Franchising

A franchise is a type of business relationship in which a business (known as ’the franchisee’) operates under another business’s (known as ‘the franchisor’) trade name or trade mark. By doing this, the franchisee appears as the franchisor’s business to the outside world. 

Franchisees tend to be local business operators who want to benefit from the franchisor’s brand.

The franchisor usually exercises continuing quality control over the franchisee and provides assistance to the franchisee. In return, the franchisee periodically has to make payments to the franchisor.

The term ‘franchise’ technically refers to the contract between the franchisee and the franchisor. However, it is commonly used to refer to the franchisee’s business. The term ‘franchising’ refers to the practice of creating a franchise system under which the franchisor ‘distributes’ its brand (ie enters into franchise contracts with other businesses).

The difference between franchising and distribution lies in the nature of the relationship between the parties and their obligations. 

Franchisors are able to exercise a greater level of control over the franchisee and its operation than a supplier would over a distributor. Under a franchise agreement, the franchisor typically has continual quality control over the franchisee (eg through an operations manual, marketing plans or inspections), while the franchisee makes periodic payments to the franchisor (known as royalties) in exchange for the right to use the brand and any know-how. 

By contrast, under a Distribution agreement, a supplier grants a distributor the right to resell its products in a given territory. While there may be some sort of regulation for the distributor, suppliers do not generally seek to regulate the operation of the distributor's business. Under a distribution agreement, the distributor typically pays the supplier a fixed fee to purchase the products and then resells them in the specified territory. The distributor usually keeps any profits made from the resale and is not required to pay any ongoing fees to the supplier for the right to sell the products under the brand. For more information, read Competition law and distribution agreements. 

A franchising system will typically comprise of:

• a successful existing business that wishes to expand (ie the franchisor), and 

• a newly formed business or an existing business with little or no experience in the proposed area of business activity, which wants to enter into this business area (ie the franchisee)

When a business wants to start a franchising system, the franchisor will typically enter into individual franchise agreements with franchisees, granting a franchise in relation to a specific geographical area. In this sense, the franchisee is a type of independent contractor of the franchisor, who uses the franchisor’s brand in exchange for royalties (normally an initial starting fee followed by ongoing service fees, often based on a percentage of franchisee turnover or mark-ups on supplies).

Key considerations for franchising

Some key considerations for businesses interested in franchising include:

Franchisability

Before deciding to franchise a business, the franchisor must decide whether their business model is in fact franchisable. Certain businesses (such as those with low margins or where the business’s success is due to its relationship with customers in a given area) may not be suitable for franchising.

The business will also need to consider how a franchise would interact with competitors and whether this may affect its market share and performance. Before deciding to franchise, a SWOT analysis should always be carried out. Similarly, a PESTEL (ie political, economic, sociological, technological, legal and environmental) analysis should be carried out to make strategic decisions about the scalability of the proposed franchise.

The operations manual

A franchising operations manual regulates the terms under which a franchisee operates a franchised business. This document sets out the day-to-day operational instructions to the franchisee and is designed to help the franchise business succeed. Operations manuals ensure consistency and adherence to the franchisor’s standards across all franchise locations, serving as a crucial tool for successful business operations.

As operations manuals provide practical guidance on how to run franchised businesses (eg covering training programmes, business setup, product or service standards, marketing, and technology usage), they may contain sensitive and confidential information belonging to a franchisor. Care must be taken to ensure such confidential information is protected (eg through NDAs and information security processes).

Protecting intellectual property 

Intellectual property (IP) rights have particular significance for franchises because franchisors will have built up substantial amounts of know-how and brand awareness, which they will seek to protect. This is particularly true regarding trade marks, a type of IP that helps protect the franchisor’s brand names and images. In fact, franchisors may require their franchisees to enter into separate Trade mark licence agreements to give them permission to use their trade marks.

Franchisors will want to ensure that their IP is protected and used in accordance with their wishes so that a franchisee's use of it does not negatively affect the franchisor’s brand. However, franchisees will need to ensure that franchisors have valid and valuable IP rights so that they can use the franchisor’s brand.

The franchisor-franchisee relationship

When considering entering into a franchising agreement, franchisors and franchisees need to carefully think about certain aspects of their business relationship. 

The franchisor will want to consider:

• payment - it needs to take into account that it is not in its interests to squeeze its franchisees excessively. Usually, an upfront royalty fee is negotiated for the initial grant of rights and, afterwards, a continuing monthly or quarterly fee is charged (usually based on a percentage of the franchisee's turnover)

• control and consistency - the franchisor will want to retain a certain degree of control over the franchisee, which can be achieved with the help of a clear operations manual. It is crucial that the franchisee complies with the operations manual and any IP licences so that customers receive the same quality of support at every outlet of the branded business

• confidentiality - the franchisor will want to ensure that the franchisee does not use the franchisor's confidential know-how to operate another similar business, either during or after the term of the agreement

On the other hand, the franchisee will want to ensure that it:

• has a realistic idea of the potential performance of the business that it will carry on under the franchise agreement

• receives enough support from the franchisor in terms of advertising and training to enable it to succeed

• has sufficient time to properly expand the franchised business and maximise the return on its investment

The franchise agreement between the parties should (among other points) address these issues to provide a clear contract and set of guidelines to the franchisor and franchises. If you require a franchise agreement, Ask a lawyer for advice or use our Bespoke drafting service. Usually, there will also be a detailed Non-disclosure agreement to help protect the parties. For more information, read Non-disclosure agreements. 

What are the advantages of a franchise?

Franchising is a useful strategy for helping businesses expand into new areas and foreign markets. The franchisor does not usually have to bear the start-up costs and risks associated with setting up in a foreign market. The franchisee will usually be responsible for bearing its own costs. Through franchising, a reputable business has the potential to establish a global or international presence. Some franchisors will offer training and financial planning, which could help offset some of the franchisee's initial investment. 

Franchisees often face diminished risks in relation to their initial investment, as their business product has already been chosen by virtue of the franchisor’s brand. However, franchisees also benefit from a franchisor’s brand (and brand recognition) and from the franchisors’s experience and support.

What are the disadvantages of a franchise?

A key disadvantage of franchising is the risk to quality control. Whilst an operations manual can assist in ensuring quality is kept to a high standard, the franchisor will still want to keep their brand’s name and reputation consistent. This can be difficult as customers could perceive a bad experience or product at one franchise to be indicative of other franchises and locations. International locations could make it difficult for franchisors to detect whether or not a particular franchise is performing poorly or is of low quality. 

Franchisees should also consider the ongoing royalty payments to the franchisor and the amount of capital required to initially open a franchise store, which is usually proportional to the franchisor's size and popularity. These fees may be high and may affect cash flow and profits when business is difficult.

Do not hesitate to Ask a lawyer if you have any questions or concerns about franchising.