Fran­chising: gaining in­de­pend­ence through part­ner­ship

You are a committed young en­tre­pren­eur and have a burning desire to start your own business. However, you don’t have a concrete business idea, you lack sales ex­per­i­ence, or maybe the market entry barriers are just too big. There are also plenty of “big players” who have already somehow managed it. These suc­cess­ful busi­nesses already have a func­tion­ing business concept, harbour in­flu­en­tial re­la­tion­ships, and have the necessary capital. How tempting would it be to just get involved in a business that is already suc­cess­ful without having to give up your appetite for in­de­pend­ence? Fran­chising might just be the right choice for you. Here, we explain how it works.

The French term “franchise” refers to granting certain priv­ileges to others. After several changes in meaning through­out history, this term now primarily refers to priv­ileges of an economic nature. “Fran­chising,” also called “con­ces­sion purchase”, is in this sense a form of dis­tri­bu­tion based on a part­ner­ship between two parties: the fran­chisor who sells the rights to use their brand (i.e. brand name, logo, design, business idea, and dis­tri­bu­tion rights to products and services), and the fran­chisee who receives these trans­ferred rights. This part­ner­ship forms a “franchise system.” Due to the division of labour and synergies, both par­ti­cipants usually benefit from fran­chising, creating a win-win situation.

Due to in­creas­ing market entry barriers (es­pe­cially with regard to financing), it is becoming in­creas­ingly difficult for committed young en­tre­pren­eurs to set up their own companies. The need to be a self-employed all-round talent in all things related to creating a business (business, financial, and legal aspects) is already nipping many en­tre­pren­eur­i­al spirits in the bud.

If this effort also makes you shy away from setting up a business, then fran­chising could be an in­ter­est­ing al­tern­at­ive. By in­teg­rat­ing yourself into an already-es­tab­lished business model, a large part of the or­gan­isa­tion is taken care of for you. This allows you to enter the market much quicker and easier than if you were self-employed outside a franchise system. Your fran­chisor’s ex­per­i­ence and resources reduce the risks of setting up a franchise – and can also protect you from common mistakes made by many beginners. Nev­er­the­less, you remain legally in­de­pend­ent at all times – you alone are re­spons­ible for your business.

A fran­chisor is usually driven by mo­tiv­a­tion to further expand their business activ­it­ies and advance their company eco­nom­ic­ally. Fran­chising offers them the op­por­tun­ity to expand quickly into new markets without having to set up and manage their own branch systems. Fran­chising is therefore also regarded as an efficient, low risk form of in­ter­na­tion­al­isa­tion for good reason. A stronger effort to spread the brand brings added value to the customer, whilst the company becomes more at­tract­ive to regional suppliers at the same time. In this way, profits can be increased in the long term.

Fran­chisors see their fran­chisees as strong allies. In contrast to employees, they are demon­strably more motivated, work harder, and often have local re­la­tion­ships and knowledge. The proximity of fran­chisees to regional markets also allows the fran­chisors to react quickly and flexibly to the needs of end consumers and to con­tinu­ously adapt and further develop the business model.

Franchise systems are becoming in­creas­ingly popular as a counter-model to tra­di­tion­al forms of dis­tri­bu­tion and are often also competing with larger cor­por­a­tions. They can be found in a broad range of in­dus­tries: retail (The Body Shop), education (Spaghetti Maths), and real estate (Engel & Völkers), while some opticians (Pearle Vision) and fitness studios (Curves) work together with in­de­pend­ent company founders.

The franchise sector is becoming more and more important globally. Most of them belong to the service sector (tutoring, sports programs, car rental, and cleaning services) followed by retail trade and crafts. Fran­chising is also wide­spread in catering and food services – the most well-known fran­chisor in this sector is certainly the fast food giant McDonalds.

There are three different types of com­mer­cial franchise systems:

• Product fran­chising is when there is just one specific product or product group sold by the fran­chisee (e.g. Coca Cola)
• Service fran­chising is where the part­ner­ship agreement relates to a par­tic­u­lar service (e.g. Subway)
• Wholesale fran­chising is where the man­u­fac­turer supplies a whole­saler with material, equipment, and know-how to complete a product and pass it on to the retail trade for dis­tri­bu­tion (e.g. Ikea)

The franchise approach is also in­creas­ingly being adapted in social projects. This “social fran­chising” transfers the concept, which is in fact highly com­mer­cial, into the non-profit or­gan­isa­tion area. This is not about expanding a business, but instead about the (in­ter­na­tion­al) dis­sem­in­a­tion of a social idea or a char­it­able project. Franchise donors in this case are, for example, found­a­tions or non-profit as­so­ci­ations that have already achieved a certain degree of awareness.

