Franchising has emerged as a popular business model that offers entrepreneurs the opportunity to own and operate their own businesses under the umbrella of an established brand and at the same time offers brand owners the ability to expand their reach through the effort and investment of others. Franchising has grown so popular that according to US Census data and other recent surveys, approximately one in every ten businesses in the United States is a franchise. That equates to over 800,000 businesses employing over 8 million people pumping more than $850 billion into the economy annually—and these numbers continue to grow.
Whether you are considering franchising your own business or becoming a franchisee, an understanding of the fundamentals of franchising is essential. In this article, we will touch on the basics of what franchising entails, the main components of the franchise relationship and an overview of how franchising can benefit both the franchisor and franchisee. Future posts and videos will touch on some of these basic concepts in more detail and discuss other aspects of franchising.
Learn some basic facts about this very popular type of business relationship.
A. What is Franchising?
At its simplest, franchising is a way of doing business where one party has a developed brand and a system of doing business and makes the ability to develop an independent business using that brand and system available to others. The parties involved are the Franchisor and the Franchisee. The Franchisor is the entity that developed the brand and business model. Franchisees are the parties that receive the right to build a business using that brand and business model.
Franchising is very regulated. The Federal Trade Commission and many state counterpart agencies impose requirements detailing what information Franchisors must provide potential Franchisees and when that information must be provided. Additionally, many states require Franchisors to register before offering franchises to potential Franchisees. Ultimately, the relationship between Franchisor and Franchisee is controlled by several key documents: a Franchise Disclosure Document (FDD), a Franchise Agreement and a Franchise Operations Manual.
B. Key Documents
- FDD. The FDD is a comprehensive document provided by the franchisor to prospective franchisees. It contains detailed information about the franchise opportunity, business risks, history of the Franchisor, information regarding the background of Franchisor management, financial performance, fees payable to the Franchisor, costs relating to opening and operating a franchised business, restrictions on certain aspects of conducting business, and much more. Generally, the FDD must be provided to the potential Franchisee before entering any Franchise Agreement.
- Franchise Agreement: The Franchise Agreement is the binding contract between the Franchisor and Franchisee that outlines the rights, responsibilities, and obligations of both parties. Franchise Agreements tend to be complex and comprehensive detailing what is required to open and operate a franchised business. Among other items, Franchise agreements will usually detail requirements relating to territory rights, franchise fees, royalties, marketing and advertising, training, support, franchise termination, confidentiality and non-competition obligations.
- Franchise Operations Manual. The Operations Manual is essentially a step-by-step guide detailing the standards, procedures, requirements and systems used to operate a franchised business. This is usually a very comprehensive document that provides a roadmap for day-to-day operations and may address such things as hours of operation, staffing, uniforms, business décor, signage, products or services offered, procurement, sales processes, accounting systems, financial reporting requirements, marketing and customer services. Operations Manuals are important because they ensure franchisees all follow the same operational parameters, which creates continuity in customer experience across the franchise network.
C. Royalties and Fees:
Royalties and Fees are also at the heart of the franchise relationship. The FDD and Franchise Agreement will describe the various fees and royalties Franchisees must pay the Franchisor. These fall within several general categories.
- Initial Franchise Fees. As a prerequisite to entering a Franchise Agreement and in exchange for the right to use the franchise brand and business systems, the Franchisor may require payment of a franchise fee. This is a one-time fee payable, usually, upon execution of the Franchise Agreement that is non-refundable.
- Ongoing Royalties. Franchisees typically pay ongoing royalties to the Franchisor which are often a function of Franchisee revenue. Some Franchise Agreements will require minimum royalty payments and/or offer sliding-scale royalty calculations based on revenue targets. These royalty fees are paid for the life of the franchise.
- Event or Operations Specific Fees. Additionally, Franchisees may be required to pay certain fees related to specific business operations, such as mandatory contributions to franchise-wide advertising funds. Likewise, certain business events could trigger a fee, such as fees to renew a Franchise Agreement or transfer ownership.
In conclusion, franchising offers a mutually beneficial partnership between franchisors and franchisees, leveraging the strengths of both parties to create successful businesses. By understanding the key components and benefits of franchising, entrepreneurs can make informed decisions about whether franchising is the right path for their business aspirations. Whether you are looking to expand your existing business through franchising or seeking entrepreneurial opportunities as a franchisee, franchising presents a compelling option worth exploring.