As we conclude our 'Franchise buying guide' series, which has covered decision-making, due diligence, and financial considerations, we now explore the various types of franchise models available.
Building on the knowledge from previous articles in our 4-part series, this final instalment helps you understand different franchise structures and their implications for your business goals. Our franchise legal team can provide expert guidance on selecting and negotiating the most suitable franchise model for your needs.
Contents:
- What is a business format franchise and its benefits?
- What is a master franchise?
- What is a buy-to-let franchise?
- What is a franchise buyout?
- What is a pilot operation?
- What is the difference between franchising and distributorship?
- What is the difference between being a franchisee and a licensee?
- What is the difference between being a franchisee and a reseller?
- What is the difference between being a franchisee and operating an outlet?
- What is the difference between being a franchisee and being part of a joint venture?
- Understanding franchise types and models
- Your guide to buying a franchise
What is a business format franchise and its benefits?
A business format franchise (also known as a second-generation franchise) is the most common type of franchise and has two key elements:
- The franchisee operates its business under the franchisor’s trade name or trademark, so the outside world views the franchisee as the franchisor (think Subway and McDonalds).
- The franchisor must be able to exert substantial influence or control over the way the franchisee operates its business.
By buying a business format franchise, you get the benefit of buying a business with an established reputation. This means it will be easier for your business to trade in the market and subsequently generate a profit.
Choosing to buy a franchise also provides independent traders with a name to operate under. This allows traders to continue profit-making through sales, whilst avoiding the hassle of setting up their own business and building its reputation.
What is a master franchise?
A master franchise is an arrangement where the franchisor grants a franchisee the right to sub-franchise within a territory. A master franchise is a good opportunity for investors with enough finance to develop a network of franchises in a territory. You would need be familiar with the local market, have relevant experience in the industry and good management skills.
When a master franchisee enters a sub-franchise, the head franchisor will make sure they accept only the highest quality of sub-franchisees. You buy a master franchise by entering into a franchise agreement. This may require you to open and operate a specified number of operations.
What is a buy-to-let franchise?
A buy-to-let franchise is a specific type of franchise in the property market. By buying a buy-to-let franchise, you will be purchasing a letting agency where your profits will be made through a commission on the sale of property.
The process of buying a buy-to-let franchise is the same as buying a franchise from a franchisor. You would need to enter a franchise agreement, in addition to obtaining the relevant licences required by law.
What is a franchise buyout?
A franchise buyout is when a franchisee buys out the franchise. As a result of the buyout, the franchisee will become the owner of the entire franchise. This includes any franchisees existing under franchise agreements with the franchisor. Buying out a franchise may be more expensive than buying a franchise because the seller is selling complete ownership of its business.
What is a pilot operation?
A pilot operation is when a company wants to start a franchise business, so starts up a pilot operation to test the business format/idea.
If you are buying a franchise, you should find out whether the franchisor has conducted a pilot operation, as they’ll have gained insight into the business and identified areas of improvement, the level of demand for services and goods in a location, and the strengths and weaknesses of the business. This means the business will be thoroughly tested and more likely to be successful.
Similarly, make sure the franchise you are buying is not the franchisor’s pilot operation. A pilot operation usually only operates for a year or two. As the full strengths and weaknesses have not been identified, it can be risky.
What is the difference between franchising and distributorship?
A distributorship is typically where a manufacturer or supplier of goods (the principal) appoints a third party (the distributor) to market and resell its goods under a distribution agreement.
Here are the key differences between franchising and distributorship:
| Franchising | Distributorship | |
| Buying and selling goods | While you may choose to buy goods from the franchisor, this is not necessarily part of the franchise deal. You may have a choice where you buy your raw materials. But you will need to make sure these are of good quality, so you comply with the quality control procedures imposed by your franchisor. | The distributor must buy goods from the principal for the relationship to exist. |
| Exclusivity | A franchisor may not need you to enter an exclusivity agreement to deal with just their brand. | A principal may require you to sign an exclusivity agreement. This will prevent you from dealing with competing products, thereby protecting the principal’s commercial interests. |
| Trade name and branding | You will always use the trade name and branding of the franchisor, as the purpose of the arrangement is to operate a business with the franchisor’s brand. | You will trade under your own name. A rare exception includes car distributors where the car manufacturer will give you permission to display its brand on your premises. |
| Know-how transfer | You will need the franchisor’s know-how in order to provide goods and services that are of the same quality of the other franchisees. | You do not need any know-how from the principal in order to resell the goods. |
| Control | The franchisor has a great deal of control over you, so that it can maintain the quality of its brand. | The principal usually has very limited control over the way you operate. This is because you buy goods from the distributor on your own account. |
| Royalties | A franchisor will expect a royalty in return for the know-how and goodwill it gives you. There will also be a royalty for any profits made from using the franchisor’s brand and distinctive raw material. | No royalty is paid to the principal. The principal’s profits are based on the sale of the goods to you. |
What is the difference between being a franchisee and a licensee?
