What is a Franchise?
Franchising is the practice of using another person’s business model. The franchisor grants the franchisee the right to distribute its products, techniques and trademarks for a percentage of gross monthly sales and a royalty fee. The franchisor dictates all aspects of the business, including prices, hours, sourcing, advertising, software and even location, furniture and uniforms for employees. The franchisee is given an operation manual and is required to take training.
There is a registered public offering document called a Disclosure Statement that provides all of the information for a potential franchisee to make an informed investment, including all of the start-up costs, as well as the franchise’s history and track record. The terms of the agreement are contained in the Franchise Agreement document. The franchisor’s trademark is the centerpiece of the franchise.
Establishing a New Franchise
If you want to create a new franchise, consult your attorney right from the beginning, as there both federal and state regulations to comply, and you must have your Disclosure Statement prepared and approved before you can even begin offering franchises for sale. You may need to get approvals in multiple states if you plan to sell in states that require registration and approval. The first step, of course, is to make sure you have a valid federal trademark registration for your company brand, and to refocus your branding strategy to make it more appealing to prospective franchisees on a national level.
Purchasing A Franchise
If you are considering purchasing an established franchise, the following is a helpful checklist of items to look for and analyze:
FRANCHISEE’S CHECKLIST
- Initial Franchise Fee
- Royalties based on gross sales*
- co-op advertising contributions
- local advertising
- grand opening fees
- service fees
- training fees
- inventory requirements
- sales quotas
- failure to meet sales quota: non-exclusivity and/or termination
- Site and lease approval fees
- lease payments
- required construction and build out costs
- product purchase charges
- territorial rights or right of first refusal
- term and options/right to renew
- assignability and assignment fees
- right of first refusal
- financing available
- covenant not to compete
- personal guarantee requirements/good guy clauses
*royalty rate and advertising spend are likely not negotiable, unless a master regional franchise involving multiple franchise locations
DISCLOSURE STATEMENT REVIEW
When looking at the Disclosure Statement, make sure it includes a cost schedule and contact info for other franchisees so you can get some firsthand feedback. There should also be info on the current number of operational franchises, earnings claim information (past or projected sales and profits), the Franchisor’s principals, the franchise’s litigation history and the franchisor’s net worth. Most importantly, check the status of the franchise’s trademark and intellectual property rights.
When negotiating, ask your attorney about whether the personal guarantee can be limited (so-called “good guy clauses”) and whether there are opportunities for additional stores or a master franchise.