A franchise is an agreement to license a business. The business owner is called the franchisor. The person who gets the right to operate the business is the franchisee. The agreement lets the franchisee operate a business using the franchisor's intellectual property.
Advantages of Franchising
A recognized, proven business model. When you buy a franchise you get a business model someone else has successfully developed. You get established and recognized trademarks, service marks and trade names. You get the goodwill and other rights associated with the franchised business. You get a turn-key operation.
Training and assistance. The franchisor should help train you to run the business. Established franchises will have market research to help you find a good place to locate the business.The franchisor usually has strict rules and standards as to how business is conducted. The rules cover things like the goods and services to be sold and the design and construction of the business facility.
Financing. Lenders may be willing to lend you money if you're opening an established and successful franchise. They may be less willing to lend money to an entrepreneur seeking to open an unproven business. A franchise with well-known and well-accepted products or services can significantly reduce business risks and enable you to own and operate a business on your own with no previous experience.
Buying a Franchise
If you're approved as a franchisee you'll have to pay for the right to run the business. You'll have to make an up-front payment to the franchisor. Then you'll pay the franchisor a percentage of sales monthly.
Your total investment in the franchise will be much more than the up-front fee. This includes all your start-up costs, leased space, capital costs and working capital. Often the franchisor will have special equipment and fixtures you must buy from them or their suppliers. Check to see if you pay the franchisor's cost or if there is a markup.
If you're considering franchising, you'll want to carefully investigate:
- The specific costs
- Financing availability
- Expected earnings
- Franchise agreement length
Types of Franchises
Basically, there are three types of franchised businesses:
- Distributorships. In this kind of franchise, a manufacturer grants someone the right to sell his product. The franchisee may be given an exclusive right to sell the product within a specified territory. These are known as product franchises
- Business format franchises. Here, the franchisee operates his business under the franchisor's trade name. The franchisee is identified as a member of a select group of dealers. The franchisee must follow set operating methods. The goal of the franchisor is to build nationwide or worldwide consumer recognition and acceptance of trademarks and the products and services associated with them
- Manufacturing or processing plant. The franchisor licenses the essential ingredients or formula for making a product. The franchisee makes the product to the franchisor's standards and sells it either at wholesale or retail
Franchise opportunities are heavily regulated. Both federal and state laws apply. They're needed because the control the franchisor has over the franchisee can be abused.
At the federal level, franchising is regulated by the Federal Trade Commission ("FTC"). Franchisors must give an extensive disclosure document to prospective franchisees. This Franchise Disclosure Document (FDD) lets the franchisee evaluate financial and business risks.
The federal franchise rule states what specific information must be disclosed. You can find the amended Rule in the Code of Federal Regulations, Volume 16, Part 436, 16 CFR § 436. The Franchise Rule Compliance Guide helps franchisors in complying with the rule and is available at the FTC's Web site.
The franchisor must provide the FDD to prospective franchisees at least 14 days before reaching an agreement with or accepting any money from the franchisee. This gives the franchisee time to fully check out the business. A franchisee should not cave to high-pressure tactics.
Many states have franchise laws similar to the federal law. These franchise laws attempt to level the playing field between franchisor and franchisee.These laws set the parties' minimum rights.
Well-established and successful franchisors won't make significant changes to their standard franchise documents. Less established franchisors might be more flexible. In setting up a franchised business, third parties, such as landlords and lenders, may also be involved.
Franchise agreements are complicated. Required third-party arrangements add complexity. Franchise opportunities require a substantial investment. You should consult with a franchising attorney and accountant early in the process of considering or negotiating a franchise agreement.
Questions for Your Attorney
- How do I pick the right franchise opportunity?
- What advantages are there in becoming a franchisee rather than starting my own business?
- How can I protect my franchise from competition from other franchisees?