What Is Franchising?

Franchising is a way of financing expansion of businesses distributing products and services. It can create quicker growth while sharing risks and shifting the expansion costs. A franchisor normally provides the franchisee with training and on-going support for starting and operating a business that utilizes the franchisor’s trademark(s) or service mark(s), and its business systems. A franchisee usually supplies the start-up capital and manages the operation on a day-to-day basis. There is  typically an initial franchise fee and on-going royalties that the franchisee pays the franchisor for the right to use the franchisor’s marks and systems, and for ongoing assistance by the franchisor.

Federal law defines franchising as having the following three elements:

(a)           The franchisor has given the right to a franchisee to distribute goods and services under franchisor’s trademark, service mark or other commercial symbol.

(b)           The franchisor provides significant assistance to or has significant control over the franchisee’s method of operation.

(c)           Franchisee must to pay at least $500 before or within 6 months of opening for business.

If your business fits this definition, you must comply with the Federal Trade Commission Franchise Rule (FTC Rule), which regulates the offering of franchises. The FTC Rule requires that a prospective franchisee be provided with specific information about you, the franchisor, and the franchise opportunity. The required information must be provided in a document called a Franchise Disclosure Document (FDD) (previously called a Franchise Disclosure Statement or Uniform Franchise Offering Circular (UFOC)). The FDD will also include the franchise agreements and other contracts used by the franchisor.

Some states have their own franchise regulations. In twelve states, it is required to register the franchise before you can sell franchises in that state.  In those states, you not only have to comply with the federal guidelines, but you also have to comply with the state guidelines.  Other states do not require registration, but have specific laws that regulate the franchise relationship, such as termination and renewal of the franchise.

What businesses are the type that can be franchised?

Almost any type of business can be franchised – businesses that sell services or products, but not all businesses are candidates for franchising.

Is your business a candidate for franchising?

Operating a franchising business is different from operating the franchised business and different skill sets are involved for a franchisor who must sell franchises, train franchisees and provide continuing support to the franchisees in the system.  You must determine if you or your employees have the skills and organization to be a franchisor, and you must also determine if the business lends itself to franchising.

Factors to consider:

Can your concept and prototype be reproduced with other persons operating it?

Is your prototype providing enough profit to provide a franchisee with an adequate return on their investment, after paying royalties?

Can your concept be successful in other locales?

Can your concept be easily put into a training program and taught to others?

What can you provide to your franchisees on an ongoing basis after you have trained them in your systems and assisted them in opening, such as group purchasing or marketing materials?

Does your concept require special certification or a unique attribute to be successful?

Do you have the personnel to continue to operate your current business and  start a franchise company?

The fundamental elements of a successful franchise company:

Existing Concept – An operating business that is profitable and can be duplicated with other operators.

Brand Value – The business must have features and characteristics that distinguish it from the competition and provide a value to the franchisee. This is done through trademarks and service marks, store design if a retail location, advertising materials, and marketing programs.

Standardized Systems – This is the roadmap for how the business operates. These systems should be clearly illustrated in an operation manual and must be presented in a way that is transferable to franchisees.

People Power – You must have the proper people in your organization to market the franchise and meet the franchisor’s obligations under the franchise agreement. Those usually include people skilled in sales, finance, training, operations, and marketing.

Franchise Law Compliance – As stated above, there are federal and state franchise laws with which you will need to comply. This begins with having a Franchise Disclosure Document to deliver to prospects, and becoming registered in some states if you make offers in those states.  There are also rules governing the type of advertising you are allowed to do and what types of representations may be made outside of the FDD.

Capital Requirements – Franchising a business, like any business venture, requires sufficient capital. The amount varies depending on the type of business and how quickly you want to grow the business. Initial costs include legal and accounting fees in preparing the agreements and FDD and fees to specialists to create manuals and other operation tools. There may also be sales fees and costs of marketing the franchise.

Business Plan – As with any new business, it is recommended that you have a good business plan that outlines the strategies and timetables in expanding the business through franchising.

Professional Advisors – Engaging experienced franchise counsel is especially important in starting a franchise business.  Most attorneys have little knowledge of the intricate laws and regulations governing franchising and an experienced franchise lawyer can assist you in making many of the business decisions that accompany beginning a franchise, including issues of royalties, territory restrictions, purchasing requirements, term of the franchise, advertising funds, and operation manuals.