For many entrepreneurs and aspiring business owners, the prospect of starting a new business from scratch can be daunting, overwhelming, or even impossible due to financial restrictions on business loans. For these individuals, an alternative to forming a completely new business is the prospect of franchising, which allows an owner to “start” a new business venture while relying on the institutional knowledge and structure of an existing enterprise.
A franchise is the expansion of an existing trademark, service, or advertising approach to a new location through a business arrangement between the existing owner of the trademark or service and a new individual or group who would like to use that trademark or service to start a new business that expands upon the owner’s existing set-up. A franchise agreement is created that sets forth the relationship between the franchisor (the existing owner) and the franchisee (the new business partner). Often, the franchisee will replicate the franchisor’s business model in a new location, or will sell goods or services also offered by the franchisor. In so doing, the franchisee allows the franchisor to expand into a new market that he or she might not otherwise be able to reach, while the franchisor provides the franchisee with business advice and guidance that would be unavailable if the franchisee had simply started his or her own business from scratch.
Elements of a Franchise
Franchises are governed by the United States Federal Trade Commission (“FTC”) and relevant state franchise laws. According to the FTC and its laws, a business relationship must have three components in order to be a franchise. First, the franchisee must have been given the right to provide goods or services under the trademark, service mark, trade name, logo, or other symbol of the franchisor. Second, the franchisor must retain significant control of or provide significant assistance to the franchisee’s business. For instance, the franchisor may require the franchisee’s business to look similar to the original business, to participate in the same promotional and sales campaigns as the original business, or to provide franchisor-approved training programs to all employees. Third, the franchisee must be required to pay a certain amount of money to the franchisor as a “fee” or “payment” for the trademark and services that the franchisor has provided.
1The franchisee has the right to sell goods or services under a symbol of the franchisor
2The franchisor retains significant control over or provides significant assistance to the franchisee
3The franchisee is required to pay the franchisor a fee
Franchises are subject to strict regulation by the FTC and states, including regulation of the business relationship between the franchisor and franchisee, disclosure requirements, and registration requirements. For this reason, it is very important for potential franchisees to carefully consider the FTC’s rules and regulations, as well as the laws of their state, before formally agreeing to a franchising relationship.
Types of Franchises
Franchises may vary depending on the degree of involvement of the franchisor in the business practices of the franchise. One type of franchise relationship is known as product or trade name franchising. This occurs when the franchisee merely contracts with the franchisor to use the product, trademark, trade name, or commercial symbol of the original franchisor. A common example is a car dealership, where the franchisee sells the cars bearing the symbol of the franchisor. The second type of franchise relationship involves a more long-lasting business relationship, where the franchisee agrees to operate a business under a format virtually identical to that of the franchisor, know as “business format franchising.” In this type of a franchise, the franchisee imports not only the trademark or products of the franchisor, but also the business model as well. This is most commonly seen with businesses such as fast food companies.
Product / trade name franchising = using a franchisor’s product, trademark, trade name, or commercial symbol Business format franchising = operating according to a format or scheme virtually identical to the franchisor’s
Weighing the Pros and Cons of a Franchise
Determining whether to pursue a franchise as opposed to a new independent business is a difficult decision, and it often involves a close consideration of your own individual tolerance for risk or joint ownership. While a franchise offers significant opportunities for profit without the risk of starting a completely new business, it also often means relinquishing significant portions of control to an existing franchisor. Additionally, no matter the extent to which the profits of your business may be a result of your own hard work, they will likely be subject to a percentage take by the franchisor as well as possible fees for training, equipment, and products.