Launching a business is a little like walking a tightrope, with any long-term rewards coming only after overcoming some risk. Being well-informed and realistic from the outset is essential. One of the first considerations is the legal form that the business should take. An option that has the potential for achieving a good balance between risk and reward is the franchise.
A franchise is a relationship between the owner of a trademark or trade name (franchisor) and an individual or entity (franchisee) who contracts to use that legally protected identification in a business. The details of the relationship are controlled by a franchise agreement, but most franchises share some common characteristics. Typically, the franchisee sells goods or services that are either supplied by the franchisor or at least must meet standards set by the franchisor. In simple terms, the franchisor provides the ingredients that come from the proven experience of an established line of businesses, while the franchisee provides the elbow grease and all of the other intangibles that are needed if a fledgling business is to get off the ground and prosper.
There are two types of franchises. The simpler version, known as a “product/trade name franchise,” is the sale of the right to use a business name or trademark. In the more complex form, called a “business format franchise,” the fates of the parties are tied together more closely and for a longer period of time. In this format, the franchisee trades some of its independence in exchange for various forms of assistance from the franchisor.
One benefit of a franchise is that the prospects for a healthy bottom line are enhanced, since the risks of the investment are reduced by being associated with an established company and its good name. But that boost is not without cost. A would-be franchisee should always be aware of the financial commitment involved, but not be too quickly scared away by the reality that here, as in most business matters, “you have to spend money to make money.”
It is only prudent to consider carefully a number of likely expenses. There is the initial franchise fee, sometimes nonrefundable and usually at least a few thousand dollars. Costs to rent or build an outlet and to purchase the initial inventory will be significant. The full range of expenses depends on the type of business, but some of the other typical expenses include fees for licenses and insurance, ongoing royalty payments to the franchisor based on income and for the right to use the franchisor’s name, and payments into the franchisor’s advertising fund.
Who’s in Charge Here?
It is the nature of a franchise that, in exchange for getting to hitch its wagon to the franchisor, the franchisee agrees to give up some of the control over how the business will operate. There still should be room for putting a personal stamp on the business, but the franchise business model is not for someone who would have difficulty giving up the decision-making power that comes with starting a business. Owners of a “Mom and Pop” do not need permission for their store’s color schemes, but the franchisee probably will.
As set out in the franchise agreement, the franchisor will usually have the final say about the specific goods and services that may be sold, site approval for the business location, design or appearance standards, as well as authority over an array of operational matters such as hours of operation, signs, employee uniforms, and even bookkeeping procedures. On the larger scale, the franchisor also may limit the franchisee’s business to a specific territory.
A franchisee’s breach of the franchise agreement, such as by failure to make payments or to comply with performance standards, could result in termination of the franchise and loss of the franchisee’s investment. Even without a breach, a franchisee must foresee that franchise agreements generally run for a finite period, such as 15 or 20 years. Of course, if both sides so desire, the agreement can be renewed under the same terms or perhaps even terms more favorable to the now-proven franchise. But the franchisor could decide not to renew, and it usually reserves the right to do so for its own reasons. If there is a renewal, the parties must agree again to all of the terms and conditions. The franchisor may take that opportunity to make changes in the deal to its benefit. In that event, the franchisee would be wise to give a fresh look at whether owning a franchise still makes business sense.
Anyone seriously considering buying and running a franchise needs to do the homework first, and the Federal Government has made that process more organized. The Federal Trade Commission (www.ftc.gov) requires franchisors to prepare a disclosure document, sometimes called a Franchise Offering Circular, that puts in one place a wealth of information about the franchisor, current and former franchisees, and what the franchisee is agreeing to when the franchise agreement is signed. Reading and understanding the disclosure document, not to mention the franchise agreement itself, is essential. One should always seek independent professional advice before making a commitment to a franchise arrangement.
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