Franchising - Explained

Posted on: 01/04/2022

Category: For your business

Franchising is a growth area worth about 17.2 billion in the UK. More people are employed in franchising than ever before as the sector continues to grow. Recently there has been a record rise in females entering the franchising business and franchisees under 30.

In the US, franchise set ups are starting to be heavily regulated but this is not the case in the UK. Having said that there is the British Franchising Association which is a voluntary set up tries to promote a code of ethics for franchising arrangements. They also can offer assistance, know how and contacts for developing a franchise business.

So what is franchising?

It is effectively ‘a business in a box:’ a safe way to become your own boss. It is the grant of a licence by one person, the franchisor to another, the franchisee, to allow the franchisee to trade as their own business under a proven brand and business model.

The franchisee effectively receives a business package in return for paying a fee based on a percentage of their gross monthly receipts. The fees usually consist of the following:

1. An initial start-up fee – this should cover the costs that the franchisor incurs in getting the franchisee set up and running. There is not usually a profit element in this for the franchisor.
2. An advertising levee - this is usual set at around 2.5 – 3% of the gross monthly receipts.
3. A management fee of around 8%.

What is required?

So what documents are required to set up a franchise business? Firstly, there will be a franchisor disclosure bundle (in effect the sales particular of the proven business model). It is important that this is fair and represents fully the business model that the franchisee is buying into. It needs to be honest and truthful particularly as it is often the case that franchisees taking on a franchise business have less experience or financial backing than the franchisor. Although these are business to business contracts, the law of misrepresentation would step in if this part of the process is untruthful.

There may well be a non-disclosure or confidentiality agreement which is entered into pre-contract. This is important because the franchisor will be disclosing a lot of knowledge about their own business prior to the franchisee coming on board. They don’t want the franchisee going off and setting up a competing business!

The franchisor produces an operating manual –the day to day detail of how the business needs to operate. It is a franchisor produced document although there are consultants who can assist with this. Although it needs to fit within the terms of the franchise agreement, it is often prepared before the franchise agreement.

Leases of property – depending on the nature of the franchise business there may well be a lease entered into by the franchisor who then sub-leases to the franchisee or the franchisee takes out a lease direct with the landlord.

A Franchise Agreement – these tend to be very robust legal documents of around 40 pages long. They set out the terms of the marriage and need to try and cover the terms of the relationship in as much detail as possible. They are usually very pro-franchisor and onerous. They have to be to protect the reputation and branding of the franchisor. The franchisee should feel comfortable with this because they know that each franchisee is signing up to the same terms and therefore as a group are operating to promote the brand. The franchisee can rarely negotiate the terms of a franchise agreement but they must be fully aware of what they are signing up to. As a business to business contract the franchisee cannot later say they didn’t understand and try and wriggle out of the contract. It is in both parties’ interest to have certainty and in the best interest of the brand to ensure that all members of the franchise business are connected with similar rights, commitments and obligations.

A properly drafted franchise agreement should deal with identifying the correct individuals or companies, the definition of the business, the fee structure, the rights to renew, the rights to terminate, accounts, insurance, franchisors obligations, franchisees obligations, territory, exclusivity and intellectual property.

Franchising is not heavily regulated by law in the UK but there are a number of legal areas that need to be considered as would be the case with any other heavyweight supply type arrangements or business terms in particular competition law, GDPR and intellectual property.

The agreement must deal with not only the set up and running of the franchise business but also termination or renewal in a robust way. This helps minimise risk and exposure on both sides. The franchisee needs this as they are investing in this business personally and financially and therefore needs some security with that investment. The franchisor needs to know they have a successful motivated and loyal franchisee on board. It is not just about profit for them but also about their brand which can be damaged by a rogue franchisee.

So how could SME help?

For the franchisee, we can go through the franchise agreement in detail and produce a written summary or report so that you know exactly what you are entering into. This could stop any nasty surprises further down the line when you are already bound in.

For the franchisor, legal help is required to make sure that the master document that will run the business is watertight and protects the brand. It is crucial it is correctly drafted. They are often a bespoke document for the business. The legal fees in getting this right are well worth the investment particularly as this document may be rolled out several times over several years.

Why…? Why not?

The advantages of franchising for the franchisor include a cost effective way to grow the business, more limited risk and liability, perhaps speed of growth, easier management, allowing the brand to become more recognisable, allowing businesses to be run by franchisees that may be more motivated than local managers and perhaps receiving the support from the franchisee who may have future ideas for the business.

Some disadvantages for the franchisor are the loss of control, training up the franchisee takes time, providing the infrastructure and resources and capital to allow the growth of the franchisee network, dealing with fully performing franchisee, lack of direct customer contact and issues surrounding confidentiality.