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Franchise Definition
What is a franchise?
If you are new to franchising, then the first thing you need to know is the answer to the quesion: "What is a franchise?" A franchise is a business operating under a privilege granted to make or market a trademarked or patented good or service under a trademarked company. This company, a franchisor, allows the interested party to purchase and run the company in a specific area or territory and provides them the tools to succeed.
There are several reasons an entrepreneur will choose to open a franchise insead of starting a business from scratch. The biggest advantage is the reduction of risk. Franchises are usually up and running much more quickly that new businesses, and are therefore usually more profitable more quickly. One of the most important attributes purchased when one buys a franchise is the business model. Since the business model is already in place, the trial-and-error of opening a new business is already completed and you are able to start focusing on growing your business right away.
Another advantage is the managerial know-how and resources. Franchisors already have experience running their company successfully, and they pass on their solutions for success -- including marketing, operations, pricing structures, and partnerships -- to their franchisees.
In order to better understand franchising, take a look at the list of common franchising terms below.
Common Franchising Terms
Franchisor: A franchisor is a company that owns the brand, trademarks, and products of a company and gives the right to franchisees to purchase and run a franchise location.
Franchisee: A franchisee is a purchasor of a franchise who then runs the location of the purchased business. The franchisee is responsible for certain aspects of the business, but many decisions are predetermined by the franchisor and must be kept by the franchisee.
Franchise Disclosure Document (FDD): A franchise disclosure document discloses detailed information about the franchisor and the franchise organization. This document is intended to give potential franchisees enough information to make an educated decision about their investment. This document will detail information about the franchisor any any affiliates, litigation history, fees and expenses, training, advertising costs, franchisee obligations, franchisor obligations, renewal and termination terms, territory designation, and earnings claims.
Receipt Page/Acknowledgement of Receipt: When you receive a Franchise Disclosure Document, you will be asked to sign a receipt page or acknowledgement of receipt. This is not any sort of binding contract, it simply puts on the record the date on which you received the FDD. A prospective franchisee must receive a franchisor's FDD at least 14 days prior to signing any contract or paying any money to a franchisor. All signing a receipt page means is that you've received the FDD agree to consider it.
Franchise Agreement: A Franchise Agreement is the legally binding contract between a franchisee and franchisor signed when a franchisee purchases a franchise from a franchisor. The franchise agreement will contain the FDD, will define the franchisee's territory area, start date, trade name, etc., details licensed rights, franchisor services, franchisee payments, and franchisee/franchisor obligations.
Initial Franchise Fee: In order to purchase a franchise, you will usually be required to pay an initial franchise fee. This fee can also be called an up-front entry fee. The initial franchise fee grants a franchisee the rights to use the name and system, and sometimes operational procedures, training, manuals, and other franchisor-provided assistance. It does not include build-out fees, which include inventory, fixtures, rent or real estate costs, or furniture.
Royalty Fee: Royalty fees are ongoing payments from franchisee to franchisor. The amount a franchisee pays in royalty fees is usually based on some percentage of overall net sales of the franchise, but can also be a fixed fee or based on a sliding scale. The royalty terms will be spelled out in the FDD and Franchise Agreement.
Advertising Fund: It is typical for a franchisor to require regular contribution to an advertising fund. These funds are usually put into a general account that will be used for marketing efforts affecting the entire franchise. These efforts can include television campaigns, web-marketing campaigns, graphic design costs and promotional material creation. The fee required toward an advertising fund will be detailed in the FDD and Franchise Agreement and can be based on some percentage of overall net sales, can be a fixed fee, or can be based on a sliding scale.
Uniform Franchise Offering Circular: Same as Franchise Disclosure Document (FDD) described above
