What Exactly is Franchising?
Franchising is a business agreement where a franchisor grants a franchisee limited rights to replicate a business structure in other locations. Federal laws, such as the Franchise Rule created by the Federal Trade Commission, guide the establishment of a franchise in the United States. However, each party must consult the franchising laws peculiar to the particular state in which they wish to replicate the business to ensure a legally valid contract or business agreement.
Popular forms of franchising include a business format franchise and a distribution franchise. Business format franchises replicate the company’s business model across different locations. The franchisees have the right to use the company’s trademark, which provides a guide on how the franchise’s day-to-day operations would look. Restaurant chains are a popular example of business format franchises.
Another form of franchising is distribution franchising or product franchising, where the business owner gives a right to their intellectual property (the right to sell) to retailers to distribute their products for a fraction of the profits. For instance, a car brand may have many dealers looking to distribute the product for the company. The distributor would then give a part of their sales rights, usually in the form of a license, to the franchisees. However, the distributor does not tell the franchisees how to run their dealerships or provide a business model for sales.
When franchising, the franchisor must set measures to protect their intellectual property, including trademarks and copyrighting of franchise materials. Attorneys specializing in these matters are useful for expert advice and guidance through the franchising process, including drafting and filing legal documents such as an FDD — franchise disclosure document — a requirement of the Federal Trade Commission and an elaborate document. Among other things, the FDD contains as an exhibit the form franchise agreement franchisees will be required to sign, outlining rights and obligations of the franchisee.
Additionally, every franchise should have an Operations Manual detailing protocols for the day-to-day operations of the business. The Operations Manual is only made available to franchisees and can evolve as the franchise gains sophistication and knowledge and as business operations develop.
Before signing any franchising agreement, franchisees should conduct ample research. Among other things, they must ascertain the fees that will be incurred, determine whether the business structure will be profitable and determine if the franchising agreement would yield satisfactory returns. Other financial points, such as required purchases from third parties, referral bonuses or discounts should also be noted. The franchisor’s FDD is an important place to start as it is a “disclosure” document that is supposed to disclose all of these categories of interest.
To ensure the success of any new franchise business, franchisors and franchisees must have a realistic and efficient strategy including not only advertising, marketing and sales, but also operations. If you are thinking of franchising, or thinking of buying a franchise, be sure to do your due diligence.
