Franchising your business for the first time can be a daunting prospect. Our franchising lawyers have substantial experience in supporting first-time franchisors through the general and legal aspects of franchising a business. In this guide, we look at franchising basics and the general and practical issues for new franchisors to consider.
- What is a business franchise?
- Franchise models
- The benefits of franchising a business
- Scale up through franchising your business or organic growth or M&A?
- Getting a business ready for franchise
- Selecting a franchisee
- Paperwork needed to franchise your business
- What does it cost to franchise your business?
- Making money from franchising
What is a business franchise?
Franchising your business gives a franchisee the right to operate a copy of your business that, to the outside world, is identical to your business and to the other franchises you create. Franchising is contractually governed through a franchise agreement where the franchisor gives the franchisee the right to use the franchisor’s trade name or brand features and business format in the sale of its products or services.
Why allow someone to copy your business idea and brand?
Money. Through franchising, you grow your business by making a profit from each franchise through a royalty fee for granting your franchisees the right to replicate your brand with a franchise agreement setting out the payment and general terms each franchisee has to comply with as well as detailing your commitments to manage the franchise network and to provide ongoing support, know-how, and guidance on how to run the franchised business.
Expansion. By using franchising a business can expand faster than might otherwise be possible as the franchisee bears the risk and cost of setting up new outlets. See The benefits of franchising a business below
There are 3 main franchise models:
- Franchise – this involves selecting a franchisee (also known as a unit franchisee) to run a franchise business from a franchise outlet or within a defined area with the franchisee having the rights to use the brand, tradename, IP and software necessary in the course of the franchise business
- Master franchise – a master franchise allows the master franchisee to operate the franchise within their agreed territory and to also have the authority to grant sub-franchises to third parties within the region. The franchise agreement normally specifies the number of sub-franchises the master franchisee should establish within a specified period
- Franchise development - the franchisee is given the right in the franchise agreement to open a number of franchise outlets in their territory but rather than create sub-franchises they must be opened, funded and managed by the franchisee
Franchising lawyers recommend legal and accounting advice is taken on the best franchise model for your business before you progress franchise marketing plans.
The benefits of franchising a business
The benefits of franchising your business include:
- Growth – franchising your business can be a cost-effective way to achieve growth as you don’t have the same outlay as opening up a new branch or expanding into another region or city. A franchisor doesn’t incur the expense of buying stock and equipment, paying employees, or procuring new premises. Those costs are borne by the franchisee who launches and runs the franchise business
- Profit – the franchisee pays an initial fee for being granted the right to operate using your trade name. With a fixed initial fee, the franchisor receives fees regardless of whether the franchise makes a profit. In addition the franchisee will pay a monthly fee o the franchisor which is usually a percentage of the franchisee’s turnover
- Reduced daily management – the franchisee manages the franchise business on a daily basis whilst the franchisor provides support and overall management of the franchise network to ensure consistency, brand reputation, and to grow the network
- Development of brand – with more franchise outlets your brand will develop with the business plan being to attract higher franchise fees through the strength of your brand
Scale up through franchising your business or organic growth or M&A?
Growing your business through franchising is one option to achieve growth and an increase in turnover. The alternatives include scaling-up through organic growth or M&A. The path you go down to achieve increased profit depends on your commercial objectives, your assessment of the risk, and your cost-benefit analysis.
Franchising isn’t necessarily the easy option as you need the skills and time and energy to run your own business, monitor your franchise network, market the franchise model, and continue to tweak and improve the business model through analysing the performance of the franchisees.
Franchising may take less initial outlay than organic growth through expansion by leasing new commercial premises and employing additional staff to expand your business into a new region but it does take as much organisational and managerial skill. Without significant commitment to franchising, you risk fragmenting your business and damaging your business reputation by franchisees not being supervised or managed and monitored sufficiently to maintain brand image and standards.
The success of the franchise model for growth depends on:
- You putting on place a business plan - you need to plan how you will start to franchise and map out how you want to expand and manage your franchise network whilst budgeting for the cost of doing so.
