How franchising works: the two sides of the story

When the word ‘franchise’ is mentioned, many people in the UK think of a series of blockbuster films or railway operations. But this article looks at the world of business-format franchising, from both sides – the franchisor and the franchisee.

Author: Cathryn Hayes, Franchise Director at Revive! Auto Innovations

According to the British Franchise Association (BFA), business-format franchising, is the granting of a licence by one person (the franchisor) to another (the franchisee), which entitles the franchisee to trade under the trademark/trade name of the franchisor and make use of an entire business package, comprising all the elements necessary to establish a previously untrained person in the business and run it with continual assistance on a predetermined basis.

A strong and successful business-format franchise should provide: –

An established market for the franchisor’s products or services.
Proven sales, marketing, and operational procedures.
The benefit of an established business name.
Training, ongoing support and help in running the business.
Where appropriate, help in finding, fitting out and furnishing premises.

In this article, I am going to look at the two sides of the franchise relationship – the franchisor and franchisee. To be successful, both parties need to benefit from the relationship.

Franchising from the franchisor’s perspective
Franchising has grown considerably in the UK over the last thirty years and is now established in many business sectors, especially the fast-food and service industries. It can be a great way for a business to expand across the UK and beyond, without the potentially huge capital investment needed to grow a wholly-owned operation.

As a franchisor, you will award a licence (franchise) to local operators to sell your products or services, trade using your brand, using your trademarks and logos for a specific period.

The franchisee will have a personal stake in the business and own their business so you can expect them to be more motivated to grow and make it a success than employed managers. However, you specify exactly how your franchisee must operate, they need to comply with your rules in terms of how the business operates.

There will be costs involved at the outset to develop your franchise operation, but franchisees will pay you an initial fee that will, over time, help to reimburse these costs. When franchisees have launched and are trading, you will receive a regular income from them by charging a management service fee or marking-up the price of goods you may supply.

At first glance, it may seem too good to be true, but as well as benefits, franchising can have its drawbacks which we will explore in this article. The development of a successful franchise network requires careful planning, ongoing monitoring, plus advice and support from professionals, such as a franchise consultant, accountant, franchise lawyer and specialist banking teams.

It is important that a business planning to franchise has demonstrated that it is viable and profitable and has sufficient capital to expand, as even when franchising is done properly by a successful business, it could take some years to achieve a positive cash-flow and worthwhile profits.

This article offers a brief overview of the aspects a business needs to consider when expanding through franchising.

What is franchising?
Franchising is a “joint venture” between an independent person (the franchisee) and a business (the franchisor) which wishes to expand its activities.

The venture is governed by a legal contract. This gives the franchisee the right to operate using the franchisor’s trade name/trademark, in accordance with a business-format or “blueprint”. All aspects of the franchisee’s business are strictly controlled including image, products or service, systems, and administration. This method is usually known as business-format franchising.

As a franchisor you will: –

Allow franchisees to use your trading names, logos, business style and format.
Help franchisees establish their own businesses to a pre-determined format.
Provide continuing training and support to enable franchisees to operate and develop their businesses successfully.

If you are planning to franchise, you should already operate a successful business with a good track record and have sufficient management and financial resources to develop and support a franchise network.

The advantages

You can achieve faster business growth without large-scale capital investment because each franchisee will finance their own business.
You can quickly grow the number of outlets under your brand, distributing your products or supplying your services.
Instead of high numbers of staff and managers for a wholly company-owned operation, you would have only a small head office with a few highly skilled staff to support your franchisees.
Franchisees invest their own money in their new business, so they are more likely to be highly motivated, and keen to minimise costs and maximise sales.
As they are running their business locally, franchisees will often have considerable local knowledge and may already be involved in local community life, which is likely to help the business.
Franchisees are responsible for financing and maintaining their units and for the employment and management of any staff.

The disadvantages

Developing a franchise network can be expensive at the outset, both in terms of management time and capital outlay.
Your investment won’t be recovered until franchisees are appointed and you receive initial fees and then a regular income from them as their businesses grow.
You receive only a part of the profit made by the outlet, instead of all the profit if they were owned by you.
Franchisees own their own businesses so you need to persuade and influence them rather than issue instructions as you would to your own staff. Communication and people management skills are vital for franchisors.
To protect your brand and company reputation you need to monitor not just the sales performance of each franchisee, but also their quality standards and customer service as well as brand standards.
Some franchisees may cause you difficulties issues as you grow. They will gain in-depth knowledge of your business through your support and training and may subsequently try to use it to set up as competitors. Some may try to reduce the amount they pay in management service fees by not disclosing all their income.
Therefore, recruiting the right people and having a rigorous vetting process is vital. You must also be sure that the people you select as franchisees can accept the responsibility and stress of running a business.

