The internet has changed franchise business costs, but not the risks

Caroline McDavid and her husband started South Carolina-based franchise business Juiced Fuel in 2022 to take that pesky stop at the gas station out of people’s day. They’ll come to you, top off your tank, and be on their way. There’s no real estate involved, no fancy office space, or hiring fairs to contend with. Just a truck and the ability to find people willing to pay to have done what most of us do – albeit grudgingly – on our own.

The fees involved upfront for a Juiced Fuel franchise are $59,500, plus a truck, which usually ends up putting the initial costs at closer to $100,00 to start.

“I hear all the time that people have been burned by franchises and strive to make sure people are not forced into paying something they weren’t aware of. This is a new concept, very important for this to be successful. Our brand, baby we created,” McDavid said.

Juiced Fuel has sold 19 territories from Kansas to Kentucky to the Carolinas. Their flagship business based in Charleston has made over $1 million since it first opened.

The McDavids’ venture represents a relatively recent trend in franchising: mobile-first businesses that leverage smartphones and apps to deliver services directly to customers. These franchises often center around filling in the gaps in a customer’s life whether it be dog poop scooping, mobile car detailing, cleaning dryer vents or, fueling up your car.

There have always been what are described as “low-cost” franchises — there is no precise definition as some businesses tagged with the description require as little as $10,000-$15,000, while the International Franchise Association typically cites those requiring under $100,000 to start. According to the IFA, they continue to grow, at a rate of 2.8% this year. Home-based and mobile franchises are leading this category, according to IFA data, with the lack of real estate costs a factor in keeping the required initial investment down.

“We’re seeing a significant rise in emerging franchise opportunities across sectors like pet services, tutoring, mobile car detailing, fitness coaching, home services, and even wellness,” said Brian Luciani, chief growth officer at SMB Franchise Advisors. He says these are all built on the premise and promise of leveraging the flexibility and low overhead of a lean model while still providing a solid franchise support system behind them.

Owning a franchise is, in some respects, a classic example of the American dream. Business textbooks and websites are packed with case studies of bootstrap-pulling businessmen and women who have prospered through franchising. Often the franchising has involved golden arches, smiling colonels, or other iconic brands. Traditional franchising, though, can have an increasingly high financial barrier. Some market estimates for the cost of obtaining a McDonald’s franchise license and getting a restaurant up and running reach above $1 million. In its own materials, McDonald’s recommends a minimum of $750,000 in liquid assets to be considered as a franchisee and at least $100,000 of working capital required for each restaurant purchased.

The wide financial gap between new low-cost and existing higher cost franchise models is part of the problem, according to Keith Miller, public affairs director for the American Association of Franchisees. “It’s too easy to call yourself a franchise and imply that you are a proven business,” Miller said.

Experts say that the low cost can be an enticement to lure in the buyer before getting socked with more fees. They advise any current or prospective franchise owner to consider the following factors:

Headline investment numbers don’t tell the whole story

“When it comes to franchising, the headline investment number you see — typically $25,000 to $50,000 — can be very appealing, especially for first-time entrepreneurs looking for lower cost entry points to business ownership,” Luciani said. But he says that the initial franchise fee is just one piece of the economic puzzle. His firm always advises entrepreneurs to focus on the total cost of ownership: working capital, local marketing, licensing, insurance, and the time investment required to scale to profitability.

“The best franchisors are transparent about the total business costs and are committed to building sustainable systems that help franchisees succeed long-term,” Luciani said.

New, unproven franchise models often rely on selling licenses

Miller says prospective franchisees are drawn in with visions of being their own boss, having a proven business model, and no experience necessary.

“The fact is, though, many of these low-cost franchises are not proven at all and the franchise company itself has little experience or financial stability,” Miller said. New franchises that call themselves “emerging brands” are often unproven and need to sell franchises to stay afloat.

“Most franchises need to have 80 to 100 units to be self-sufficient on royalties. Until then they may need to sell a franchise this week to make payroll next week,” Miller said. That type of business model creates a problem because they are selling to someone who may be able to write a check but not necessarily run a business. “Selling to weak candidates and not having a solid base at the franchisor is a roadmap to failure for all involved,” he added.

A focus on low-cost alone can result in failure

The history of the franchise business is full of examples of the lure of low entry costs leading to business owners getting bogged down in bigger expenses later.

Heather Lawley of Forney, Texas, owned a Jazzercise franchise, paying $1,250 for the “audition.”

Jazzercise was once a pioneer in low-cost franchising, but now competes in the space with scores of other fitness businesses. Lawley said as a franchise owner she was responsible for finding and paying for class space and advertising. When Jazzercise changed their logo a few years ago, Lawley changed and updated signage at her expense. “I am glad I am not an owner anymore,” Lawley said, adding that it was difficult to turn a profit. It is also a business, unlike a mobile franchise, that requires some version of physical real estate, though that can be acquired inexpensively, for example, renting space from a church or conducting class outdoors in a park.

