Business franchising involves an established business (known as the franchisor) allowing a third party (known as the franchisee), to trade as their own businesses under the franchisor’s brand. This licence is usually granted on the condition that the franchisee pays a fee to the franchisor and follows its standard business model.
When to franchise my business?
A business will generally decide to set up a franchise network in two instances:
- An established business wishing to expand through building a franchise network or
- A fledgling business looking for quick expansion using the support of franchisees
How do I franchise my business?
It is crucial to prepare a business plan prior to franchising your business, including considerations for:
- Budget – it is important to assess the costs of franchising, which will likely include the internal management time in assessing the suitability of a potential franchisee, the cost of engaging a broker to advertise the franchise opportunity and a budget for the production of the legal documents
- Funding – specialist franchising lenders exist which provide funding to franchisors for the purpose of setting up new franchises
- Management structure – it is important to produce detailed explanations of the management structure and how the franchisor will retain overall control of the business and
- Ideal franchisees – the criteria for franchisees to meet to ensure suitability and how they will be identified
It is recommended that a franchisor tests the suitability of the franchise model using a pilot operation. This can be achieved in two ways:
- A company owned outlet which operates as if it was a franchised unit or
- A franchise unit run by a ‘pilot franchisee’ having been made aware that the unit will be a test franchise
A pilot operation will allow the franchisor to carry out a ‘test run’ prior to setting up the franchise network. This is an important step because it will identify a number of factors which will make the franchise structure successful, including:
- Refining business and operational processes
- Effective methods of advertising
- Staff training
- Territorial considerations and
- Applicable laws and industry specific regulations
Whilst it is recommended to carry out a pilot operation for at least one year, franchisors are increasingly proceeding straight to granting franchises to franchisees.
The operations manual governs the day to day running of the business. It contains the methodology and quality control provisions that the franchisee must adhere to whilst operating the franchise. Given that the document contains commercially sensitive business “know how”, a franchisor usually requires the franchisee to sign a confidentiality agreement prior to disclosing a copy of the operations manual.
It is crucial to develop the operations manual prior to setting up the franchise network. Franchisors often draft this document during the pilot operation phase. The operations manual is as important as the franchise agreement and should be drafted with care.
Finding a franchisee
It is crucial for franchisors to distribute accurate marketing information when securing potential franchisees to avoid any risk of having misrepresented the financial performance and potential profitability of a franchise.
There have been a number of instances in which franchisees have sued franchisors for providing misleading information. There are several ways to mitigate this risk:
- Record keeping – taking diligent notes (or recordings) of meetings with potential franchisees to record the representations made;
- Franchise disclosure document – an accurate pre-contract disclosure document about the performance of the franchise based on the current performance data, as opposed to the predictive financial performance of the new franchise; and
- Training for sales staff – ensuring that all sales staff are well versed with the latest financial information which they are permitted to disclose to the potential franchisees.
Ultimately, the most effective way of managing the risk is to ensure that all information given to franchisees is accurate.
Depending on the products or services the franchise provides and the size of the franchise, a franchisee may operate from a commercial premise as opposed to working from home. Since franchisees are often newly incorporated companies with no trading history or significant assets, a landlord may require the Franchisor to guarantee the lease or in some instances, take the lease and grant the franchisee the right to occupy the property during the term of the franchise. From a commercial perspective, the latter can be advantageous because it allows the franchisor to retain control over the premises.
The franchisor must ensure that the franchise agreement contains a guarantee in respect of the liability it may accrue during the franchisee’s occupation of the property, perhaps by way of a personal guarantee from a director of the franchisee company (or the franchisee itself if it is an individual).
Franchisors usually charge an advertising levy to franchisees to enable the franchisor to undertake national advertising. It is important that due consideration is given to the type of advertising which will be carried out prior to granting the franchise so that the franchisee is given sufficient support to enable it to succeed (and to ensure the franchisor does not breach its advertising obligations in the franchise agreement).
It is crucial to have a robust franchise agreement drafted which contains the principal terms upon which the franchise will be granted and governs the legal relationship between the franchisor and the franchisee, including:
- The term of the Franchise Agreement and renewal provisions;
- The payment obligations of the franchisee;
- The training demands of the franchisor;
- The termination provisions; and
- The resale provisions of the franchise.
Joel Gocool specialises in advising on and negotiating franchise agreements. Joel has a wealth of experience in setting up franchise networks and identifying the key considerations a franchisor should make before starting a new franchise venture. If you require advice on franchising, please contact Joel Gocool on 01276 686 222 or at Joel.Gocool@Herrington-Carmichael.com.
This reflects the law at the date of publication and is written as a general guide. It does not contain definitive legal advice, which should be sought as appropriate in relation to your own particular matter before action is taken.