In troubled times when people are more nervous about taking risk, becoming a franchisee of an established business may be a better option for those seeking to set up in business for themselves. This articles examines some of the issues involved for potential and existing franchisees, which will also be relevant for franchisors.

How does a Franchise Work?

Franchising usually involves the owner of a tried and tested business model (the franchisor) licensing its business methods and brand to third parties (franchisees) in return for a franchise fee. The parties sign up to a Franchise Agreement which sets out their rights and obligations. The agreement grants the franchisee the right to use the logo and brand of the franchisor for the specified purpose and allows them to benefit from the collective purchasing power of the franchisor and other franchisees. The franchisee is often provided with a franchise manual which sets out the methods for running the business. The manual generally includes important information ranging from how the products or services are to be provided to customers and how the franchisee should train its staff, to setting the colour scheme and branding of the trading outlet.

What is a "Master Franchise"?

In a master franchise arrangement, the business owner appoints a 'Master franchisee' who is given the right to grant sub-franchises in a designated territory. The Master franchisee has the primary interface with sub-franchisees. The Master franchisee is generally responsible for sourcing and signing up franchisees, for training and supervising those franchisees in the operation of the franchise and for dealing with territory specific issues.

Advantages for the Franchisee

  1. Business Model

The franchisor/franchisee business model can work well for both the franchisor and the franchisee. A successful franchise leverages a good business idea that has been proven to work in the past. The franchisor shares the risk of expanding its business with the franchisee and the franchisee gets the benefit of a tried and tested business formula and the consumer recognition and the associated goodwill that comes with being part of an established brand. The Franchise Agreement should set out clearly what is expected of both parties so that there is clear understanding of the mutual benefits and the obligations of each party and the risks each party assumes in relation to the proposed business. The Franchise Agreement will often incorporate a Franchise Manual, which will provide details of how the business should be run and can be of great assistance to those unaccustomed to running their own business. The franchisor will set service and product standards for the franchisee to ensure that the value and quality of its brand is maintained at all times. The Franchise Agreement generally reserves the control of the exploitation and direction of the branding of the franchised business to the franchisor.

  1. Territory

Typically, franchises are granted in respect of a specific geographical area and this may give you exclusivity in that area. It is important for the franchisee to clarify whether it will be the only franchisee operating in the designated area and for how long.

Disadvantages for a Franchisee

As well as advantages of entry into a franchisor/franchisee relationship, there may be drawbacks to the arrangements which should be considered. Some examples are:

  1. Cost and Risks for the Franchisee

The franchisee is often required to take on most of the start-up costs of establishing a new franchise. The franchisee is usually responsible for acquiring suitable premises (acceptable to the franchisor), the purchase of all stock, the recruitment and training of employees and the general day-to-day costs of establishing and running the new franchise outlet. In addition, the franchisee may also be required to pay an up-front "franchise fee" to the franchisor on signing the Franchise Agreement and must generally pay a percentage of its gross earnings to the franchisor in return for its ongoing use of the brand and the performance of the franchisor's obligations.

  1. Advertising and Promotion

The Franchise Agreement usually requires the franchisee to pay a specified percentage of its gross income to the franchisor to cover advertising costs while franchisees are generally responsible for their own local advertising. This ongoing payment obligation is likely to last for the duration of the Franchise Agreement and increases as revenues increase through the franchise business. The franchisee may also be required to conform to franchisor-approved methods of advertising, special offers, competitions etc., and may be constrained in the use that can be made of the trademarks.

  1. Requirement to Comply with Terms of Franchise Agreement

The Franchise Agreement is typically a very detailed document which will be drafted strongly in favour of the franchisor. The franchisee will be obliged to comply with its terms and there may be severe consequences for breach (for example, termination and/or the payment of damages for any loss caused by a breach).

  1. Sourcing of Products and Levels of Support

The Franchise Agreement may require all franchisees to purchase products/supplies from designated suppliers in order to ensure uniformity of standards throughout the franchise network. While the franchisee may be able to source alternative supplies cheaper elsewhere, this may not be permitted under the Franchise Agreement. On the other hand, this arrangement may benefit the franchisee, as the franchisor may have negotiated a discount based on the economies of scale of supplying to a larger franchise network. The level of support and the training programme available will vary from franchise to franchise and much will depend on how well developed the franchise is.

  1. Ownership

It may be difficult to sell on the franchise should the franchisee wish to leave and much will depend on the terms of the Franchise Agreement in this regard. Furthermore, the brand ultimately belongs to the franchisor and any goodwill built up in the business will remain with the franchisor.

What do You Need to Consider if You are Thinking of Becoming a Franchisee?

  1. Does the business have a strong track record and is it right for franchising? Has a franchise network been established by the franchisor for the business? Can the franchisor provide evidence of successful franchisees of the business?
  2. Do you want to be a franchisee? Is it a business that you are enthusiastic about? You will be expected to devote significant time and effort to the franchise and much of its likelihood of success will depend on you. Franchise agreements are medium to long term propositions.
  3. Is the franchise a strong, recognisable brand? Has the franchisor registered the trademarks in the territory? Does the franchisor own the intellectual property used in the business and does it have the right to exploit it and license it? We assist clients to vet a brand and other intellectual property assets prior to entering into franchise arrangements.
  4. Ensure that you are happy with the terms of the Franchise Agreement. The courts have demonstrated that they are not keen to imply additional terms into a detailed franchise agreement. In Jani-King GB v Pula Enterprises (2007) the court indicated that in a complex commercial agreement, where the parties have gone to the trouble of setting out the terms agreed between them, the court would be slow to interfere to imply additional terms. In this case, the court refused to imply an obligation on the franchisor to act reasonably in exercising its discretion under the agreement or a right on the part of the franchisee to terminate the agreement on giving reasonable notice; the agreement was for a fixed term with clear provisions for early termination which did not include such an early termination right.

This article was first published in the September 2009 issue of ShelfLife, Vol. 16(9).