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A carefully drafted franchise agreement is key when considering taking on a franchise. In a franchise arrangement one business (called the franchisor) licences certain elements of its business (such as its name systems and procedures) to other businesses (called the franchisee), but at the same time, retains control over the way in which those elements are developed and managed. We are all familiar with franchises operating in retail settings, but franchises are also used in a business to business environment.
Those who have previously worked in an employed setting can use a franchise to put a toe into entrepreneurial waters. Some franchisors do not require their franchisees to have had management or other business experience. However, a quality franchisor will provide extensive training, and a potential franchisee should ask other franchisees about their experiences.
The benefits of the franchise
One of the biggest challenges for a new business is generating goodwill and establishing a foothold in the market. Franchised businesses are attractive because the franchisee can take advantage of the recognised brand and established place in the market, the idea being that the time required to make a business successful and the risk of failure can be reduced. The initial cost of a franchise may be smaller than a start up business, making it more accessible to those who may not have the available capital to fund a new business. In addition, bank finance may be more readily available to a franchise model.
A franchised business often has the appearance of a much larger organisation and the franchisee may be able to take advantage of the reputation of the franchisor when negotiating other trading terms. The franchisee can also rely on the help and assistance of a good franchisor in making the business a success.
Be careful
However, careful consideration must be given to the terms of the franchise arrangement. A franchisee is often subject to substantial control from the franchisor and a franchisee’s input as to the development and establishment of the brand or business may be limited. The actions of the franchisor (and possibly other franchisees) will directly affect the business of the franchisee. The insolvency of the franchisor will almost certainly have disastrous consequences for the franchisee.
The franchisee has the appearance of an owner/manager but a slice of the profit will be paid to the franchisor, whether it be by way of royalty, mark up or up front fee. Often the franchisee is tied to purchase stock or services from the franchisor at fixed prices which means that the franchisee is not free to shop around. In addition, the continued efforts and hard work of the franchisee operate so as to enhance the franchisor’s business brand. Therefore, hard work in generating knowhow and goodwill will essentially be for the benefit of the franchisor, not the franchisee. Exit plans may not be straightforward, there are usually restrictions on the sale of a franchised business and the franchisor will almost certainly want a say or even a veto over this process.
The Franchise agreement is key
A carefully drafted franchise agreement is key when considering taking on a franchise. Ideally the franchisee will have exclusive rights to operate the franchised business in a particular area, but if not and the business model is rolled out across many different territories, the franchisee needs to make sure his territory is clearly defined, cannot be reduced over time, is large enough to make the required financial return, and that the franchisor will be available to police territorial disputes between franchisees. Competition law complicates things here – there are restrictions on how “exclusive” exclusivity really is, and specific legal advice should be taken.
If operating from premises, the franchisee should check planning, location, footfall etc. A surveyor can help with this.
There is no substitute for doing some homework on the franchisor and its other franchisees. The franchisee should obtain financial statements about the franchisor, which can be obtained from Companies House (but be aware they can be out of date). Alternatively, ask the franchisor direct. In addition, the franchisee should carry out some research on what competitors there are to the business, and what other franchisees and customers feel about the business. In addition, the franchisee should find out if the franchisor is a member of an association (for example the British Franchise Association).
The franchisee needs to be clear as to how long the agreement will run and what will happen after termination. Ideally, the franchisee will have the right to extend the term at the end of the initial period. Typically, the franchisee will be subject to certain key obligations primarily to run the business in a certain way and to pay the applicable fees. If the franchisee neglects these duties and breaches the agreement, the franchisor will usually have the ability to terminate. The franchisee will want the opportunity to remedy such breaches before any termination clause is triggered.
The franchisee should be clear as to what training, assistance and materials (such as brochures logos trademarks etc) the franchisor will provide and make available during the term and what happens regarding any enhancements made by the franchisee.
Almost certainly the agreement will provide that the franchisee is to be responsible for obtaining relevant public liability and other types of insurance and the franchisee should make we sure these are in hand.
Payments to the franchisor can vary and the franchisee needs to clearly understand what payments will become due in all scenarios. Obligations can range from a fixed monthly or quarterly fee, to more complicated target based payments dependent on sales and turnover. In particular, look out for penalties or minimum payments in the event that targets are not met. The franchisee should consider all targets carefully and make sure to produce a realistic business plan incorporating profit and loss and cash flow statements. An accountant can help here.
Finally, depending on the expected turnover of the franchised business, the franchisee should give some thought as to setting up a corporate entity (probably a limited company) to house the franchise business and should take appropriate legal and tax advice.
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