Commercial franchising: the basics
February 9, 2017
Some of the best-known franchises in the world include the likes of Starbucks, Subway, Pizza Hut, and McDonalds. However, alongside these global names, there are many smaller-scale franchisors (the owner of the brand) out there looking for people to join their business model as a franchisee.
If you have a strong business concept and are looking to grow it, or are looking to become a business owner without building everything from the ground up, franchising may be the solution for you. Here are some of the basics to take into account when considering whether franchising is right for you:
The Franchisor – A franchisor is the owner of the business concept and the brand under which the business operates. By franchising it, they grant other businesses the right to operate using that concept and brand. This method can be a great way of expanding your business without the inherent risks of setting up new stores/branches yourself.
A key responsibility is to strengthen the brand’s reputation and refine the business model so it can be easily adopted by others. Franchising is generally more successful when a business is well‑established and recognised, as newer or lesser‑known brands are less likely to attract franchisees.
Initial consideration should be whether the nature of the business (particularly the products or services offered) is suitable for franchising. For example, can the structure be replicated easily? Will the business model succeed in other areas? Is the brand strong enough? If the business is suitable, careful thought must be given to the business plan and proposed management structure to ensure that you are able to deal with the obligations which will be placed on you.
Pilot Operation – It is generally recommended that a franchisor operates one or more ‘pilot franchises’ to test the effectiveness of the system before expanding on a larger scale. An early step in the process is agreeing and entering a franchise agreement with the pilot franchisee(s). Pilot franchisees generally have more influence over the terms of the franchise agreement than those who enter into an agreement once the franchise is fully established. This is primarily because pilot franchisees are taking a greater risk with a new business model and also because there will be an element of trial and error in the operation of the system and the performance of the franchise business.
Operations Manual – the operations manual is a core element of the franchise relationship, as it explains how the franchise system operates in practice. It sets out the day‑to‑day requirements of running the business, including details on equipment (what must be purchased and from where) and its use, stock control, opening hours, accounting procedures, and other operational guidelines. The manual must be prepared by the franchisor and provided to franchisees, and it is usually developed using the franchisor’s own experience as well as insights gained from the pilot operation.
Key Duties – One advantage of franchising is that it allows the brand owner to exercise a higher level of control over how the business operates compared with alternatives such as a trade mark licence. However, this increased control comes with additional responsibilities for the franchisor. For example, the franchisor will normally be responsible for supplying information and training to the franchisee, as well as equipment, stationery, advertising materials and possibly stock. Over the longer term, the franchisor will be responsible for reviewing the business and operational performance of the franchisee, as well as continuing to provide marketing and other support to the franchisee.
Franchisee – one of the main benefits for a franchisee is the ability to tap into the franchisor’s name and reputation, which can significantly shorten the time required to build a successful business. Also, the provision of the operations manual, training and other support services reduces the need for the franchisee to have general business or management skills or specialised knowledge of the relevant business activity. Statistically, franchises have a lower risk of business failure than other start-ups, which is attractive to many prospective franchisees.
This pre-built model and ongoing support does, however, come at a cost. A franchisee will be subject to substantial control from the franchisor, which would obviously not exist if the franchisee was to set up a new business on its own. There will normally be an initial fee upon entering into the agreement, which covers the franchisor’s costs in establishing the franchise. Also, the business income will not belong exclusively to the franchisee. Whether via a royalty fee, or an uplift on goods or services, the franchisee will account for part of its income to the franchisor. This acts as a payment to the franchisor for it licensing the brand, the business system and for providing the support services. This is how the franchisor makes its money in the longer term.
With the exception of pilot arrangements, franchisees generally have very limited opportunity to negotiate the terms of the franchise agreement, which is prepared by the franchisor and applied consistently across the franchise network. As a result, a franchisee’s primary concern is whether they are able to comply with the obligations set out in the agreement and whether they have carefully balanced the potential advantages of franchising against the risk of business failure.
It is strongly recommended that prospective franchisees obtain independent legal advice on the franchise agreement, and most agreements will include confirmation that this has taken place. There are also several key terms that should be carefully reviewed before deciding to proceed.
Conclusion – Whether contemplating whether to set up a new franchise or become a franchisee, it is vital to properly scrutinise the business model and ensure it is viable before proceeding. For a franchisor, this will mean coming up with a full business and management plan and piloting the scheme before rolling it out properly. For a franchisee, this will mean reviewing the franchisor’s business, speaking with existing franchisees and considering the local market conditions. It is often useful for franchisees to take advice, particularly in relation to the financial projections provided by the franchisor, to make sure they are robust.
It is equally important to deal with the legal aspects of the arrangement properly, which for the franchisor means having a suitable corporate framework in place for the franchise and a comprehensive agreement which protects its position as fully as possible. A franchisee, while having only limited negotiation power over the franchise arrangement, will need advice on the franchise agreement and the practical implications of it.
If you would need support with your franchise, get in touch with our team using the contact form or on 02920 829 100 to see how we can help you.