The franchise systems they set up work in a similar way to their economic equi­val­ents. First, fran­chisees are con­trac­ted, receive a manual with in­struc­tions, and are trained in their future activ­it­ies. As a rule, no fees are charged, but the fran­chisor has access to valuable data records that can help with the further de­vel­op­ment of the project.

Basically, every company founder can set up their own business as a fran­chisee. Before choosing to, however, you should first really consider whether or not this dis­tri­bu­tion system is really appealing to you. Whilst working with an es­tab­lished company will take some work off your hands, you still need to fulfil a number of tasks and re­quire­ments before you can of­fi­cially open your franchise.

When you begin, you need to choose what kind of franchise system suits you. If you want to save yourself the hassle of searching online, you can try out this portal to assist you.

You can search for op­por­tun­it­ies using filters like industry, low cost fran­chises, or new fran­chises. Detailed profiles of each company provides you with a de­scrip­tion of the en­ter­prise, as well as in­form­a­tion about the year of es­tab­lish­ment, the history of the business, and the entrance fee as well as current fees and net worth required.

Ad­di­tion­al research is of course, in­valu­able, when it comes to selecting a franchise to invest in. News and press releases are a rich source of in­form­a­tion. During your selection process, you should consider the following questions:

• How con­vin­cing and future-oriented is the business concept?
• Are in­nov­at­ive/risks or proven/outdates products and services on offer?
• What about the rate of growth of the company?
• What is the current market situation in the industry like?
• How strong is the com­pet­i­tion?
• How many fran­chisees are there?
• What is the fluc­tu­ation rate among fran­chisees?
• How are the fran­chises geo­graph­ic­ally dis­trib­uted?
• Has there been any negative publicity or scandal recently?

If you are in­ter­ested in a franchise system, you can request in­form­a­tion through the Franchise Direct website. You can then apply for a franchise, and if you’re lucky, be called in to interview or receive a follow-up phone call. Be sure that the in­form­a­tion you receive is truthful, com­pre­hens­ible, complete, and veri­fi­able. You may also be offered a chance to sit in on another branch so that you get an idea of how the business is run.

The details of a franchise part­ner­ship are outlined in a franchise agreement. This agreement regulates, amongst other things, a specific co­oper­a­tion period, all im­ple­ment­a­tion re­quire­ments, as well as the legally compliant transfer of usage rights and licenses.

Special attention should be paid to the fees charged by the fran­chisor in order to amortise the capital invested in you and ul­ti­mately generate profits. This includes:

• The entry fee com­pensates (at least partly) for the costs incurred by the fran­chisor in de­vel­op­ing and im­ple­ment­ing their franchise system. It is also used to cover part of the opening and operating costs for your franchise. In the case of smaller busi­nesses, $5,000-15,000 is a common sum, but for larger busi­nesses in­vest­ment sums can be $100,000 or more.
• The fran­chisor collects franchise fees, also known as ongoing fees, as a fixed per­cent­age of your net revenue on a monthly or quarterly basis. This usually ranges from between 5-10%.
• In addition to the entry fee and ongoing fees, some franchise contracts also charge ad­vert­ising fees to finance and implement ad­vert­ising materials and marketing campaigns.

The majority of fran­chisors also set a minimum amount for the equity capital you need to be able to raise when setting up your franchise business. Whilst this can vary greatly, most fran­chises in the UK require between £50,000-200,000. If there is no concrete amount specified, a ratio of 20:80 from equity and debt capital is re­com­men­ded for financing. By using your own funds, you aren’t just proving your own cred­it­wor­thi­ness, but you are also signaling to your fran­chisor that you are willing to take risks and have con­fid­ence in the business idea.

Overall, a good franchise system presents you with fewer financial hurdles than other forms of self-em­ploy­ment. If financing is still a problem, there are a number of ways you can get access to external capital:

• Since franchise systems are tried and tested concepts, you generally have a better chance of obtaining loans and other financial support than for a solo self-employed project.
• If this argument is not enough, you can also refer to the fran­chisor’s repu­ta­tion when making your case to the bank. As a rule, the fran­chisor can provide you with documents, data, and com­par­at­ive figures that will strengthen your ne­go­ti­at­ing position.
• Although it might require more effort (and sometimes luck), you can undergo a personal search for investors or make a call for crowd­fund­ing. 
• In addition, there are public pro­mo­tion­al programs for fran­chising offered by most banks.