- Your selection of a suitable franchisee – one with business acumen, and who shares the same professionalism, vision, and passion as you for your brand
- Your franchising lawyer preparing a comprehensive franchise agreement that meets your business needs and protects your brand
- The preparation of a franchise manual that covers the detail (such as the premises decoration, employee uniform, and quality of goods, products, or service provided) and all the standards and obligations your franchisees must comply with. The franchise agreement should specify your enforcement and termination options if the manual is not complied with
Getting a business ready for franchise
There are 4 key action points to get your business ready for a franchise:
- Achieve financial stability and a profitable business – your business needs to have been in existence for at least 12 months and have a successful track record. Without that, your business won't be attractive to franchisees. A business plan can help show the potential for further growth and the ease of replication of your business model
- Conduct a pilot franchise operation - this involves running a franchise outlet for a period of at least 1 year to identify the strengths and weaknesses of the franchise model and to test the operation manual and the business format. The pilot scheme allows you to gather information about the performance of your franchise and its viability. Not only does this reduce the risk of a failed franchise, but it also increases the credibility and attractiveness of the franchise. At the end of the pilot
ingperiod, if you are happy with the level of commitment demanded from you and the potential franchise financial returns, you can start to develop your franchise network
- Value your business franchise opportunity – without a valuation of your business and the franchise opportunity from a finance industry professional you may either undervalue or overvalue the franchise. The value of the franchise may be based on your gross turnover as well as taking into account the size of the franchise region and exclusivity. An accountant can also look at the cash flow of the business over a period of time and add a terminal value and then discount this to provide a current franchise business valuation. Alternatively, they can value the franchise by estimating the entry cost. That involves assessing the cost to a buyer of creating the same business without a franchise, such as buying equipment, developing products, and marketing
- Get your paperwork sorted – this includes protecting any intellectual property that may form part of the franchise agreement
The British Franchise Association (BFA) is a key trade association for the franchise industry and provides franchisors with advice on franchising. The Which Franchise website also provides general business advice about franchising.
Selecting a franchisee
Selecting a franchisee is a bit like recruiting a senior employee or carrying out due diligence before an M&A. It isn’t like selling your business as you will have an ongoing commercial and contractual relationship with the franchisee. The success of your franchise network will depend on the business acumen and commitment of each selected franchisee.
Although the franchisee will be paying you for the privilege of operating the franchise, they will be under your control and management and will need to comply with the franchise agreement. Whilst you need your franchisee to have an entrepreneurial spirit, they also need to have the finances in place and the ability to toe the line so that all the franchises in the network remain identical in branding and vision. Ideally, your franchisee will have experience in the industry or strong transferable skills, to ensure they have the skills to successfully run the franchise business whilst accepting that they don’t have free rein because of the restrictions placed on them in the franchise agreement.
Paperwork needed to franchise your business
The paperwork needed to successfully franchise your business includes:
- Company accounts – both annual and management accounts to help evidence the profitability of the franchise opportunity
- A business plan – identifying how the franchise network will grow either by region or country
- A marketing plan and marketing material – a franchise lawyer should look at the material as the law restricts the content of your marketing
- Non-disclosure agreement so potential franchisees are contractually bound by a confidentiality agreement to keep confidential any financial or commercially sensitive information disclosed to them as part of the franchise negotiations
- A franchise agreement – the franchise agreement is the backbone of your business relationship with your franchisee and therefore needs to be wide-ranging and cover aspects such as fees, length of the franchise, IP protection, franchise agreement dispute resolution, and provisions for the termination of the agreement
- A franchise manual – providing the detail of how the franchisee should operate the business, from the required office or shop unit fit out to the selection of employee’s uniforms or logos on correspondence
For more information on the legal documents you need to successfully franchise your business take a look at our guide to the legal aspects of franchising.
What does it cost to franchise your business?
The cost of franchising depends on the nature of your business and its size but costs normally include:
- General franchise research and development of the franchise product - when preparing to franchise your business you will need to conduct market research and test your systems and procedures before running a pilot operation
- Planning – you need to think ahead to work out how much you will charge your franchisees and how you will map out your franchise territories.
- Franchise package development - to provide the necessary support to franchisees, you will need to prepare a package containing the systems, procedures, training, sales literature, and operation manuals
- Recruiting - to find and attract franchisees, you will need to make some investment in your prospectus, advertisement, franchise exhibitions, and time spent on selection interviews
Making money from franchising
There are 6 main ways to make money from franchising your business:
- Initial franchise fee – this fee can also be referred to as a development fee or exclusivity fee and is usually paid by the franchisee for the franchise, including the use of IP, the initial trainings and the exclusive right to market the product or sell within a specified territory
- Store opening fee – for Master Franchisees or Development Franchisees this upfront fee can be negotiated as a separate fee for each additional unit or store the franchisee opens up in their designated region
- Monthly fee – a regular fee paid by the franchise calculated either as a fixed amount, a percentage of the franchisee’s turnover, or sometimes a percentage of each product sold by the franchisee
- Training fees – in the franchise agreement, the franchisee can be obligated to pay for ongoing training. This not only ensures the franchisee understands the importance of consistency across the franchise but also increases profit for the franchisor
- Marketing contribution – marketing benefits both franchisor and franchisee and the franchise agreement can specify that the franchisee will contribute a percentage towards the marketing budget for the entire franchise network to contribute towards general marketing that is of benefit to all franchise holders. Usually, this fee will be a percentage of the cost the franchisor incurs or a percentage of the gross turnover. In addition, the franchisee can be required to commit to paying a percentage of their turnover or a specified sum in local marketing campaigns
- Other fees – additional fees can include support fees ( for example, if the franchisee requires additional IT or other training) or software or IP licence fees or commercial lease costs if the franchisee is renting the commercial premises they are operating from or machinery they are using from you.
For additional reading take a look at our article FAQs: legal aspects of franchising your business.