Franchising as a business model – the pros and cons

There are 2 roles in the franchising business model: franchisors and franchisees.

We’ll take a look at each of these roles below, including the pros and cons of the model for each party, as well as why a franchise model is a popular approach to scaling your small business.

A franchisor is…

…a business that allows other businesses to trade under their brand and according to fairly strict operating conditions in exchange for a fee.

By doing this, franchisors are able to expand into new geographical areas quickly, increasing their market share and at the same time, sharing the commercial risk of expansion.

Check out our Guide for Franchisors

Who’s responsible for what?

While a franchisor will need to foot the bill for specialist equipment, branding and marketing materials and sometimes also staff training, it’s the franchisee who has the responsibility of taking care of the day-to-day running of the business, including recruitment, sales, and logistics.

The franchisee will normally also have responsibility for the costs and upkeep of any premises from which the franchise business is operated and will typically carry the risk in stock, deliveries, insurance and operational liabilities.

Complaints are also likely to be the responsibility of the franchisee on a day-to-day basis.

But of course, with this expansion model, comes a lack of control for the franchisor and a reputational risk also – so they need to be able to trust those with whom they start a franchise relationship (and have a strong contract in place, of course, which amongst other things, permits regular auditing and quality control checks of the franchisee’s operations, record keeping and data).

The idea of a franchise is that the branding and customer experience is the same wherever the franchise is – and therefore, customers shouldn’t even be aware that the business is a franchise at all.

Protecting IP and reputation

This is all good in practice, providing that the rules are followed by the franchisee.

But if the rules aren’t followed, or if creative license goes a little too off brand, the franchisor’s reputation may be damaged.

This is why most good franchise agreements will include robust rights for the franchisor to enforce certain behaviour and include comprehensive audit permissions, which, if not complied with, will result in a breach of the franchise agreement and empower the franchisor to take action to protect itself, including terminating the franchise agreement and seeking compensation for any damage caused.

One more thing to consider is that becoming a franchisor will automatically give you a loosening of your confidentiality, IP and data security.

After all, in order to allow others to use your brand, you’ll need to share intellectual property with them and trade secrets.

So, you’ll need to be comfortable with that, and also have suitable clauses in your franchise agreement that states how that information must be handled and how your IP rights will be protected.

Check out our Intellectual Property hub to find out more about IP rights.

A franchisee is…

…a business who pays a fee to trade under the brand of another business.

As the franchisor already has market share, the franchisee has a head-start on building a positive reputation with both potential customers and business contacts.

This can make getting sales easier than it would be if the business started out on its own, and equally, it can help the business get funding easier than if they were to apply without the franchise connection.

So, it gives an element of independence, and is a step-change from managing someone else’s business as an employee but provides the certainty and security of working under the umbrella of a proven brand.

Check out our guide for franchisees

Fees

The franchisee does need to pay the franchisor a fee (known as royalties) for the right to use their brand – but generally, thanks to the franchisor, they don’t need to pay for company assets such as equipment, branding and marketing materials.

They will, however, need to pay an initial fee for the set-up costs to ensure that they are ready to open up business as a franchisee, and these costs will be largely dictated by what the franchisor requires.

The general principle is that the franchisor’s initial services (including training), should be sufficiently comprehensive to establish a previously inexperienced business owner as an effective franchisee from the moment that he/she starts trading as an authorised franchisee.

After that, fees are usually regularly paid by the franchisee to the franchisor for the ongoing benefit of being part of the franchise.

These fees tend to cover the franchisor’s ongoing costs of producing materials, promoting the franchise and running the franchise.

They may also include the costs of performance monitoring across the franchise ecosystem, to help maintain standards and profitability, field support to verify compliance with these standards, continuing updates of methods and new innovations and market research and development by the franchisor or those it engages to assist it.

Fees commonly range between 10–15% of the franchisee’s overall revenue.

And the franchisee should be just as entitled to verify that these fees are fair and justified, as the franchisor is to audit the revenue reported by the franchisee.

Rules, requirements and obligations

While, as discussed earlier, a franchisor has lack of control with this business model…the same can be said for franchisees.

