What is franchising?
- It is simply a system for marketing goods/services that is not unlike dealerships, agencies or concessions. The franchisor sells you, the franchisee, the rights to set up your own local branch, or cluster of branches, to market the company’s goods/services.
Would the company not be better off owning its own branches?
Yes, in terms of operating profits, but it would have to find the money to set them up, whereas it is the franchisee who funds the branches, usually through bank loans.
The other big advantage to the franchisor is that it can expect that, as you have invested your own money, you will be more motivated and committed over the long term to make the business successful than an employee.
What is it going to cost me?
This, of course, depends on the franchise. A business that you can run from home, for example, will obviously cost a lot less to set up than one that needs premises, particularly in the high street.
You pay an initial fee to cover your training, and the rights to use the brand and the business system for the period of the franchise contract.
Also you will pay regular ongoing fees, a fixed fee, or based on a percentage of your turnover, or a mark-up on the goods that you are obliged to buy from your franchisor. There may also be an advertising/marketing levy, again based on a fixed fee or turnover.
Will the initial fee be higher for the larger, 'better known' franchises?
Not necessarily. The franchisor shouldn’t be setting out to make a profit from the initial fee, but from the ongoing fees. This is one of the important principles of the system because it creates the incentive for the franchisor to help you build your business and continue to develop it. Putting it simply, in order for the franchisor to succeed, you most first succeed.
What is likely to be the scale of my profits?
This will, of course, depend on the franchise you choose, the territory or location you buy, and particularly how hard you work.
The latter is critical. Franchising is not about investing money, sitting back and spending the profits. Launching and developing a new business, even with the back-up of a competent franchisor, is hard work. Franchisors are seldom looking for what are known as absentee investors. They need hard-working, fully committed franchisees.
The question can best be answered by looking at the franchisor’s projections for the business and asking current franchisees whether they found them to be realistic.
If the figures are impressive and you are prepared to work equally as hard as the franchisees you have met, you should be able to look forward to similar profits. After all, you will have had the same training and help that they did so on that basis, given your location offers similar potential to theirs, whether you succeed or not at the end of the day is down to you.
Would it be better for me to go it alone in a conventional business and not have regular fees to pay?
You would miss the many benefits of being a franchisee, such as training, the use of the franchisor’s proven business system and branded, marketing and ongoing development.
You would also face much less risk than you would if you were starting out on your own, particularly in a type of business in which you had no knowledge or experience.
With a franchise you have all the help you need to set up your own branch of a business in which success has been demonstrated by its existing franchisees.
Speak to them, and ask their opinion of aspects such as the standard of their initial training, the accuracy of the franchisor’s financial forecasts (income, outgoings, etc.) and the level of ongoing support they receive.
Which franchise should I buy?
This is the big question only you can answer. It’s rather like asking what house or car should you buy? As with them, it depends on your personal situation, preferences and available finance.
What can you afford? What are your personal aptitudes and working background? What would you really like to do for the rest of your career? Would the business need the support and participation of your family? Would the franchise be profitable enough to support your lifestyle? Would it meet your work/lifestyle balance aspirations?
Before looking at these questions in-depth, you need to ask yourself whether you are, in fact, suited for self-employment, and whether you would be prepared to run the business according to the franchisor’s rules. You will at the end of the day own your own business, but you must accept the fact that you are not entirely your own boss as you must run it according to the franchisor’s system.
This is necessary to maintain the quality and integrity of the whole network. After all, you are buying into the system not just to benefit from the brand but also its proven business system so why try to change it?
What is the role of the British Franchise Association?
Founded in 1977, the British Franchise Association (BFA) is the sector’s voluntary self-regulatory body. It is the longest-established and largest not-for-profit trade association for franchising in the UK.
The association works in partnership with the European Franchise Federation and the World Franchise Council, influencing standards and legislation across Europe.
The association’s core aim is to support and influence high quality ethical business-format franchising in accordance with the European Code of Ethics.
The BFA proactively collaborates with government, academia, the media, other trade associations and the UK public on what constitutes franchising best practice.
It seeks to educate, influence and provide advice and guidance about what franchising is and the opportunities available via the franchise business model.
What are the different membership categories of the British Franchise Association?
The British Franchise Association (BFA) has three core categories representing the three different parties involved in business-format franchising. These are franchisors, franchisees and advisers/service providers and suppliers. This inter-relationship has often been described as being like a three-legged stool.
The first core category is for franchisors and has several classes of membership to reflect the different stages of their development.
To become an Established member, franchisors must prove a sustained trading, financial and franchising record over a period of time. The record of Established members on openings, withdrawals and failures (if any), as well as their trading and financial performance, is subject to an initial assessment and periodic re-accreditation.
The requirements for Expanding membership are the same as for Established membership, except that the criteria relating to the length of time the franchise has been operating, the size of the network and the range of experiences, are less demanding.
