Franchising Notes

An agreement that binds a Franchisor (parent company) with a Franchisee (a small business). The Franchisee pays for exclusive rights to the local distribution of the product/service.
Franchisor: The parent company that develops a product or sells the rights to Franchisee.
Franchisee: The small businessperson who purchases the franchise to sell the product or service of the Franchisor.

Allows Franchisee to buy products from the Franchisor or to license the use of its trade name.
Connects a single manufacturer with many dealers (e.g., drink bottlers, gasoline stations).

Franchisee purchases the Franchisor’s entire way of doing business.
Most used in quick-service restaurants, lodging, retail food, and table-service restaurants.

Compare its advantages and disadvantages to starting a new business or buying an existing non-franchised business.
Determine whether the unique characteristics of franchising fit your personal needs and desires.
Some small business owners would rather assume the risk and expense of starting an independent business than follow someone else’s policies and procedures.
Others prefer the advantages a Franchise’s proven system can provide.

Proven product or service: The franchisee benefits from selling a product or service that has already been established and tested in the market.
Marketing expertise: Franchisees can share advertising costs and access marketing expertise at a low cost.
Financial assistance: Trade credit on inventory and overhead reduction may be available.
Technical and managerial assistance: Franchisors provide managerial and technical support.
Opportunity to learn the business: Franchisees receive training from the beginning, which helps avoid developing bad habits.
Recognized standards: Franchisors impose quality standards for Franchisees to follow.
Efficiency: Franchises can be started and operated with less capital than independent businesses.
Potential for business growth: Successful Franchisors often have provisions for Franchisees to open new territories.

Fees and profit sharing: Franchisors charge a fee and/or a specified percentage of sales revenue.
Restrictions on freedom or creativity: Territorial restrictions can limit market size.
Overdependence or unsatisfied expectations: Franchisors may not always know what is best for every local market condition.
Risk of fraud or misunderstanding: Franchisees must carefully read the fine print in the contractual agreement.
Problems of termination or transfer: Franchisees need to understand the section of the agreement that describes how to exit the deal.
Poor performance of other Franchisees: If customers are treated poorly in one location, they may expect the same treatment elsewhere.

Expansion with smaller capital investment: Franchisors do not have to borrow heavily or attract outside investors.
Multiple sources of revenue: Franchise fees, a percentage of the franchise's monthly revenues (3-8%), and revenue from selling supplies to Franchisees.
Controlled expansion: Franchising can be accomplished with a simpler management structure
Motivated Franchisees: Franchisees have a direct personal interest in the entire operation.
Bulk purchasing: Volume discounts are available for buying supplies for all franchise locations.

Loss of control: Franchisees are still independent businesspeople.
Profit sharing: Franchisees can recover their initial investment within 2-3 years and quickly enjoy large returns (30-50%).
Franchisee disputes: Friction may arise over fees, expansion, and hours of operation.

Choosing the right franchise is a serious decision, representing a major commitment of time and money.
Before investing, determine what you need in a business and evaluate what several franchises can offer you and your customers.

Find the opportunity that matches your interests, skills, and needs.
Ask yourself:
- How much equity capital will I need?
- Am I prepared to follow franchise guidelines?
- Do I have the innate ability, training, and experience to work smoothly and profitably with the franchisor?
- Am I ready to commit long-term?

Trade associations can be valuable when investigating franchise opportunities.
Other information sources:
- American Franchisee Association (AFA)
- Better Business Bureau
- Ministry of Industry & Commerce (MOIC, Bahrain)
Before signing contracts with the Franchisor, talk to current and former Franchisees.

Are you charging the correct price?
Will the population in your territory increase, remain static, or decrease over the next five years?
Will your product be in demand five years from now?
What competition already exists in your territory for your product?
- Non-franchise firms?
- Franchise firms?

Franchisors are required by the Federal Trade Commission (FTC) to provide disclosure statements to prospective or actual franchisees.
Compare disclosure statements from each franchise you consider to help identify risks, fees, benefits, and restrictions.
Don’t assume that the disclosure statement tells you everything you need to know about the franchise.

Franchise fee: The money paid to become a franchisee.
Royalty fee: Ongoing payments that franchisees pay to franchisors.
Termination of the Franchise agreement: States how the Franchisee could lose franchise rights.
Terms and renewal of agreement: Specifies how long the agreement will remain in effect and what renewal process will apply.
Exclusive territory: The geographic size of the territory and exclusive rights for the franchisee.

Consult a lawyer and CPA before signing any franchise agreement.
Ask your lawyer about state and local laws affecting your franchise.
Ask your accountant to read financial data disclosure statements and determine if the Franchisor can meet its obligations.