Within the part­ner­ship, the fran­chisor doesn’t just determine the rules, they also act as a “mentor” of sorts for the fran­chisee with their extensive business ex­per­i­ence. The fran­chisor fulfils this role by offering (before the contract is signed) struc­tured training and/or further education, which gives you the necessary know-how to operate your franchise. In addition, you will usually receive a com­pre­hens­ive manual de­scrib­ing in detail how to run your franchise.

Strict guidelines for man­age­ment, personnel policy, marketing, sales, con­trolling, book­keep­ing, and reporting are intended to achieve a uniform ap­pear­ance for all franchise op­er­a­tions, since a ho­mo­gen­ous corporate identity increases brand re­cog­ni­tion value. However, the strong stand­ard­isa­tion of business processes also implies that you have little or no freedom to design your own business or to directly influence the de­vel­op­ment of your core business. If you are striving for “real” in­de­pend­ence, this cir­cum­stance may be a difficult one for you.

Here is a summary of your most important duties:

• Con­sid­er­ing the con­trac­tu­ally agreed prin­ciples
• Adhering to the corporate identity
• Active co­oper­a­tion with the fran­chisor
• Reporting regularly and in detail
• Implement ad­vert­ising measures as pre­scribed
• Attend necessary seminars and training courses

What do you get in return for your com­pli­ance? Here is an overview of the benefits you can expect in a good franchise system:

• The guarantee of a func­tion­ing, proven business concept
• Usage rights for the entire corporate identity, as well as dis­tri­bu­tion rights for products and licenses for services
• Help finding a location for your business
• A local monopoly, also known as ter­rit­ori­al pro­tec­tion, within the franchise system
• Support in setting up and opening your office
• Access to the fran­chisor’s IT systems (e.g. the mer­chand­ise man­age­ment system)
• Support in setting up dis­tri­bu­tion channels and re­cruit­ing personnel
• A wide range of financial as­sist­ance, like favorable pur­chas­ing con­di­tions (e.g. cost ad­vant­ages for office supplies), loans, rent subsidies, graduated fees, supplier and commodity credits, as well as the provision of financing, liquidity, and prof­it­ab­il­ity plans to prove eli­gib­il­ity for funding to banks
• Possible insurance options
• Help with the or­gan­isa­tion of an opening campaign, and the provision of ad­vert­ising material and other pro­mo­tion­al activ­it­ies

Do you yourself have a suc­cess­ful company and are con­sid­er­ing es­tab­lish­ing a franchise system? Then you should first ask yourself the following questions:

• Do I have a clearly defined business idea?
• Is this business idea com­pet­it­ive in the current market en­vir­on­ment?
• Can I make clear demands of any fran­chisees I might get?
• Do I have enough en­tre­pren­eur­i­al ex­per­i­ence for this expansion project?
• Do I have secure financing for my project?
• Have I already suc­cess­fully tested my business idea?

The last question, in par­tic­u­lar, should be a re­sound­ing yes. Generally it is necessary for fran­chisors to have at least one, or prefer­ably more func­tion­ing test or pilot companies. These are con­sidered suc­cess­ful if they have been in operation for at least one to two years and have been con­tinu­ously optimised on the basis of the ex­per­i­ence gained.

You will need to advertise your franchise di­li­gently so that potential fran­chisees can find you. You should take time to create a clear re­quire­ment profile that covers not just vo­ca­tion­al training and en­tre­pren­eur­i­al ex­per­i­ence, but also financial re­quire­ments and soft skills. Some fran­chisors also hire special re­cruit­ment agencies to meet their need for new sup­port­ers. However, you shouldn’t get frus­trated if the search doesn’t work right away – a rule of thumb says that 100 first attempts never result in a contract.

As soon as you have entered into a part­ner­ship, remember that a fran­chisor also has certain ob­lig­a­tions and re­spons­ib­il­it­ies towards their con­trac­tu­al partners. A re­la­tion­ship based on mutual trust and seeing eye to eye is par­tic­u­larly em­phas­ised. Trans­par­ency in decision making is important on both sides.

