If you are like many business owners or entrepreneurs with whom we work, you have likely been asked about franchising recently — whether by a friend, customer, or potential business partner. But what is franchising? Should you or your business consider it?
At its simplest, franchising is renting (or leasing) a business opportunity from another person or entity. Accordingly, franchising can be an intriguing option to enter a new market or industry more quickly or grow your existing business more aggressively, whether you are an entrepreneur interested in starting a new business or a business owner hoping to expand an existing venture. If you have a successful existing business concept, you may be a good candidate to be a franchisor. Whereas, if you have interest in starting a business but want to do so more quickly and with guidance from someone having valuable experience, expertise, and established success in your area of interest, then you may be a candidate to be a franchisee.
Franchising is the business of utilizing another company’s (the franchisor’s) business model, brands and intellectual property, technology and know-how, expertise, and experience for an established period of time (typically at least five years) under specific rules, requirements, procedures, and practices. Franchise fees, royalties, and other payments are made by the franchisee to the franchisor in exchange for these rights, and the franchisee incurs most of the costs and investment in obtaining the franchise rights, including launching and developing the franchised business.
As a franchisor, the franchise is a way to build a family of businesses or “stores” to provide services and/or distribute goods in a manner that avoids the substantial monetary investments and legal liability of owning and operating the businesses yourself. The success of the franchise and the franchisor depends substantially on the success and hard work of the franchisees; therefore, the franchisor is expected, and is incentivized, to provide significant assistance and training to the franchisee at all stages of developing and operating the franchised business. This franchisor assistance and training, along with having an established or recognizable brand, is a key ingredient to franchise success.
As a franchisee, because of the past success, experience, and assistance provided by the franchisor, the franchise is a way to launch a business more quickly and, possibly, with a greater probability of success than if the franchisee would “go at it alone.” Because the franchisee has a direct stake in the operation and success of the business due to its significant investment of money and time, the franchisee also has great incentives to be successful.
Franchising in the United States is governed by state law but is also regulated by federal law via federal rules and regulations enforced by the Federal Trade Commission ( FTC).
The key elements of a franchise business and “system” include:
Franchise Application
This is similar to an employment application but also focuses significantly on the franchisee candidate’s qualifications and experience in the applicable business industry and solid financial assets and position.
Franchise Disclosure Document (FDD)
This is a detailed, comprehensive document 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 whether to invest in the franchise and sign a Franchise Agreement.
Franchise Agreement
This is a detailed legal document that covers every material aspect of the franchising relationship – similar in many respects to the FDD but in a contract setting. This document includes the key roles and responsibilities of the franchisor and franchisee, and all the material terms, conditions, and obligations of both the franchisor and franchisee.
Operations Manual
This is the nuts and bolts — the “dos and don’ts” — and all the relevant details of running the franchised business day-to-day. It’s sometimes referred to as the “secret sauce” of the franchised business. This highly confidential document is intended to provide the franchisor’s knowledge, experience, thoughts, guidelines, and suggestions in writing to the franchisee to help it be successful in its franchised businesses and “stay out of trouble” with the franchisor and perhaps the law.
Assistance and Training
This is essentially an extension of the Operations Manual, providing “hands-on” help in running the business day-to-day; the franchisor provides training and ongoing assistance to the franchisee and its managers and key staff before, during, and after the launch of the franchised business, including giving constant feedback in the development, growth, and operation of the business.
Marketing and Promotion
The franchisor must have a program that markets and promotes the franchised business to help support the franchisees as a group, generate greater awareness of the franchise brand, and develop new franchises in other territories.
Importantly, whether you are a franchisor or franchisee, it is imperative not to rush into franchising. Careful preparation, review, and analysis of the key franchise documents will go a long way to helping you increase your probability of success. It is also important to consider utilizing legal counsel with relevant, meaningful franchise experience and expertise since franchising can be very complex and legal intensive.
If you are considering launching or investing in a franchise or have any questions related to franchising or licensing, contact our franchise legal team led by Varnum partner Timothy K. Kroninger.
For additional information, please see our advisory Exploring Franchising: Legal and Business Considerations for Launching a Successful Franchise.
This post was originally published December 11, 2017. It was updated March 15, 2024.
