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Franchising Basics: Key Elements of a Franchise System and Business

December 15, 2021

For an entrepreneur or any person interested in beginning a new business or growing an existing one, franchising might be an excellent option for entering the market more quickly or growing an existing business more aggressively, and perhaps increasing the probability of success.

If you have a business concept and some success with an existing business, you may be a candidate to be a “franchisor.” Whereas if you are interested in starting a business but want to do so more quickly and with guidance from someone who has valuable experience, knowledge and expertise in your business area of interest, then you may be a “franchisee” candidate.

In a nutshell, franchising is the business of obtaining the rights to use another company’s business model, trademarks/brands, technology (including patents) and know-how, expertise, and experience for a set time period (such as five years or more) and under set rules, requirements, policies, and practices. Franchise fees, royalties, and other payments are made by the franchisee to the franchisor for these valuable rights, and the franchisee incurs most of the costs and investment in obtaining the franchise rights, including launching and developing the franchised business under the “control” and approval of the franchisor.

As a franchisor, the franchise is a way to build a family of stores or businesses to provide services and/or distribute goods that can avoid the substantial monetary investments and legal liability of owning and operating the businesses itself. The success of the franchise and the franchisor depends substantially on the success of the franchisees; as a result, the franchisor is expected, and is incentivized, to provide valuable assistance to the franchisee at all major phases of developing and operating the franchised businesses.

As a franchisee, because of the past success, experience, and assistance of the franchisor, the franchise is a way to launch a business more quickly and possibly with less risk of failure, and greater probability of success, than if the franchisee would simply “do it alone.” Because the franchisee has a direct stake in the operation and success of the business due to their significant investment of money, time, and resources, the franchisee also has great incentive to be successful.

Franchising in the U.S. is essentially governed by state law but is also regulated by federal law via federal rules and regulations enforced by the FTC.

The key elements of a franchise system and business include:

Franchise Application

Similar to an employment application, the franchise application also focuses significantly on the franchisee candidate’s qualifications and experience in business including the applicable industry and, importantly, solid financial assets to begin and support the franchised business.

Franchise Disclosure Document (FDD)

The FDD is a detailed, comprehensive document (typically over 200 pages) covering 23 specific items governed by federal regulation that is intended to provide the franchisee candidate with all the relevant information needed to make a well-informed decision about whether to invest in the franchise and sign a franchise agreement.

Franchise Agreement

This detailed legal document (typically well over 60 pages) covers every aspect of the franchising relationship. It is similar in many respects to the FDD but in an agreement format, including the roles and responsibilities of the franchisor and franchisee and the terms, conditions, and obligations of both the franchisor and franchisee.

Operations Manual

This manual provides the “do’s and don’ts” – sometimes referred to as the “secret sauce” – and all the relevant details of running the business both long term and day-to-day. This document is essentially the franchisor’s knowledge, experience, guidelines, and suggestions provided in writing to the franchisee to help them be successful in their franchised business and to avoid issues and problems with the franchisor and perhaps the law.

Training Program

This provides face-to-face and voice-to-voice details, essentially an extension of the operations manual, to help in running the business day-to-day. The franchisor provides training to the franchisee and its managers and key staff before, during, and after the launch of the franchised business, including giving them regular feedback in developing, growing, and operating the franchised business.

Marketing and Promotion Program

The franchisor must have a program that helps to market and promote the franchised business and support the franchisees as a group, generate greater awareness for the franchise brand and business, and generate new franchises in other territories for the good of the overall “franchised system.”

Whether you are a franchisor or franchisee, it is important to go into franchising with “eyes wide open” and do your homework (“due diligence”). Careful preparation, review, and analysis of the key franchise documents will go a long way to helping you increase your odds of success. It is also important to consider seeking competent, experienced legal counsel because franchising can be complex and legally intensive.

This post was originally published December 11, 2017. It was updated December 15, 2021.

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