Despite Lawley’s experience, a recent report from the New York Post indicates that the franchise is experiencing renewed popularity among younger Americans.

Jazzercise did not respond to multiple requests for comment.

Working capital is as important as start-up costs

Jenn Woodhull-Smith, a lecturer in North Carolina State University’s Poole College of Management, teaches franchising, and draws upon her own experience as a low-cost franchise owner. She owned Fun 4 Raleigh Kids, part of the Fun 4 US Kids franchise network of hyperlocal sites that cater to families, and which has an initial investment estimated in a range of $26,000-$59,000, according to Entrepreneur.com‘s Franchise 500 rankings (the franchisor’s website lists a franchise fee as low as $10,000, but the franchise fee is one component of initial investment costs). Woodhull-Smith says it was a good fit when her children were younger. She also owned a Wine & Design franchise, which combines two of her loves, art and wine, though costs are estimated to be significantly higher. According to Entrepreneur.com, its initial investment ranges from $70,000 to as much as $222,000.

“With these lower cost ones, many people find them much more accessible. They can self-fund these lower-cost franchises without looking for big loans or having huge sums of money,” Woodhull-Smith said.

And she says a franchise can make for a good side hustle. But Woodhull-Smith warns that for a franchisee, it is not just about the start-up cost but about how much working capital one has to keep the business afloat before breaking even and generating a profit.

Look for a franchise that offers experience-based training

Woodhull-Smith says that the appeal of a franchise, even at – or maybe especially at – the sub-$100,000 level is that, in theory, the corporate entity has already done the spadework. Of course, the franchisee has to carefully vet the franchisor to make sure that is the case.

In a perfect world, the franchise business founders have done the research and hard work up front and built a successful business model or they wouldn’t be in business, Woodhull-Smith said. And if the franchisor is reputable, the training provided for franchisees is invaluable. “Franchisees can avoid the pain points because the franchisor has gone through them,” she said. But she added that there are also plenty of fly-by-nights that do little training.

Woodhull-Smith loved the experience of owning a franchise, but she stresses the importance of fiscal discipline.

“When I start businesses I only spend the money that will drive revenue to the business. In the excitement of owning a brand new business, sometimes people spend superfluously on things they may not need,” Woodhull-Smith said. “You don’t need to be fancy, you need revenue.”

Legal protections in the franchise industry are not strong

Low-cost franchise models, in particular, suffer from a lack of oversight and generally less candidate vetting. While some states – Maryland, California, and Washington – look at franchise documents more closely than others, there is no formal scrutiny of businesses that want to franchise. And franchise brokers that sell franchises to prospective buyers in return for a bounty from the franchisor are unregulated.

Miller said that even the Biden administration’s aggressive Federal Trade Commission still managed to only file two actions against a franchisor, and those were the first since 2007. The FTC considered tightening rules on franchising during the Biden administration, but those efforts never came to fruition.

Miller hopes more oversight at the federal level will be realized through the Franchisee Freedom Act, which was introduced as congressional legislation this summer.

“The vast majority of franchisees are small businesses with less than 20 employees,” said Georgia Democratic Congressman Hank Johnson, a co-sponsor of the bill with U.S. Representative Jan Schakowsky (D-Illinois) and U.S. Representative Jared Huffman (D-California). He said the bill aims to “give franchisees access to the courts so that they can address claims against the franchisor, putting them on a level playing field when enforcing their rights.”

Currently, individual franchisees cannot file their own lawsuits against franchisors for violating FTC rules — only the federal government can enforce those regulations.

Franchise documents for several businesses reviewed by CNBC all carry the same bold-faced warning: Note, however, that no government agency has verified the information contained in this document. Even states that look more closely at franchise documents are not necessarily vetting the franchisor, Miller said.

Many potential business pitfalls are buried in documents

Miller says the legal warnings for any entrepreneur interested in the franchise business are many and range well beyond limited government involvement in franchising. They are often buried in many of the documents: out-of-state dispute resolution, spousal liability, and a personal guarantee by the franchisee, are among issues that franchisees need to be aware of. Miller added that many franchisees don’t factor in service on debt they’ve taken on to open the franchise in the first place.

“Nobody counts the debt service. People blow through their SBA loan, second mortgage on their house, credit card debt, and even if they are successful in the business they still can’t outrun the debt,” Miller said.

Despite all the potential pitfalls, though, Miller is pro-franchise.

“It is a brilliant business model that creates opportunities but leads to abuse because of the lack of oversight,” he said. Miller helped pass California Assembly Bill 676 in 2022, which enhanced protections at the state level.

In the final analysis, beyond both the financial and legal hurdles, franchise owners, even those who have struggled, say there has to be an another reason to get into the business: because you love it.

“Make sure to understand why you are wanting to have a Jazzercise class and be aware the market is difficult,” Lawley said. “We teach because we love it. Your heart has to be in it,” she said.