What’s in a franchise?
David Robinson, a Corporate Consultant with London firm of Solicitors, Fletcher Day, examines some of the pros and cons of this route into business.
The last twelve months have been an extraordinary time for us all – and, hopefully, one never to be repeated. Many people have seen dramatic changes in their lifestyle and not least in their income. Short time working, redundancies and job losses have all come into the mix.
For many, the last twelve months’ events have been a catalyst in a decision to start their own business. The motivation may be to be your own boss or to find an alternative source of income. But what are the alternatives when it comes to starting your own business? Where do you start?
You could start with a completely original idea and work up from there. Many tough decisions lie ahead. How do you launch your idea? How do you become noticed in the marketplace? How do you build the goodwill needed to sustain the future business? How is the business to be funded? An alternative may be to enter into a franchise arrangement with an already established brand.
Franchising has grown enormously over recent years. It should not, however, be seen as an “easy fix” way into the business. As with any other business venture, careful thought and planning is required.
SO, WHAT IS A FRANCHISE?
A franchise is an arrangement where the owner of an established brand (the “Franchisor”) effectively licences another entity (the “Franchisee”) to use the Franchisor’s brand and operating methods in relation to the Franchisor’s products. Many well-known brands offer franchises. They range from confectionery retailers to hairdressers to vehicle valeting services. The choice is huge.
HOW DOES IT WORK?
The Franchisor and Franchisee enter into a contractual arrangement under which the Franchisee is licensed to run a business in a certain location(s) selling the Franchisor’s products or services under the brand name and brand identity of the Franchisor. Normally the Franchisor will locate potential properties in an area in which it is prepared to have a business operated under Franchise. The Franchisee will have little say. The “fit out” will be in the style required by the Franchisor and probably using the Franchisor’s chosen contractors. This will be at the Franchisee’s expense. The Franchisee will be the Tenant under the Lease of the Property and will have all rental and other liabilities.
WHAT ARE THE BENEFITS?
The main benefit to the Franchisee is its ability to make use of the Franchisor’s goodwill and brand identity. One of the main issues in starting any new business is how to become noticed in the market place and how to generate all-important goodwill, which brings clients and customers back time after time. Building a level of goodwill and brand awareness will usually take years. Taking on a franchise is a good way of getting into the relevant market with the backing of an established name and business “get up”. It does, however, come at a price, as we shall see below.
WHAT IS THE DOWNSIDE?
Taking on a franchise will involve the Franchisee accepting certain requirements and restrictions on the way it can operate the business. A franchise fee will be payable – and so may other fees become due – as we note below.
HOW IS THE ARRANGEMENT CONTROLLED?
A franchise arrangement is regulated by two documents:
1. The Franchise Agreement
Under this agreement, the Franchisor grants the Franchisee a licence to use the brand name and identity of the Franchisor in relation to the sale of the Franchisor’s products/services. The agreement will set out in detail the terms of the grant of the licence. In particular, the level of the initial franchise fee payable by the Franchisee to the Franchisor and any other payments to be made in connection with the arrangement, such as an annual Royalty payment It will also set out certain requirements as top how and restrictions on the way in which the Franchisee is to operate the franchise business. (in this latter respect, there is likely to be some overlap between the Agreement and the Operating Manual) In addition, many Franchise Agreements require the Franchisee to purchase all of its products from the Franchisor. This will often be at full price, not a discounted rate. If the Franchise sources the products at a lower rate, it will be in breach of the Franchise Agreement;
2. The Operating Manual
This is an operational document setting out more practical issues as to the way the franchise business is to be operated – for example, the type of premises from which the business is to operate, the methods of advertising which the Franchisee is permitted to use. The Operating Manual will cover a wide range of matters. By way of example;
- Measures to protect the Franchisor’s established goodwill in relation to its brand identity. This is one of the main concerns for the Franchisor. The Franchisor is likely to have spent many years building up to its brand identity and goodwill in the market place. Therefore, it will be very keen to protect that identity and ensure that any actions on the part of a Franchisee do not detract from it. For example, an upmarket confectionery business will want to make sure that any franchise of that business is operated from appropriately prestigious premises. All Franchisors will require a Franchisee to use only approved advertising material that is in line with the Franchisor’s brand identity;
- Pricing policy and guidelines;
- Marketing policies – the Franchisor is likely to offer assistance to the new business in relation to marketing. This will be charged as an additional and ongoing cost to the franchised business.
Careful and considered thought needs to be given to the documents involved – particularly in relation to the Franchise Agreement. As ever with legal documents, the detail is all-important if serious adverse consequences are to be avoided. A full explanation of the legal effect of the terms of the Agreement is essential if the full implications of the arrangement are to be appreciated. Proper care and due diligence are essential to assess not only the potential legal but also the financial risks likely to be involved.
BUT WHAT DOES ALL THIS COST?
The Franchisor will charge an initial franchise fee – or licence fee – for the use of its brand and goodwill. The level of franchise fees varies greatly. The higher the profile of the Franchisor’s brand in the marketplace, the higher the fee is likely to be. Franchises are granted for a pre-determined period, usually with an option to renew for a further period. A renewal fee will be payable.
In addition to the initial franchise fee, where the Franchisors provides other assistance to the Franchisee – usually in relation to marketing – further fees will be payable for those services. There may also be an annual royalty payment based on the gross profit of the Franchisee.
AND WHAT ABOUT FINANCE?
As with any business decision, careful and proper planning is the order of the day when thinking of entering into a franchise arrangement. Initial finance in relation to the franchise fee may be available from banks/mainstream providers. A detailed and reasoned business plan will be required, including profit forecasts.
Security is likely to be required to secure any borrowings. That security may take the form of personal guarantees from the Franchisee – most likely secured on a personal/residential property. That increases the risk of the proposed venture considerably. There may be a possibility of “peer to peer” funding, although the cost of that form of funding is likely to be high. The Franchisor may also require Personal Guarantees.
SO, WHAT DO YOU THINK?
There is no doubt that taking on a franchise can be a good way into business. The main advantage is the ability under the arrangement of the Franchisee to use the Franchisors brand identity and goodwill. The “downside” is that that comes at a cost – an initial fee, renewal fees and, possibly, fees for further assistance from the Franchisor (often related to marketing). The would-be Franchisee should also bear in mind that the Franchise Agreement and the Operating Manual will include some quite tight restrictions on how the Franchise will need to be operated.
Our experienced Franchise Lawyers will be happy to advise you and act for you. For any enquiries in relation to Franchising please contact David Robinson or Paul Nathan.
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