Where to start
The first step is to find out more about franchising and see how you can use the experiences of others to avoid mistakes. Contact the BFA as they have a wealth of experience and offer franchisor training and support. A visit to a franchise exhibition will be a good introduction to the sector and you can attend the free seminars, hearing from professionals in the market.

Think about appointing a franchise consultant to help you put your franchise operation together. I recommend that you use a BFA-affiliated consultant, speaking to two or more to ensure you chose the right one for your business.

The next big step is to set up one or more pilot operations – a vital ingredient in creating a franchise that will have a long-term future. The benefits of the pilot units are: –

They will demonstrate whether the business is viable on a stand-alone basis.
It will enable you to identify any problems and put them right. Franchisees, who have parted with their hard-earned savings to buy your franchise, expect to receive a tried and tested format in which any difficulties and problems have been ironed out.
Part of the pilot process is to put together a comprehensive operations manual. This will be one of the methods of ensuring that franchisees follow your systems and procedures.
The pilot will give you a better idea of how much the setting-up costs for the business will be, what sales are required for break-even, and what level of profits franchisees could expect.

The franchise agreement
Again, I strongly recommend you use a BFA-affiliated specialist franchise lawyer to draw up your legal contract. This important document will set out the terms under which you are selling the franchise, your obligations, and those of the franchisee. It must accurately reflect the promises you have made in your franchise prospectus and marketing material, and it should be fair. However, it also needs to include the controls that are necessary to protect both you and the franchisee.

Preparing for launch
When the pilot is running successfully, you will be ready to prepare for the launch of the franchise. These are some of the things you will need to do: –

Prepare a prospectus to attract suitable franchisees. This should give clear, concise, and accurate information about your business and promote a strong company image. Be careful with any claims of income and profits, these should be backed up with the results from your pilot operations. You do not want to bring people into your franchise with misleading information.
Make sure you have plans for a comprehensive training programme for your franchisees. You could include practical experience for them in one or two of your outlets/stores or with your own staff.
Consider whether you will have sales areas or territories for each franchisee, this is usual with many franchise operations to ensure that a franchisee knows they can grow their business within set boundaries.
Decide how to calculate the initial franchise fee, management services fees, advertising fees, mark-ups, and any other payments that the franchisees will be making.
You may need to prepare projected cash-flow forecasts and profit projections, based on your pilot operations, taking care not to promise that franchisees will reach specific profit figures.
As mentioned earlier, you should prepare a comprehensive operations manual, covering all aspects of the day-to-day operation of the business.
Consider applying to join the BFA. It has established a code of business conduct for its franchisor members and is a source of information for both prospective franchisees and franchisors.

Recruiting franchisees
Bringing in suitable franchisees will be key to your success as a franchisor so ensuring you recruit people with the right skills and attitudes is vital. The reputation of your business and the future of your franchise network could be at stake.

Spend some time at the outset thinking about what will make a good franchisee in your business. Will they need sales skills, is there particular technical expertise they need, what experience and attributes will help them to be successful? Plan your interviewing/vetting procedures to ensure that candidates have these skills.

Don’t rush this part of the process. When you launch your franchise, you will be keen to get things moving as quickly as possible, and to start recouping some of your initial outlay. However, if you lower your standards and recruit the wrong people as franchisees, this will lead to problems in the longer term.

Popular recruitment methods include leads from your own website, exhibiting at franchise shows, advertising on specialist websites, and in franchise magazines and trade magazines covering your business sector – a mix of all, or several of these.

Franchisee finance
Depending on the start-up costs, franchisees will probably need to borrow to buy into your franchise and will have to put in some cash as well. In the early days of your franchise operation, banks will probably lend around 50 per cent of the costs, but when your franchise network is well-established with a good track record, new franchisees may be able to borrow up to two-thirds of the costs.

There are several banks with specialist franchise departments and if you provide them with information about your franchise network, they can begin to build up a profile of your franchise. This is used to support lending managers when they are considering a request for finance from one of your franchisees and means that the bank will have a better understanding of the business.

Franchisees will need to prepare a business plan, together with financial forecasts to support their request for finance. You will probably need to help with this, but the franchisee should understand the figures and “own” the business plan.

Franchising from the franchisee’s perspective
Starting a business on your own can be risky and there are a large number which fail. However, buying a franchise can reduce those risks and give you a greater chance of success.

