1. What is a franchise?
The term franchise is generally taken to mean the legal arrangement, whereby one party grants a license to another for the purpose of retailing its goods and services, often in a specified territory or area. This type of franchise is usually called a ‘business’ format because the franchisor presents the franchisee with of a model with how the business will operate, and imposes stringent controls on the franchisee in respect of how the business will be run. This is the most common type of franchise.
2. Why take out a franchise?
From the franchisor’s point of view franchising offers an opportunity to expand quickly and at a reduced cost. The greater the number of franchises there are the more purchasing power the franchisor will have. This will benefit both the franchise holders and the franchisor. From the point of view of the franchise holder this gives them an opportunity of becoming self employed. It also offers them to get straight into running the business as the franchisor will usually have extensive training programes and will pass on the know how of getting started up cost effectively. The franchisor will also have the benefit of the ongoing advice and support that is associated with a franchise. Also it is said that it is often easier to raise finance to buy a franchise than it is to raise finance to set up business on your own. This is particularly true when the brand is a well known one and is a well run franchise.
3. Disadvantages of owning a franchise
As with most commercial arrangements there may be pitfalls with franchising and it is important to be aware of these. The principle disadvantage from the point of view of the franchisor is the loss of control suffered. They do not have direct control over the production and this may be frustrating if thy have always had this. He will of course seek to put restrictions on the franchisees in regards many issues. Yet from the franchisee’s point of view this can be very restricting and they may resent this level of control. From the franchisee’s point of vie the principal disadvantage is of course that they must pay a percentage of their profits to the franchisor.
4. Preconditions to setting up a franchise
Both the British Franchise Association and the Irish Franchise Association Codes of Ethics for Franchisors require that a franchisor has at least one years experience itself in running a business before considering franchising. From the point of view of the franchisee it is preferable to look at a pilot operation which has produced an audited set of accounts and where it will be possible for the franchisee to evaluate the profitability of business.
5. Intellectual property considerations
It is important to remember that at early stage that the franchise agreement itself will confer on the franchisee a package of intellectual property rights. If the franchisor’s intellectual property rights have not been protected then they should be considered immediately. The intellectual property will usually be either a trademark of some kind, a patent over a process that the company has developed, a copyright or a registered design. The franchisor will arrange for all licenses to be given to the franchisee under the agreement and can only be used under the terms of the agreement.
6. The Operating Manual
This contains all the know-how which the franchisor has accumulated in the operation of the pilot scheme and all the necessary information in relation to successful running of the franchise. It is effectively the blueprint for the operation of the franchise business. It will cover all the practical information required by the franchisee and will include matters such as accounting systems, sales and service reporting requirements, equipment requirements etc. As it contains the business secrets it will not be given up until a binding agreement is in place. The agreement will usually provide that that the content of the manual will be kept confidential and will not be copied or disclosed to third parties.
7. The Franchise premises
Not all franchises are property-based. Many operate as mobile franchises, for instance through the use of customised vans, and others may be operated from the franchisee’s own home. In many cases, however, a premises will be required. If this is the case then the franchisor will need to consider how important the location of the business is for the development of the franchise network. If it is of major importance then he may wish to retain control of the premises in some way, so that if the relationship breaks down he can continue to run it himself or get a new franchisee.
8. Drawing up the Franchise Agreement
Once the franchisor is in a position to offer franchises, he needs to consider the preparation of the franchise agreement. This document will license the franchisee to carry on the business, using the know-how, the trade name and the trade mark, in accordance with the manual. It is important to adopt a reasonable approach when drafting the franchise agreement. It is necessary to strike a balance between protecting the franchisor and giving a workable document to the franchisee. A standard franchise agreement should be used with all franchisees which imposes the same controls on all of them. The agreement will also need to comply with competition law requirements.
9. Franchise Fees
One usually finds that the money given by the franchisee for the grant of a franchise is threefold. Firstly there is the initial fee. This is generally a substantial cash sum paid by the franchisee to the franchisor for the privilege of becoming part of the franchise network. It generally includes a fee for the entitlement to use the trademark, the franchisor’s costs of approving the franchise, approving the premises etc. Secondly there are the management fees. These are generally calculated as a percentage of the turnover, although I some product based franchises the fee is included in the wholesale price of the product and no separate fee is levied. Thirdly it is usual for the franchise agreement to provide that the franchisee will make a contribution towards the cost of having the brand advertised. This is usually calculated as a percentage of turnover.
10. Obligations of both parties
A franchisor’s obligations are likely to relate to such matters as the fit-out of the premises, the provision of training and the provision of the manual. Their continuing obligations include promoting the brand during advertising, not to compete with the franchisee by granting other franchises in the area and the obligation to provide ongoing advice and assistance to the franchisee during the term. The franchisee’s obligations are more widespread. They include the control of the franchise premises, the franchise business, the products, the trade mark, the payment of fees, record keeping, confidentiality provisions, non compete obligations and insurance and indemnities.