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What is a franchise?

Franchising is an extremely adaptable method of distributing products and services. It allows for rapid expansion but spreads the risks and costs of expansion. A franchisor typically provides the franchisee with training and support for starting and maintaining a business which uses the franchisor’s business system and trademark or service mark. A franchisee typically supplies the capital for starting the business at a new location, and the day-to-day operation and management of the new unit. The franchisee usually pays the franchisor an initial fee and an ongoing royalty for the right to use the franchisor’s marks and business system, and for ongoing support.

What are the benefits of franchising?

The franchisees provide all capital for expansion and bear all risks, while the franchisor receives a franchise fee and an annual royalty (generally 5% to 15%) on the franchisees’ gross revenues. As proprietors of their own businesses, franchisors are motivated to work harder than company employees would.

Under a franchise system, the company need not finance expansion out of profits, loans or investors’ capital; the franchisees put up the capital. Franchisees also make motivated managers, for their savings are at risk and they stand to reap the rewards of their successes. Salaried managers lack both those incentives, and so typically will not work as hard or as intelligently as franchisees.

For a more detailed analysis, please see the Benefits section of this site.

Who regulates franchising?

Franchises are regulated by a variety of federal and state laws. Additionally, international franchises must comply with the legal requirements of other nations. Please see this site’s sections on American and international franchise law.

What are some of the issues we will need to consider in planning our franchise concept?

What minimum qualifications will you require for new franchisees?
How will you find qualified prospects?
How much will the initial franchise fee be?
Will you offer financing?
How much will the royalties be?
Will there be any other fees? If so, how much?
What kinds of controls will you have to make sure franchisees pay all they owe you?
How long will the franchise term last?
Can the franchise agreement be renewed for additional terms?
Will you require franchisees to purchase certain goods or services?
Will you require franchisees to buy them from designated suppliers?
What kinds of ongoing value will you provide to franchisees to keep them in the system after you have trained them on how to run the business?

What types of legal documents are commonly used in franchise systems?

UFOC – Provides potential franchisees with the disclosures required by law.
Franchise agreement – Outlines the legal relationship between franchisor and franchisee.
Owners Agreement – Signed by the owners of the franchisee; includes a confidentiality agreement, non-competition agreement, personal guaranty, and restrictions on transfer.
Development agreement – For franchisees who buy the right to open multiple franchises in a certain area.
Sub franchise agreement – For a relationship under which the sub-franchisee will grant franchises to third parties.

What kind of support should we provide to franchisees?

The support you should offer depends on the type of franchise involved. It might include the following:

Site selection
Negotiation for leases and required products or services
Unit layout
Training – operational, sales, management, customer service, etc.
Identification of suppliers
Sale of certain products or services to your franchisees
Staff recruiting
Marketing materials and promotions
General business advice

Your site says that $50,000 to $250,000 is necessary in capital. Why do we need so much money to get started?

There are two reasons:

1. Financial Ability. If you plan to sell franchises in a state where you have to file your UFOC for review by the state franchise regulators, you must be able to show that you have the financial ability to perform your obligations under the franchise agreement. The franchise regulators will examine your audited financial statements that are included in the UFOC. If these statements do not show sufficient liquid capital, the regulators may refuse to register the franchise unless one:

infuses additional capital into the company;
files a surety bond;
files a guaranty of your performance by another company which has audited financial statements showing sufficient liquid capital;
agrees to impound all fees collected from each franchisee in that state into a special account until after the franchise regulators approve your withdrawal of the funds;
agrees to not collect any fees from each franchisee in that state until after the franchise unit is open for business.

There is no hard and fast rule on sufficient liquid capital. New franchisors without any operating history may be required in some states to have liquid assets of at least two times the initial franchise fee.

2. Start-Up Costs. Like most businesses, there are certain costs involved in starting a new franchise. These costs can be controlled to some extent by deciding which types of start-up service are necessary, choosing to do some of the start-up work, and carefully selecting your franchise lawyer and accountant. At one extreme, you can hire a franchise development company to do practically everything for you. At the other extreme, you can do almost all of the start-up work yourself.

Can we franchise on a very limited budget?

Yes, this is possible but it has its risks. Here are the bare minimum steps to start a franchise:

Draft a UFOC and a form franchise agreement. Use templates found in some franchise books, or use a competitor’s documents as a guide.
Get audited financial statements from an independent certified public accountant.
Register your franchise if you plan to offer franchises in a registration state.

There are other procedures that are not required but will provide you with certain legal protections, and are easily worth the cost.

Form a new entity to be the franchisor. Check with your state’s corporations department or secretary of state on how to do this yourself, or search online for low-cost service companies that will help you.
Register your marks with the U.S. Patent and Trademark Office.

Another way to start a franchise on a limited budget is to work with those who are willing to take risks with you now in exchange for a share of possible rewards in the future. Some franchise lawyers (including myself), some franchise consultants, and some franchise development companies may be willing to take a share of future franchise fees and royalties instead of all or part of their normal fees.

What should be in the franchise operating manual?

The operating manual should include all of the mandatory requirements for operating the franchise according to your quality standards. It should contain all of the details about the franchise’s general obligations stated in the franchise agreement. A typical manual includes the following sections:

Introduction – Welcomes the franchisee into the system and outlines the broad terms of the franchisor-franchisee relationship.
Background – Provides background information about the franchise system, such as its history, management and mission statement.
System – Includes a detailed description of the franchise system.
Site selection – Explains the physical requirements for the franchise location and includes factors to consider in searching for appropriate locations.
Unit layout and decorating standards – May include prototype plans for layout of the franchise unit, and specific information about the requirements for any required décor.
Required purchases – Lists the furnishings, fixtures, equipment, supplies, signs and other items and services the franchise must purchase, and includes any relevant specifications or approved suppliers.
Equipment operation – Instructs on how to use, maintain and repair equipment relating to the franchise operations.
Operating standards – May include specific operational requirements and suggestions in categories such as staff training, accounting, fees and reports, customer service, advertising, use of the marks, product preparation, service standards, pricing and purchasing policies, appearance standards, inventory control and insurance.
Contact information – important contact information for the franchisor’s staff, approved suppliers and emergency contact information.

What are some Internet resources for research on franchising?

A quick search using a search engine like Google will provide a number of resources. However, you should never rely solely on information garnered from the Internet, especially in more complicated areas such as international franchising. Always consult a legal professional on details of franchising. Here are some sample resources that may be helpful in researching international franchising.

International Franchising Trade Shows. The International Franchise Association’s website includes a listing of upcoming events by date and country.

Franchise Associations. Many countries around the world have franchise associations. These local organizations often have matchmaking programs to help franchisors with international expansion. The International Franchise Association’s website includes a listing of these organizations with contact information.

American Chambers of Commerce. The International Franchise Association’s website includes a comprehensive listing of these organizations.
International Franchise Association
1350 New York Avenue, NW Suite 900
Washington, D.C. 20005-4709 USA
Phone: 202-628-8000
www.franchise.org

U.S. Chamber of Commerce
1615 H Street, NW
Washington, DC 20062-2000 USA
Phone: 202-659-6000
www.uschamber.com

Global Trade & Technology Network
1301 Pennsylvania Avenue, NW, Suite 925
Washington, D.C. 20004 USA
Phone: 202-628-9750
www.usgtn.net

Overseas Private Investment Corporation
1100 New York Avenue NW
Washington, DC 20527 USA
Phone: 202-336-8400
www.opic.gov

Franchise Update magazine’s website has some information about international franchising.

Also see Franchise International magazine’s website.