As a franchisee, you have the opportunity to own and run a business under an established brand with a proven business format and market. A well-established franchise should provide all the essential elements for a successful business, except the most vital piece, the person who will run the business. The missing piece is you – the dedicated and motivated franchisee.

Advantages

You own your individual business but have the benefit of a recognised brand name and a blueprint to follow.
A good franchise offers business systems and products/services which have been market tested and proved to work. As a result, the risk of your business failing is usually greatly reduced.
The franchise package you receive at the outset will normally include training, operations manuals, book-keeping and accounting systems, marketing guidance and ongoing support. You will, therefore, not have to spend time or money developing these.
You should also receive practical help in setting up and launching your new business, so you are more likely to avoid any major teething problems.
Depending on the type of franchise you are buying, you should benefit from bulk buying and the negotiating capacity of the franchisor, and have an established, reliable source of supply.
Your business will also benefit from the franchisor’s advertising and promotional campaigns.

Disadvantages

There will be costs to pay for the franchise licence and other start up costs which you will have to fund.
The franchise is governed by a legal contract which will outline your obligations in detail and means that you must run your business in strict compliance with the franchisor’s specifications.
As the success of your business grows you may want to expand and grow further, your neighbouring areas may already be occupied by other franchisees.
If other franchisees damage the brand name or image of the franchise, this could have an impact on your business too.

So, how do you check out a franchise?
The first step is to assess the franchisor and its business. When you take up a franchise you are entering into a long-term business relationship, so it is very important that you spend some time looking into the background and performance of your prospective “partner”. You should check how long the franchisor has been in business and in franchising.

A good franchisor wants you to be happy and confident that you are making the right decision and will welcome your enquiries as evidence of your good sense. Be cautious if the franchisor attempts to deny you the time to do your research and tries to rush you into a decision.

The BFA offers a free online training course which will help you to learn about important legal and financial considerations, as well as what franchisors look for in a prospective franchisee. www.thebfa.org.

Research
Review financial information on the franchisor, including its audited accounts. In the case of a new franchise, you should look carefully at the performance of the pilot operations. If there are no pilots, you are entitled to ask what you are getting for the franchise fee and how the franchisor can demonstrate the feasibility of the franchise.

Talk to the franchisor about the performance of existing franchisees and the franchisor should be willing to let you have a list of franchisees to contact.

You should do some research into the market for the products/services in your chosen area and what the future growth could be. The franchisor may have carried out market research in your area, but you should also do your own, ensuring that you understand what the business potential is and can identify and understand the strength of your competition.

Support
Critical to your likely success or failure is the level of support and training provided by the franchisor, both at start-up and on an ongoing basis.

Support from the franchisor can include accountancy packages and advice, national and local advertising, regular communication and meetings with other franchisees, new products, service and market information, and ongoing training. Most franchisors will put on annual national conferences, and some have franchisee associations.

There should be a comprehensive operations manual, which gives you guidance on all aspects of running your operation. An important aspect to consider is what help, if any, does the franchisor give in respect of any staff recruitment and staff training you may have to undertake.

Some franchisors will train your staff for you while others will train you to train them, and many will provide some training and guidance about general employment issues. You will also need to consider the legal and regulatory issues, particularly in relation to the public and employees, such as insurance, health and safety, tax.

Your franchisor should be able to signpost you to some support services if necessary and should keep up to date with any changes that may occur from time-to-time in the laws and rules that could affect your business.

Franchise contract
The next step is to consider the legal implications of the franchise contract. This is a very important document as it sets out the rights and obligations of both you as a franchisee, and your franchisor. You should receive a copy well in advance. It is strongly recommended that you seek independent legal advice on the contract from a solicitor specialising in franchise agreements.

You would not normally expect a franchisor to amend the terms of the contract to suit you as franchisors generally prefer to have a standard contract for all their franchisees. However, having the contact vetted is not a waste of time as it is important that you fully understand its terms and limitations. If you do not like the contract, you are, of course, free to walk away.

Financing
The next step is to examine the financial aspects of the franchise. These broadly speaking fall into two categories – the start-up costs and the projected income and profits. Looking at the start-up costs first, it is important that you identify the total amount of money required to get the business going, including any working capital you will need.

Against the costs will be set the amount of cash you can put into the venture, leaving the sum you will need to borrow. It makes sense to do a full review of your own personal financial situation, ensuring you know how much you need to take out of the business regularly to pay yourself.

