A friend of mine, Kevin, has been brainstorming about how to flex his entrepreneurial muscles. While we were talking about his passions, interests, and knowledge, I asked him if he'd rather start a business from scratch or join a franchise. He gave his outlook on the general pros and cons, and then he threw the question right back at me. To avoid an hour-long response, I gave the best and worst answer possible—"it depends."

As with every important question, it usually just leads to more questions. I don't have all the answers, but as an accountant, I can offer some details to help you make a better-informed decision. If you have similar thoughts to Kevin, here are some key considerations to throw on your whiteboard.

Inital Costs

If you think of a franchise as an exclusive club, this is what you pay to join.

• Initial franchise fees – These can be anywhere from $40,000 to $150,000. Sometimes this fee also covers the cost of standard equipment required.
• Territory rights – Headquarters will assign a specific territory to you, for example, a 10-mile radius around your location. This is sometimes referred to as a development area fee and can cost $15,000 to $30,000.
• Required equipment – Certain equipment is required to set your franchise up for operations, and this can vary greatly depending on your industry. Costs can be as low as $20,000 and as high as $400,000.

Royalties

Many franchises will take 3% to 10% of your gross sales as royalties. Think of it as a fee for using their logos, their ideas, their products, and their reputation. In addition, they may take another 0.5% to 3% of your gross sales for corporate or national marketing, often called a brand fund fee. Sometimes there is yet another smaller percentage taken for local advertising.

Other Fees

If you're surprised about the above, prepare to be even more surprised about these other fees that franchises commonly charge:

• Point of sale (POS) fees – Using the required POS system can cost $100 to $600 per month.
• Electronic funds transfer fee – Payments to the corporation can cost you an extra $0.50 to $1.50 per transaction.
• Initial training fee – As a new franchise owner, you need to take corporate training, which can be $1,000 per person.
• Certification – Some industry skills require testing and certification before you can perform those jobs for customers. These can be $500 per person.
• Convention fees – Some corporate franchises hold annual conventions. Registration can be $500 per owner, with guests costing about half of that.
• Referral fees – If corporate refers leads to you, they can charge 5–10% of the sales that come from those leads.
• Software fees – Required proprietary software can cost $50 to $300 per month.
• Vendor approval fees – Using a non-approved vendor can cost $2,000 to $4,000 for evaluation.
• Renewal fee – Renewing your franchise agreement can cost $1,000 to $15,000.

Violation Fees

The above fees apply when you're doing everything right. If you do something wrong in the franchise’s eyes, you could run into these fees:

• Late reporting – Late accounting or reporting can result in daily penalties or additional royalty charges.
• Incorrect recordkeeping – Poor records may cost $2,000 to $6,000 per month until corrected.
• Audit or examination – Corporate audits can cost $300 to $500 per day.
• Territory violations – Working in another franchise’s territory can result in $2,000 to $6,000 per violation.

So...starting a business from scratch is better?

Not necessarily. Starting your own business has its own disadvantages. A franchise has a system that has been proven to work, at least to some degree. On the other hand, you're the new kid on the block. You may have a better idea and a better product or service than your competitors, but whether the market agrees is always a toss up.

That takes us to our final point—franchise or not, starting a business is risky. Even though different studies state different percentages, they all point to a high failure rate for startups.

So now that you have a little more info than you did yesterday, which do you think is the better option? I'm willing to bet you're thinking, "it depends."