franchising in America: The Development of a Business Method, 1840–1980](https://uncpress.org/9780807843789/franchising-in-america/)." Pages 12–13. UNC Press Books, 1992.
>     
> 2.  Federal Trade Commission. "[Franchise Rule Compliance Guide](https://www.ftc.gov/system/files/documents/plain-language/bus70-franchise-rule-compliance-guide.pdf)." Pages 1, 24–119.
>     
> 3.  Thomas S. Dicke. "[Franchising in America: The Development of a Business Method, 1840-1980](https://books.google.com/books/about/Franchising_in_America.html?id=kARCDwAAQBAJ)," Page 119. UNC Press Books, 1992.
>     
> 4.  International Franchise Association. "[2025 Franchising Economic Outlook](https://indd.adobe.com/view/41aaf895-c7f7-43ff-9004-9455305199f3)." Pages 1, 6.
>     
> 5.  Franchise Help. "[McDonald's Franchise](https://www.franchisehelp.com/franchises/mcdonalds/)."
>     
> 6.  International Franchise Association. "[Royalty Fee Requirement Definitions](https://www.franchise.org/sites/default/files/ek-pdfs/html_page/Avg.-Royalty;-Royalty-Fee-Requirement_0.pdf)."
>     
> 7.  U.S. Small Business Administration. "[Small Business Facts](https://www.sba.gov/sites/default/files/Business-Survival.pdf)."