You must be prepared to take a realistic view of what type of franchise you can afford as you will need to put in a stake yourself, the bank will not lend 100 per cent of the funds required.

Having established the start-up costs and your borrowing needs, you will then have to look at the potential earning power of the business on a realistic basis. Does it justify the level of investment that it calls for and how long will it take you to recover the investment?

Projections
You will need to ensure that any profit and cash-flow forecasts prepared by the franchisor for your franchise cover all the likely costs, including borrowing and that they are based on realistic figures, normally the performance of existing franchisees. This is also a good opportunity to look closely at any fees that you need to pay on an ongoing basis.

Borrowing money
Deciding to start a franchise is a big step and one of the hurdles for many, is approaching the bank for finance. Of course, there is a lot of work to do to before you, or your bank, part with any money. You will need to research your chosen franchise thoroughly, making sure that it is the right one for you and that you are fully aware of what is involved.

You will also need to ensure you can afford the franchise you are interested in, and that the business offers a good return on your investment. Decisions on how much you are prepared to invest, and whether you will draw on savings or financial support from your family, should all be made before going to your bank.

You will find that for an established franchise system most major banks will lend up to 70 per cent of the start-up costs, while for new franchises the figure will probably be around 50 to 60 per cent.

You should approach your bank having considered or prepared the following: –

How much will you be able to borrow? Prepare a full list of your personal expenditure: mortgage, car finance, household bills, etc. This will show how much money you will need to take out of the business for living expenses.
What security can you offer to back up your loan? You might, for example, have a life policy with some value, or have equity in your home.
Start preparing your business plan. This is a vital document to obtain finance from the bank. Your chosen franchisor will often help you with this. As part of your business plan, you will need to prepare cash-flow forecasts for the first couple of years. Your franchisor will help, but you need to be sure that you understand the figures, what they are based on, and how much turnover you will need to break-even.

The bank will look at several things before agreeing to lend to your new franchise venture. Although they will all have their own requirements and approach, this is a broad outline of what a funder will look at:

You – who are they lending the money to? The bank will look at your qualifications and track record; your financial resources; and assess whether they think you can run the business. The franchisor will also have considered these qualities to ensure you are a suitable franchisee. The bank may ask to see statements from your personal bank and will need to see your identification documents such as a passport if you are not already a customer of theirs.

How much are you asking to borrow: As well as considering how much you would like to borrow, the bank will also consider the purpose for which the money will be used, including working capital, stock, premises, or vehicles and of course the franchise fee.

The funders will also consider whether there is sufficient demand for the product/service you will be offering and look at the type of finance you are looking for (overdraft, loan, or a package of financial services), as well as how much you are personally prepared to invest in the business.

Normally, you will be expected to contribute towards the total start-up costs from your own resources, but it is important to get the balance right. Often, start-up business owners underestimate how much they will need to borrow to make the business successful, so it is important to put a realistic case to your bank. Your franchisor will normally help with setting out details of the start-up funds required and the preparation of cash-flow forecasts.

Repayment: Funders will always look closely at how the business is planning to repay any borrowing so your plan should show how you plan to do this. Will repayment come from future trading profits, after allowing for all your other financial commitments, or from the sale of an asset? Does the cash-flow forecast show that you will be able to afford to repay the loan? What assumptions have been made in the cash-flow forecast? What level of sales are needed to break-even and are they achievable? Is there a contingency plan for any setbacks?

Security: Depending on the amount of the borrowing, banks will often ask for some security for the loan. This will only be used if the business fails to repay the borrowing but if you are providing a guarantee or a second mortgage over your property, you should take independent legal advice.

As a potential franchisee, you should be in a better position than someone setting up a start-up business from scratch, especially if they have never been self-employed previously.

You have the backing of a proven business format, plus the track-record of how similar franchisees are successfully operating their businesses, to show the bank in support of your loan application.

So, there we have it – the two sides to franchising – a business in which both need to be fully committed to their responsibilities to each other and both need to succeed if the franchise is to survive and prosper.

Take the time to look at all the different types of franchise available and think carefully about what you would like to do. Running your own business is hard work, even with the support of a strong franchise network behind you so you should look for something that you will enjoy as you build your new future.

About the author
Cathryn Hayes, Franchise Director at Revive! Auto Innovations, has over 25 years of franchising experience.

Previously Head of Franchising at HSBC, followed by a short-term senior role at the British Franchise Association, Hayes has a high profile within the sector, contributing regular articles to the franchise press and other business media.

cathryn.hayes@revive-uk.com

Posted: 20th September, 2022