Under a licence, the licensor grants a third party (the licensee) the right to use their intellectual property rights and know-how of the licensor, usually to manufacture produce, and sell goods.
This is different from a franchise, as the franchise agreement does not usually relate to the manufacture of products. Instead, a franchise agreement regulates how the franchisee runs the business, made possible through using the franchisor’s brand, intellectual property, and know-how.
What is the difference between being a franchisee and a reseller?
A reseller is a party that finds buyers for a seller’s goods. Although similar to a distributor, the reseller does not take ownership of the goods, instead, they act as a middleman, helping sellers find buyers.
Whereas a reseller has very little connection with the seller, a franchisee will build a close relationship with the franchisor to ensure its business is similar, if not identical, to the whole franchise.
The franchisee will also be using the intellectual property rights and software of the franchisor, whereas the reseller has no access to a supplier’s technologies.
A franchisee also owes greater obligations towards a franchisor. For example, the franchisee must promote the franchise brand and inform the franchisor of potential improvements for the business. In contrast, a reseller has no obligation to promote and improve the business of the seller/supplier. Instead, the reseller provides a means for a seller/supplier to access a customer base.
The formalities of becoming a franchisee and reseller are also different. To become a reseller, you will enter a reseller agreement with the supplier or manufacturer.
What is the difference between being a franchisee and operating an outlet?
An outlet is a store that sells products or services to the public after buying these from a manufacturer or wholesale supplier.
As the outlet may buy a large quantity of products, the manufacturer/wholesale supplier will usually sell them at a discount. The outlet can then sell at a higher price to make a profit from its sale.
This is different from a franchise, as the franchisee shares the brand of the franchisor, and provides the same service as the other franchisees.
A franchisee also receives a great deal more support from the franchisor and receives training and know-how to help the franchisee’s business.
When operating an outlet, you may be buying goods from several different suppliers to sell through your outlet. You will, therefore, not receive any additional support when running the outlet, or any additional training. It is also unlikely that you will have the obligation to promote and develop the brand of any manufacturer, unlike your obligations as a franchisee.
The formality for becoming a franchisee and for operating an outlet are also different. An outlet is usually purchased by entering a sale and purchase agreement.
What is the difference between being a franchisee and being part of a joint venture?
A joint venture involves two or more parties pooling resources to complete a specified business activity or project together.
By entering an arrangement where the losses are distributed between the parties, the parties can increase their resources and technology to pursue a profitable venture.
As a joint venture party, you will be entitled to distribute profits according to the arrangement detailed in the joint venture agreement and share the costs between yourselves as agreed in the agreement.
This is different to being a franchisee where you retain your own profits and incur your own losses, independent from the franchisor and the other franchisees. Also, as a franchisee, you must pay an ongoing fee to the franchisor for using the franchisor’s brand for business. Contrastingly, a joint venture party does not usually have to pay an ongoing fee for having access to the other parties’ resources. Read more about our Joint Venture Agreement services here and check out our joint venture agreement FAQs.
Understanding franchise types and models
Understanding the nuances of franchising models and the differences from other business models is critical when considering buying a franchise. From business format franchises to master franchises and buy-to-let franchises, each model offers unique opportunities and issues for both franchisors and franchisees. It is also important to understand the difference between franchising and other business growth initiatives, such as distribution and joint ventures. When considering the various options, benefits and potential pitfalls of different models, legal advice is an invaluable way to help you understand the legal risks and requirements to make an informed decision.
Your guide to buying a franchise
Armed with the comprehensive knowledge from our complete franchise guide series, you're now better equipped to make an informed decision about franchise ownership. For personalised legal support throughout your franchise journey, from model selection to agreement negotiation, contact our experienced franchise lawyers who can help turn your franchising aspirations into reality.
