Franchising is simply a method for expanding a business. It can be an extremely powerful way for a company to expand, but it is not right for every company. It is important to keep in mind that franchising is simply an alternative method of expansion.
Franchising also does not have to be the exclusive method used by a company to grow. Most franchisors today use a variety of expansion techniques at the same time, and it is not unusual for a company to have company-owned locations, franchisees, alternative distribution strategies, and licenses in the same market. Putting together your expansion and downstream distribution strategy is not limited by your choosing to become a franchisor.
Franchising is based on a contractual relationship between the brand owner (the franchisor) and the local operator (the franchisee) to distribute products or services using the franchisor’s brand name and system. While every franchise is a license, not every license is a franchise under the law. From a regulatory point of view, in the United States, a franchise arises whenever a company licenses to someone the use of its trade or service mark; the licensee pays the company fee for the right to use their marks, and, depending on state laws, the company retains significant control over how the licensee operates their business, has a marketing plan, or a community of interest with the licensee. But is important to understand that the definition of a franchise can vary significantly under state law, and it is important that you don't simply rely on the federal definition of what a franchise is in deciding whether or not you meet the definition.
Under federal law in the United States, the Federal Trade Commission regulates franchising. Under its regulations (frequently referred to as the Franchise Rule), the FTC defines a franchise as any continuing commercial relationship or arrangement, whatever it may be called, in which the terms of the offer or contract specify, or the franchise seller promises or represents, orally or in writing, that:
- The franchisee will obtain the right to operate a business that is identified or associated with the franchisor’s trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor’s trademark;
- The franchisor will exert or has authority to exert a significant degree of control over the franchisee’s method of operation, or provide significant assistance in the franchisee’s method of operation; and
- As a condition of obtaining or commencing operation of the franchise, the franchisee makes a requirement payment or commits to make a required payment to the franchisor or its affiliate.
But remember, the definition of a franchise can differ from state to state; what constitutes a franchise in New York may not be a franchise across the George Washington Bridge in New Jersey.
The type of franchising most identifiable to the average person is called a Business Format Franchise. In this type of relationship, the franchisor is licensing a system for delivering the products and services, not just their brand name. In these franchises the franchisor usually provides operating manuals and training, ongoing support, quality control, and a marketing strategy of part of their franchise system. There is an ever-growing range of industries that use franchising and it is estimated that over 120 separate industries today use franchising.
Another type of franchise that is actually larger in sales than Business Format Franchising is called a Traditional Franchise or Trade Name Franchise. In these franchises it is the product that is most important, as it generally requires pre-sale and post-sale servicing by the franchisee. Automobile dealers and soda and beer distribution fall under this category.
Unfortunately, to avoid what some people view as a highly regulated and complex business, some companies look to avoid franchising and modify their route to market to avoid becoming franchisors. While franchising is certainly not right for every company to use, where it is appropriate, making modifications to your licensing arrangements simply to avoid becoming a franchisor makes little sense. The definition is quite broad and frequently lawyers not familiar with franchising advise their client on how they believe they can structure their licensing arrangements not to be a franchisor. To be certain that advice is soundly based, you should always get a second opinion from a qualified franchise lawyer. Remember, if it were easy to avoid the franchising definition, a lot of companies would do so.
Franchise law is primarily about the offering of a franchise, not the structure of the franchise you choose to offer or the business. When developing a franchise system you need to be aware of the law, but franchise law, franchise disclosure, and franchise sales, while regulated, are fairly easy to understand with experience. That is why you always want to work with franchise lawyers and consultants who have the right credentials, client experience, and franchising experience.
At its core, franchising is about the relationships between the franchisor and the franchisees. The franchisor provides the franchisee with leadership and support, and exercises some control over the franchising operations and the franchisee's adherence to brand guidelines. In exchange, the franchisee usually pays the franchisor a one-time initial fee (called a franchise fee) and a continuing fee (known as a royalty). In franchising, the franchisor does not control the day-to-day affairs of the franchisee. The job of the franchisor is to set and enforce brand standards; the job of the franchisee is to manage their business and staff to achieve those brand standards.
When structured and managed properly, both franchisor and franchisee benefit financially from the relationship.
There are many articles available online about franchising that can be found on the About.com franchise portal at franchises,about.com. If you don't get your answer there, give us a call.