Sur­pris­ingly, there is no body in the UK re­spons­ible for franchise reg­u­la­tion. This is because the UK does not have any franchise specific laws, instead fran­chises are subject to general UK business laws. The British Franchise As­so­ci­ation are a non-legal entity who promote and accredit aspects of fran­chising in the UK. However, as there are no specific laws or specific body reg­u­lat­ing fran­chises, the UK does not have a legal defin­i­tion for fran­chises. They instead use the European Franchise Fed­er­a­tion’s defin­i­tion:

“Fran­chising is a system of marketing goods and/or services and/or tech­no­logy, which is based upon a close and ongoing col­lab­or­a­tion between legally and fin­an­cially separate and in­de­pend­ent un­der­tak­ings, the Fran­chisor and its in­di­vidu­al Fran­chisees, whereby the Fran­chisor grants its in­di­vidu­al Fran­chisee the right, and imposes the ob­lig­a­tion, to conduct a business in ac­cord­ance with the Fran­chisor's concept.” (Source: European Franchise Fed­er­a­tion)

Despite there being no franchise specific le­gis­la­tion, there are a few key laws that fran­chisors and fran­chisees should be par­tic­u­larly know­ledge­able of. Fraud laws are ap­plic­able, par­tic­u­larly the Mis­rep­res­ent­a­tion Act of 1967, however, there is still no re­quire­ment to provide fran­chisees with a dis­clos­ure document before signing a contract as is standard in the US.

Other important laws to bear in mind are the Fair Trading Act of 1973, the Trading Schemes act of 1996 and the Trading Schemes Reg­u­la­tions of 1997. Whilst these laws are intended to regulate pyramid schemes and multi-level-marketing op­er­a­tions, they would also make fran­chising illegal if it were not for the Trading Schemes (Exclusion) Reg­u­la­tions of 1997. This reg­u­la­tion states that an agreement is exempt as long as:

• The franchise runs as a single-tier trading scheme, and
• That all fran­chisees are re­gistered for VAT at all times.

If you are a fran­chisor or fran­chisee and choose to join the British Franchise As­so­ci­ation, you will be required to adhere to their Code of Ethical Conduct. This code should not be included in any con­trac­tu­al agreement unless already agreed upon, and is intended only to provide guidelines. The most pertinent re­quire­ments for the Code of Ethical Conduct state that:

• A pro­spect­ive fran­chisor must test out the idea before starting to sell fran­chises
• There are specific re­quire­ments per­tain­ing to the return of pre­lim­in­ary deposits.
• Any ad­vert­ising intended to recruit fran­chisees must be clear and truthful
• Any and all dealings between fran­chisors and fran­chisees must be handled fairly.

More in­form­a­tion on the BFA and their Code of Ethics can be found on their website.

In general, fran­chising offers more ad­vant­ages than dis­ad­vant­ages for all parties involved. Nev­er­the­less, there are a few risks that need to be con­sidered. These include the fact that the win-win situation with a franchise system always arises from a com­prom­ise: with the help of committed sup­port­ers, a fran­chisor can expand their business, but forgo their turnover. The fran­chisee, on the other hand, can draw on existing expertise and resources to set up their business, but also needs to adhere to clear rules and have virtually no op­por­tun­ity to help shape their business or the core company.

Another par­tic­u­lar risk is the close re­la­tion­ship between the two parties: if an in­di­vidu­al business is perceived neg­at­ively, this can affect the image of the entire brand. The fran­chisee’s business suffers if there are problems with col­leagues or at headquar­ters. An un­sat­is­fact­ory buying ex­per­i­ence can change a customer’s per­cep­tion of the company as a whole. In addition, negative publicity from social media and the internet is spreading faster than ever before. It’s not par­tic­u­larly helpful that fran­chising enjoys a rather ques­tion­able repu­ta­tion in parts of society anyway as an “exploiter concept” or “bogus self-em­ploy­ment” – at­trib­uted to the few black sheep in the industry.

In the following overview, we have once again sum­mar­ised for you the ad­vant­ages and dis­ad­vant­ages of fran­chising for both fran­chisees and donors:

In recent years, it has become in­creas­ingly difficult for committed young en­tre­pren­eurs to overcome the numerous barriers to market entry on the way to setting up a business. Fran­chising can help you to fulfil your dream of economic in­de­pend­ence after all. However, not everyone is made for the role of a fran­chisee: if you not only want to be legally in­de­pend­ent, but also have creative and en­tre­pren­eur­i­al freedom in your business design, you will probably be dis­ap­poin­ted by the sales model, because you must play according to the rules of the fran­chisor. In this case, the in­di­vidu­al of founding of a company might be the better choice.

If you are still in­ter­ested in the concept of a franchise, you should carefully examine your partner company and the con­trac­tu­al basis. Is it a proven business model? Are there already many fran­chisees? Is the re­la­tion­ship between fees and services right? If you can answer these questions with a clear “Yes” after suf­fi­cient pre­par­a­tion and research, chances are good that you will profit fin­an­cially from fran­chising.

Please note the legal dis­claim­er relating to this article.