Membership is available to businesses with a successful trading record in the UK of at least one year and that are in the process of developing a franchised business. The business will already have a franchise agreement in place and will be able to demonstrate that its development programme is founded on good franchising practice.
All the above franchisor classes must adhere to the association’s regulations and most importantly, its Code of Ethics, particularly in the terms in their franchise contracts.
Membership is available to established international brands that can evidence they have a proven business model that has traded successfully with an established network of franchisees in its country of origin. .
The second core category is for franchisees in the networks of the franchisors who hold BFA membership. This type of membership is free for eligible franchisees.
The third core category is for advisers/service providers and suppliers to the sector, such as accountants, bankers, consultants and lawyers. Two types of membership are available in this category: Advisor member and Supplier member.
There are implications for prospective franchisees in the various classes of franchisor membership. The longevity of Established members indicate that they offer the safest investment, but are likely to have the narrowest choice of territories.
Some may have networks that are sold out and therefore can only offer occasional resales that, as going concerns, are often offered at considerably higher prices than start-ups.
In the latter case, loans will be easier to obtain because the outlets have established successful trading records.
The position with companies that are listed Emerging members is the opposite. As their networks are young, there is likely to be a wide choice of territories on offer, all at start-up prices.
The downside is that loans may be harder to obtain as the risk assessment factor can only be supported by projections based on either company-owned pilot units or early franchised units.
I often see franchisees described as franchise owners. Is this true?
No, it’s misleading. It is the franchisor who is the franchise owner. This could be significant in a legal case in which a franchisee claims he was mislead by the phrase.
Certainly, the franchisee owns his business, but it is only able to trade in a particular franchise under a contract with the franchisor for a stipulated period, usually with the option to renew for a further term.
The length of the period is important because it must be long enough to enable the franchisee to make an ongoing profit, whilst repaying the whole of the money with interest that has been borrowed from the bank to pay the initial franchise fee and setting-up costs. These costs can be considerable in such sectors as fast-food and retailing. If the franchise period is not long enough to repay the debt, the bank to protect its client would be unlikely to make a loan.
It is only by owning the business that the franchisor can be in the position to police the network and ensure that each franchisee maintains the brand’s standards and reputation. As we have seen, the success with which the franchisor exercises its control is crucial over the long term.
This issue was made clear by one of the UK’s earliest and most successful franchisors who preferred to call the system ‘business leasing’, as it is a process in which the franchisee ‘leases’ the franchisor’s brand and business-format for a contracted period.
Might the necessity to strictly follow the franchisor’s formula make the business insufficiently challenging?
This question is often overlooked. Some franchisees are, of course, more ambitious than others. There are those who are looking mainly for a comfortable work/life balance, rather than making large profits.
However, franchising does offer the ambitious the opportunity to become a multi-unit franchisee with a significant regional chain of outlets.
If you are highly ambitious, negotiate with your prospective franchisor at the buying stage to include in the agreement an option on extra territories/sites. Some franchisors particularly welcome franchisees who have aspirations to open a number of outlets and are particularly looking for candidates with the ambition to become multi-unit franchisees.
The benefits for the franchisor is that it doesn’t have to face the costs of recruiting and training the ambitious franchisee and, most importantly, knows that he is successful in the business. You suit them, and they suit you. Also financing extra units is easier as it can come from the profits of the earlier branches.
True entrepreneurs are, however, unlikely to be fulfilled in conforming to what they increasingly see as restraints imposed by the franchisor and they may, in fact, be better suited to starting a conventional business from scratch and go on to develop it as a franchise system.
What does the phrase, comfort zone mean in the context of franchising?
It describes the stage at which the franchisee’s business has become so profitable that he chooses not to develop it further. He has reached his ambition and is happy with his work/life balance.
This causes two problems for the franchisor. Firstly, it puts a cap on the future royalties it receives from taking a percentage of the franchisee’s turnover. Secondly, it gives competitors the opportunity to capture a greater share of the market.
This situation is not easy for the franchisor to overcome. It can offer incentives, such as a reducing sliding scale of royalties for higher turnovers and persuading the franchisee to sell back part of his area to create an extra territory for a new franchisee. Ultimately, however, the franchisor may have to try and entice the franchisee to sell by offering to buy him out at an inflated price.
What are master and regional franchises?
A master franchise covers the whole of a country and a regional franchise, an individual region of the country. Such franchisees act similarly to a franchisor in respect to recruitment and control.
In return, they pay a percentage of their income from initial and ongoing service fees from their franchisees to the parent franchisor. The latter usually imposes a development target on the number of franchisees recruited over specific periods to ensure the holder develops the system.
Franchisors sell such franchises, rather than franchising directly, to avoid the cost and risk of piloting and developing their system in a country in which they have no experience of the market or culture.
