Some of the biggest brand names operate on a franchise basis; for example, the education provider Kumon Maths and fast food outlet Subway. It’s a way for the established business (the franchisor) to strengthen its brand presence and reach, and provides the person operating the franchise (the franchisee) with the opportunity to run a business without the risk that comes with starting a company from scratch.
Franchising is just one way of expanding your business and, for some owners, it yields very positive results. However, it is not necessarily the best choice for every business.
Whereas a ‘traditional’ business model would see you make money from selling your goods or services, as a franchise your income would come from selling franchises, franchise fees and royalties. This requires scale if a steady and adequate level of income is needed.
Careful consideration should, therefore, be given to the pros and cons of this model, including the legal implications. An experienced lawyer can provide tailored advice to help you make the best decision for your business and, if it’s the right model for you, to realise the advantages of franchising.
What fees are involved in franchising?
Initial franchise fee
A franchisee will typically pay an initial franchise fee (IFF), as an up-front investment. Franchisors use this money to fund the set-up costs of the franchise and initial franchisee training.
Setting the IFF is not necessarily a straightforward decision. As a franchisor, you will want to cover some of the costs associated with franchising. As mentioned previously, it takes time and money to develop the relevant documentation (such as operating manuals and marketing material) and to train franchisees. While the IFF shouldn’t be viewed as a way to make profit, it is an opportunity to balance some of the costs you have to cover. You will have to be able to justify your IFF to prospective franchisees, so understanding your strengths and why you have an edge on any competitors is important. If you can explain why your franchise fee is fair for both parties then you are on the right track.
Royalty fees
When the franchise is up and running, the franchisee will then pay royalty fees on an ongoing basis – usually monthly. This is where you would make money as a franchisor. As for what amount you should charge; this can be decided in a few ways but is most commonly worked out as a percentage of gross sales (usually around 4 per cent), so if the franchise is doing well, you receive more in royalties.
Some franchisors use increasing and decreasing percentage models. These tend to be used to act as incentives; for example, you could decrease the percentage of gross profits to be paid as royalties to incentivise franchisees achieving increasing performance and profitability. Alternatively, you may wish to choose to charge an increasing percentage model for a franchise located in, let’s say, London’s Covent Garden – a location likely to attract more consumers and generate a higher level of profit.
But what happens if a franchise doesn’t make much profit? To mitigate this, you can agree to a minimum royalty, which must be paid regardless of the franchise’s performance. Another similar option would be to charge a fixed royalty, rather than working the figure out as a percentage of gross sales – although this is less appealing to franchisees in locations that are likely to experience seasonal peaks and troughs in trade.
How does franchising scale over time?
Many franchisees will wish to invest in a single unit (i.e. shop) and maintain it. However, you will find that some wish to capitalise on their success and, at this stage, may move into what is referred to as a ‘multi-unit franchise’ by investing in another. The franchisor should allow this to happen only where they are confident that the franchisee is capable of successfully (and profitably) managing multiple units.
What is a franchise agreement?
A franchise agreement is a contract between a franchisor and franchisee. It should set out the expectations and responsibilities of both parties, as well as the length of the agreement; for example, five years with the option to renew, as well as directions in the event of a dispute.
It will be important to take legal advice when drafting and negotiating the franchise agreement.
What are the advantages of franchising?
Cost-efficient expansion
Franchising can be an extremely effective way of expanding your business. It gives aspiring entrepreneurs a more accessible, less risky way to attain and operate a business and, as a franchisor, it allows you to reach even more customers and increase awareness of your brand. It is appealing from a cost point of view as well, as the franchisee makes the investment in the initial set-up of the franchise.
Shared responsibilities
In addition, certain daily responsibilities, such as staffing, are passed onto the franchisee, alleviating some of the burden from the shoulders of the franchisor. This can be a very appealing part of franchising your business.
Relationship-building
That said, one of the most fulfilling parts of the franchising model is in the relationships built within the network of franchises. Once you have trained a franchisee and they are up-and-running, they are usually motivated to make it a success and will put in a lot of effort to do so. Partnerships between franchisors and franchisees are often strong and can be very rewarding on both a personal and professional level.
What are the risks of franchising?
Changes in the law
It’s important in any business to keep on top of changing regulation and take an active interest in the socio-political landscape, which often influences the direction regulators will go in next. Employment law, for example, is one area that could particularly affect franchisors. It is an area that is rapidly changing, particularly with the rise of the gig economy. Take, for example, Uber, which has faced several issues regarding the status of its employees. This is something that could affect both franchisors and franchisees, who may deal with ‘self-employed’ or ‘contract’ workers. To mitigate risk, franchisors should seek legal advice from a lawyer specialising in employment law, who will be able to make sure they are up-to-date on these issues and able to avoid any pitfalls.
Legal disputes
Often, relationships between franchisor and franchisee are positive. However, there is always a chance that a dispute could develop. One of the most common types of disputes concerns misrepresentation.
As a franchisor, you are not required by law to disclose any specific information or documentation, but it is still important to make sure you are transparent and honest with potential franchisees when entering into an agreement. The law on misrepresentation means that franchisees can seek remedies if they feel they have entered into an agreement based on falsehoods made by the franchisor. In this case, the agreement may be ended, and the franchisee may claim for damages.
Another common area of dispute is failure of the franchisee to meet agreed performance targets, or the franchisor may have failed to deliver appropriate training. The franchise agreement should be sufficiently robust and thorough to address such eventualities, which is why it should always be created with input from a lawyer.
Reputational damage
Some business owners worry about reputation damage should they choose to franchise their business. However, given that a franchisee must invest much of their own money into the franchise, it is unlikely that they would allow standards to slide. After all, if the franchise becomes unpopular or unsuccessful, they will become less profitable.
As a franchisor, it’s also advisable to put in place appropriate systems to support your franchisees and help them to keep quality levels high. It is also incumbent on you to ensure that franchisees have the appropriate skillset when you enter into a franchise agreement with them.
With social media becoming an increasingly important tool for customer service and brand awareness, it is also prudent to ensure that social media guidelines have been clearly set out and understood by franchisees, as their use of social media can have unintended consequences and may present the brand in the wrong light. Creating business-use and personal-use guidelines for franchisees – and ensuring that they are read and understood – can prevent this kind of damage from occurring in the first place.
Which steps should I take next?
While it is true that entering into a franchise agreement is not as complicated in the UK as some other countries, where franchise agreements are more heavily regulated, it is still important to seek legal advice. A lawyer will guide you through the legal considerations you need to be aware of, as well as any political- or business-related factors they think you should consider.
The British Franchisee Association is also a reliable resource for those looking to franchise their business.
