The Business Law Blog
Are You Considering A Franchise?
There are many ways to go about starting a business. You can buy a small business or start your own. Starting from scratch and building a business from the ground up has a certain romanticized allure. Alternatively, franchising an established and tested operation is a much safer, more predictable, and for many, a more appealing option.
A franchise is an opportunity presented by an existing business (the “franchisor”) that affords a franchisee the ability to operate a model of the franchisor’s existing business. The underlying franchise relationship is based on a license agreement known as a “Franchise Agreement” that exists between the franchisor and franchisee.
Typically, the franchisee must pay an up-front fee in exchange for the ability to use the franchisor’s proprietary systems, brand name, trademarks, and marketing materials. While most franchises share a common look and feel from a consumer’s perspective, the franchisor and franchisees operate as independent businesses, and the franchise relationships can vary greatly from one franchise to the next.
The most straightforward franchise relationship is the “direct-unit” or “single-unit” franchise. As suggested by the name, a direct-unit franchise gives a franchisee the right to operate a single franchised business at a single location. Under this model, franchise system growth could be hindered by the need for a new franchise agreement for each individual franchise location. As a result, the alternative “multi-unit” development is often preferred by franchisors and is commonly used to expedite franchise system growth.
Many franchisees initially prefer to enter into direct-unit franchises. Opening and managing multiple franchise locations from the beginning comes with distinct challenges that can lead to complications. Direct-units tend to require more modest investments, which is less of a risk for the franchisee.
Direct-Units have startup costs and overhead are lower than that of a multi-unit franchise. Direct-unit franchisees can expect to see profit sooner than multi-unit franchisees (keeping in mind that their profit is also limited by what can be achieved by their single location).
Multi-unit franchise relationships grant developers the right and obligation to create and operate a set number of franchise locations subject to time and geographic restrictions. Because multi-unit agreements result in a single franchisee operating multiple locations, the franchisor can spend less time and money trying to find multiple franchisees to achieve the same amount of expansion. As a result, franchisors often incentivize multi-unit franchises by passing along some of these savings to multi-unit developers in the form of reduced franchise fees.
Franchisors and franchisees may both enjoy the benefits of a multi-unit franchise relationship. Despite a greater initial investment, greater financial risk, and more responsibility on the part of the franchisee, multi-unit franchises can be much more lucrative in the long run. Having multiple franchise locations means having multiple revenue streams, reduced franchise fees, and the ability to share resources across multiple franchise locations meaning lowered costs and the potential for greater profit margins.
Franchisors also appreciate these advantages, while also being able to spread their franchise geographically for a greater market share and improved brand presence among consumers. Both franchisors and franchisees must be aware that placing too many locations in the hands franchisee could lead to franchise mediocrity if each franchise location is not properly managed and cared for. As a result, it is important to consider a franchisee’s ability to run multiple franchise locations, as well as the standards to which each location should be held.
Differing only slightly from multi-unit franchise relationships, “master franchise” relationships not only require a franchisee to own and operate multiple locations, but they also give franchisees the right and obligation to offer and sell franchises to other potential franchisees. When a master franchise agreement is signed, the master franchisee typically pays a franchise fee to the franchisor. However, because the master franchisee becomes the franchisor in their market area, they also collect a unit franchisee fee from each franchisee they recruit, and they enjoy the benefit of splitting this franchise fee with the original franchisor.
Master franchising relationships create more opportunities for a franchisee’s financial gain. These relationships also require franchisees to take on greater responsibilities by developing and supporting new franchisees within their territory. These additional responsibilities are often better suited for hands-on, managerial-minded franchisees interested in greater involvement with their franchise locations.
From a franchisor’s point-of-view, master franchising relationships require less infusion of cash and often result in rapid franchise expansion. This benefit must outweigh a franchisor’s desire to retain franchise control and to give up a small portion of profits with a franchisee.
Somewhere between a multi-unit franchise and a master franchise is an “area representative”. In an area representative relationship, a franchisee owns and operates multiple franchise locations, however, instead of acting as franchisor in a particular market area, the area representative franchisee acts as a franchise salesperson and field support within the area.
The area representative then shares in the franchise fees and royalties paid to the franchisor as a result of the area representatives efforts as middle-man. Franchisors often enjoy the alignment of incentives between franchisor and franchisee in an area representative relationship. Individuals with good sales skills tend to excel as area representatives, and can be very valuable for franchise growth and expansion.
Do you need help deciding what franchise to open? Read, “The 10 Best Franchises to Open in 2018″
How to Structure Your Franchise Relationship
The way you choose to structure your franchise relationship will depend on the goals and capabilities of the franchise, the franchisor, and the franchisee. Each franchise relationship structure comes with its own advantages and drawbacks, and it is critical to determine the right combination for everyone involved.
The amount of risk and earning potential, the roles and responsibilities of each party, and the alignment of these considerations with the ambitions of each individual all play a role in which type of relationship is best suited for the situation. Ultimately, careful consideration and strategic compromise can lead to a long, fruitful business relationship for both the franchisor and the franchisee.
Are You Ready To Start Your Franchise, Today?
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