What is a franchise?
Understanding franchises and what to look out for
Karen Edwards is an experienced associate solicitor, listed as a rising star in the Legal 500. Here, she looks at franchising, and gives an introduction into how a franchise business model works, and what to look out for when considering whether to purchase an existing franchised business or starting up in a new territory.
How the franchise business model works
Franchising is a business model which essentially enables one party (the franchisor) to grant a licence to another party (the franchisee), allowing the franchisee to operate their own business using the franchisor’s brand.
Why take on a franchise?
There are several advantages to trading under a franchise. The franchisee has the comfort of knowing that they can enter into their chosen market using a proven business model. They are equipped with a start-up package, provided by the franchisor that often includes things like marketing and promotional materials, price guides, terms and conditions and items such as uniforms, staff handbooks and training manuals.
What to look out for
Typically the franchisor will exercise regular quality control over the franchisee and be on hand to offer continuing guidance, which can mean that someone who is previously untrained in the type of business being franchised, is capable of running it.
However, a franchisor will likely operate very strict controls over a franchisee as to almost every element of how the business is run; from what suppliers the franchisee uses, to what they must spend on advertising every year. The franchisee also has to account to the franchisor for commission and other fees, and usually has various performance targets to meet.
Can you get out of or sell a franchise?
Of particular importance is the franchisee’s rights on exit. A franchisee should ensure that within a franchise arrangement, they are able to not only grow the business to a point where it has some sale value, but also that they are able to realise that value.
Usually, a franchisor will give the franchisee the ability to sell the franchised business to a third party, subject to the franchisor having a first right of refusal. In the event that the franchisor does not wish to purchase, the franchise agreement will likely stipulate that the acquiring third party has to be approved by the franchisor and must also satisfy certain criteria.
Karen Edwards comments:
“I have seen various cases whereby a franchisee has either built up a business from scratch, or has paid a purchase price to buy an established franchise, but has been precluded from exiting for a fair price because the criteria of the buyer is so stringent. It is vital that a franchisee properly negotiates the exit provisions in their franchise agreement to ensure that they do not fall into this trap.”
What happens at the end of a franchise term?
It is also worth noting that once the franchise term comes to an end, the franchisee will no longer have the right to trade using the franchisor’s brand so would effectively have to cease the business.
Therefore, if a franchisee is looking to realise some value for the business they have built up (prior to expiry of the franchise term) they should ensure that the agreement gives them the ability to try to sell the business without the franchisor imposing overly cumbersome or unrealistic criteria.
Should I buy a franchise?
As with all business structures, it is important to understand both its positive, and perhaps less attractive, traits so that you can decide if it the right venture for you.
Franchising should not be entered into lightly, but it can prove to be a relatively easy and quicker way to start a business than it would be building a business from scratch. Whilst the element of control exercised by, and the financial accountability to, the franchisor may be too much for some, the reduced risk of the business failing and the ongoing support may be just right for others.
Franchise agreement advice
If you are considering entering into a franchise agreement, we would strongly advise you seek legal advice.
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