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Franchises

Franchises comprises some of the most ubiquitous business models in the world.

Many brands have grown into global franchises. [©Jupiter Images, 2009]
©Jupiter Images, 2009
Many brands have grown into global franchises.

Franchises

A franchise is a business contract between two parties: the franchisor and the franchisee. The franchisor is an established company with a recognizable trade name or trademark. The franchisee is the purchaser of the right to operate a business using that name, in exchange for a fee. According to the International Franchise Association, more than 75 different industries use the franchise model, providing the widest possible range of entrepreneurial opportunity in business.

Pros and Cons of Franchise Ownership

Franchise ownership is an affordable way to become a successful business owner. The franchisee receives the substantial benefits of both a well-established business model and instant brand recognition. The franchisor is a useful resource, often providing the franchisee a full range of business services, such as training and operational support. The franchisee may also benefit from national advertising, group purchasing power and the uniform standards of the franchisor.

In exchange for the purchase of a demonstrably successful business, the franchisee sacrifices independence. A franchise agreement is typically very strict, with the franchisor retaining control. The franchisee has little or no ability to make decisions without franchisor approval. The franchise is granted for a fixed term with a possibility of renewal. The franchisor may refuse to renew the franchise when the term of the agreement has expired, leaving the franchisee with little recourse.

Franchise Agreements

The Federal Trade Commission regulates franchises and protects franchisees under the Franchise Rule. This rule requires full disclosure to the franchisee of all of the information necessary for an informed decision. This disclosure document is called the Franchise Disclosure Document (formerly known as the Uniform Franchise Offering Circular or UFOC). The FTC requires the 14-day period before signing an agreement as well as before making any payments to the franchisor. The disclosure document must specify certain background information about the franchisor, as well as the particular terms that will govern the franchise relationship.

In addition to the disclosure document, the parties must sign a separate franchise agreement and a purchase contract. The agreement is a legally binding contract covering each party's specific obligations. Unlike the disclosure document, which is uniform, each franchise agreement is unique since terms and conditions vary by and within industries.

Costs

There are two basic fees involved in the purchase of a franchise: an initial or front end fee and royalty payments. Fees vary widely depending on industry, size, location and the total number of franchises.

The front end fee is the initial payment for the right to use the business concept and trade name, as well as the operational support to get the business started. The front end fee is determined by the profitability of the business. These fees can range up to $50,000. In addition to the front end fee, the franchisee must pay periodic royalty payments. These royalty payments, usually in the range of three to eight percent, are based on a percentage of revenue.

There may be the additional cost of either renting or buying a building, as well as improvement costs or security deposits in the case of a lease. Some franchisors provide an allowance to help defray the costs of property improvements. The franchisee is also responsible for normal business expenses, such as payroll, insurance, employee benefits, equipment costs, inventory and utility payments. The franchisee may be required by the franchise agreement to purchase inventory and supplies directly from the franchisor.

Selecting a Franchise

There are a variety of franchise models, each with different fee structures, conditions and requirements. According to the American Association of Franchisees and Dealers, there are eight general criteria that a franchisee should consider when selecting a franchise, among them:

  • Choosing a well-accepted trademark
  • Ensuring that franchising is the primary mechanism of product distribution
  • Looking for a strong franchisee organization


There are several ways to research franchise opportunities. Most large cities host trade shows or franchise expositions that allow the prospective franchisee the chance to instantly compare offerings. Entrepenuer.com provides a yearly list of its top ten franchises, along with links to Internet franchise finders. It is also possible for the potential franchisee to obtain information directly from the franchisor.

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