They usually hedge their bet by including in the agreement a buy-back option that they can exercise after a period of time if the franchise proves successful.
It is not unknown for a wealthy U.S. franchisee to take a master franchise for a foreign country in the system in which he has made his wealth. This is an example of the more unusual entrepreneurial opportunities within franchising.
Are there any franchise laws to protect franchisees?
No, there are no laws in the UK specifically addressed to franchising, as there are in many countries, but the system is, of course, subject to commercial law.
The relatively few cases that have reached the courts have usually been brought by franchisees for misrepresentation. Has the franchisor misrepresented the profits the franchisee could expect? Has the forecast for the sales figures been exaggerated or the setting up costs reduced?
Whether the franchisor has answered these questions accurately can usually be found by interviewing existing franchisees. Care must, however, be taken to ensure that the franchisee hasn’t been primed. That can best be avoided by having the freedom to approach all franchisees.
Franchising has, however, a favourable reputation largely due to the work of its self-regulatory trade association, the BFA in creating and enforcing its code of ethics. Membership is voluntary but even non-members are aware that in order to recruit successfully they must undertake to adhere to the association’s regulatory measures.
The banks have also contributed by establishing franchise departments with a thorough knowledge of the system and franchisors. They often have financial insight into particular franchise systems as their franchisees are clients of the bank.
How does the EU view franchising?
Favourably, the EU keeps its eye on the system through the European Franchise Federation, a body in which the individual national associations within Europe, such as the BFA, are members.
The EU initially became legally involved because the agreement between a franchisor and its franchisees is a restrictive contract (territorial rights, purchasing restrictions, etc.) and thus conflicts with its competition law.
This problem was recognised, when a case, brought by a franchisee, raised the legality of the franchise agreement in the EU, came before the European Court of Justice in 1986.
This led to the EU granting franchising exemption from certain clauses in its competition law that would have made the system unworkable in Europe. This is now enshrined within the EC Block Exemption Regulation on Vertical Restraints.
If there are things in the franchise contract I don’t like, can I change them?
No, not in a well-run franchise. The contract sets out the rules under which the business has to be operated and, like the rules of a game, they must be followed to the letter. The quality and reputation of the system will depend on its standardised business formula which is spelt out in the contract and the operating manuals you must follow.
If franchisees were allowed to make their own changes, standards would differ from outlet to outlet; the franchisor would lose control; and customers would not get the same service across the network.
As a result, the quality of the franchise and its brand would decline, and along with them the resale value of your business, when it comes to the stage you want to sell and make a substantial capital gain.
The franchisor’s refusal to make changes is an indication of the strength of its system. Conversely, if it allows changes to its formula it is a sign of weakness and often its desperation to recruit franchisees. One of the most essential jobs of the franchisor is to police its network effectively.
If I can’t change the contract, do I need a solicitor?
Yes, the contract is complex and you need a solicitor specialising in franchising to explain it to you. It should set out in detail what the franchisor is going to do for you and what you will have to do in return. All this needs to be spelt out in the contract and, as it will govern how you run your business, you will need to understand it to the letter.
As the franchisor has to protect its interests and those of the network even beyond the point at which you may have left the franchise, the contract can still control the options available to you after the two of you have parted. A franchisee can’t take the sign down and continue trading as before but under a different name.
After all, it provided your training and its business system. It wouldn’t like you to become a competitor and will want to resell your territory to a new franchisee.
If I find myself in dispute with my franchisor, what is the best way of dealing with the issue?
Dispute resolution is recommended as an alternative to the courts. The BFA provides mediation and arbitration procedures that have the benefit that they are carried out by adjudicators who are familiar with the franchising system. Your franchise agreement may even oblige the parties to first consider mediation before turning to the courts.
Why are there covenants in franchise agreements that restrict the activities of franchisees after they have left the franchise?
These are post-termination, non-compete covenants to protect both the franchisor and its network by preventing the outgoing franchisee from setting up a competing business. The franchisor has provided the franchisee with training, know-how, operations manuals and the trade secrets (collectively known as its intellectual property). It also needs to be in the position to re-sale the franchisee’s territory.
The covenants prevent the ex-franchisee for a specified period, usually 12 months, from copying the franchisor’s system to start up a similar business and from soliciting his former clients.
The covenants must not infringe the anti-competition laws of the EU and the UK. Covenants, which are essential for the franchisor to control its franchisees, are by nature anti-competitive and in the past threatened to make franchising unworkable within the legal regimes of the EU and UK. This was, however, overcome by giving franchising exemption from aspects of competition law so long as it confirmed to particular clauses.
It is important for prospective franchisees to seek advice from an experienced franchise solicitor on these covenants so that they are fully aware of the restrictions that will face them when they subsequently decide to leave the franchise.
To learn more, click here to view a recent post on our site: ‘Court of Appeal ruling regarding post-termination restrictive covenants’.