By operating under another business’ brand there are a whole host of rules and regulations that they will need to follow.

Even the franchisee’s ability to sell or transfer the business can be subject to restrictions imposed by the franchisor.

And of course – if the franchisor goes out of business – or equally, if they go into debt, or otherwise encounter operational or reputational difficulties – the franchisee will be affected by those circumstances too.

When it comes to the franchise agreement, it shouldn’t come as a surprise to a franchisee of a well-established franchise to hear that the agreement ‘is what it is and is not negotiable’.

This is not at all unusual.

Franchise agreements are generally very unilateral in nature.

This is because the franchisor will want all franchisees on uniform terms in support of the integrity of the brand and its own quality controls (and it will of course have the greater bargaining power as a result).

If you don’t like these terms, you’ll probably need to find an alternative franchise opportunity.

In actual fact, a franchisor who is willing to negotiate on key elements of a franchise agreement for an established franchise might well sound a warning alert for a prospective franchisee.

An overly willing negotiating stance could indicate that the franchise is not so stable as it should be, or at least, not as well run.

The rules aren’t just for the protection of the franchisor either.

Many of them equally protect other franchisees from the potentially damaging actions of a franchisee who ‘goes rogue’.

Fellow franchisees would expect the franchisor to have the contractual force to protect their business reputation and revenues in the event of damaging conduct by someone else.

Do your research

Franchisees should do their ‘due diligence’ (background checks) on a franchisor ahead of signing any paperwork, a part of such research being to talk to existing franchisees and understand their experience of the franchisor’s system.

You may not be able to change the contract terms, but you can and should understand what signing up to them will really mean for your own business aspirations.

Before you decide on either option…

Becoming a franchisee

If you’re thinking of becoming a franchisee, it’s paramount that you check with the franchiser that they’ve provided you with absolutely everything you need to weigh up exactly what’s required in running the franchise and decide if it’s definitely something you want to do.

Do talk to fellow franchisees who are already part of the system and check whether the franchise is a member of the Irish Franchise Association (IFA), which has a code of ethics in relation to franchising operations that are specifically designed to protect franchisees from being unfairly exploited.

Whether or not you might be considering contracting with an IFA member, it’s worth taking a look at this best practice guide since it flags up clauses or requirements that the IFA – and wider European laws – consider to be in conflict with good franchise practice and therefore unfair.

Take a look at our publication on Buying a franchise which covers in detail all the issues you need to consider when buying a franchise.

Becoming a franchisor

And equally, if you’re looking to become a franchisor, ensure that you give all of this information to any potential franchisees, and ensure the information you give in regard to potential earnings are based on fact.

If a franchisee isn’t provided with correct, comprehensive information in an appropriate way, they’re entitled to make a claim against the franchisor if they fail to make the franchise work.

If you’re not already a member of the IFA, you may want to consider registering as it clearly holds a certain credibility and comfort factor for franchisees.

You can also gain a fair amount of support from the association, which may be particularly helpful if you’ve not had a franchise arrangement before.

Check out our publication on Starting a Franchise which discusses in detail what you need to know about starting your own franchise business.

What should a good franchise agreement contain?

Up front, a good franchise agreement should state:

1. the length of time for which it will endure, until a review and/or renewal is agreed by the parties, and how any such review and renewal will work
2. the rights that the franchisee will be granted in respect of the product or service in question
3. the geographic scope of those permissions
4. whether or not they are exclusive within that geography
5. the fees payable and the logistics and mechanics of how those payments will be measured/verified and paid
6. what targets or quotas may be relevant to the relationship and the consequences of them not being met
7. how the franchisee must promote and market the franchise business and on what contractual terms it is permitted to do business with its customers (often the franchisee will be expected to operate to a standard model sales contract or standard set of terms and conditions)
8. how data, including customer data, will be handled, processed and even shared between the two parties
9. what the franchisor is contributing to the franchise relationship, for example:
10. the trademarks, trading name, goodwill and ‘get-up’ with which the franchise is associated as well as other IP rights, like copyright in materials, records and/or code, designs and potentially also patents
11. the business format – meaning the system recorded usually in an operations manual, which will contain descriptions including some that are confidential and proprietary to the franchisor, such as recipes, processes, specifications, design drawings and details of patented products or services
12. what the franchisee will get from the franchisor in return.

Additionally, and also importantly …

Obligations

Franchise agreements contain a significant number of obligations on franchisees, these typically include ensuring that the premises, décor, display, sales and marketing materials, levels of staff qualification and pricing conform absolutely with the franchisor’s mandate, or rule-book.

They will also extend to insurance, financing, payments, debt collection and other activities affecting the way that the franchisee spends its revenue and operates its business activities on behalf of the franchisor.

They will set requirements and deadlines for the way in which the franchisee accounts to the franchisor, organises its business model and fulfils its regulatory and reporting responsibilities.

Generally, it will be considered reasonable for a franchisor to include a right from time to time to require a ‘cosmetic’ makeover of the franchisee’s premises, in line with any general refreshment of the franchise branding.

The franchisee will usually be expected to pay for this.

However, a requirement to completely refit out a premises may not be reasonable.

And the same applies to any right on the franchisor’s part to require the franchisee to completely relocate their premises.

Restrictions

Typically, the agreement will also contain a list of prohibited activities and restrictive covenants, like not working for another rival business during or for a specified period after the franchise relationship is ended and placing staff under rigorous confidentiality obligations and restrictions on where they can work next also.

This is generally considered lawful on the basis that the franchisor would otherwise have no incentive to share confidential information and protected IP with the franchisee.

Changes of control

Another area the agreement should cover is what happens if there is a change of control of the franchisor, or the franchisee, or indeed, what happens if the franchisee decides it might want to sell or to transfer the franchise, or if the franchisee dies or becomes otherwise incapacitated.

What if the franchisee wants to sell?

One of the biggest motivations for a franchisee is to make a capital return on the efforts it contributes to making the franchise a success.

So, the franchised business should be capable of being sold – according to reasonable conditions imposed by the franchisor, which will include approval rights in relation to the business to whom the franchisee may be permitted to sell and the process that must be followed in the event of a proposed sale.

A franchisee should expect to find in the franchise agreement, criteria that it must apply to any prospective purchaser of its franchise business, and that mirror the criteria to which it was also required to confirm when it applied to be a franchisee.

Some franchisors include a contractual option to buy the business in the event that a franchisee wants to sell.

If this is the case, franchisees should check that the price that the franchisor would pay is a fair market price and on good faith terms which do not entitle the franchisor to a discounted rate if it exercises the option.

Termination events, and rights

When, how and in what circumstances the agreement can or will be terminated, is another important area that both parties should understand well – particularly any provisions that describe what the franchisor will treat as a breach of the franchisee’s obligations, and what a situation of breach entitles the franchisor to do.

While the franchisee might not have the bargaining power to negotiate a more diluted version of these, it should nevertheless enter into any contractual relationship with its eyes wide open.

IP ownership, protective action, and licensed rights

The franchise agreement will also contain clauses covering the ownership of the franchise IP by the franchisor and the obligations on the franchisee to assist the franchisor in protecting those rights, if infringements occur, including those committed by third parties.

The agreement will typically emphasise that use of the franchisor’s IP does not give the franchisee any share in these rights or control over them.

Liabilities, compliance and risk

Insurance obligations, responsibility for stock, sales relationship and communications, and liability in the event of the franchisee causing harm to the franchise or any of its fellow franchisees, or the franchisor, will also be covered in some detail.

Insurance, like the costs of accounting and other business operational good practices will be at the cost of the franchisee.

The franchisee will also be contractually obliged to conduct all of its activities in a legally compliant manner, and in accordance with accepted best practices.

There are generally directions as to how customer complaints as well as disputes between the franchisor and franchisee must be handled, and a good agreement will always include wording to cover which law applies to any interpretation of it and whose courts/regulatory bodies will be entitled to resolve any disputes relating to its terms or the operating activities of the parties.

You can find our Franchising Agreement template here.