How to Setup a Franchise Business
Starting up a franchise can be a daunting task to take on. This niche of business is rather complex and involves a lot of legal considerations. However, the rewards a successful franchise brings are well worth the effort. This article is intended for entrepreneurs who are interested in starting their franchise enterprise. In this article, we will look at 1) what is franchising? 2) franchising today, 3) types of franchise, 4) benefits of franchising, 5) is a franchise suitable for you? 6) factors to consider when deciding upon a franchise, 7) starting a franchise, and 8) conclusion.
WHAT IS FRANCHISING?
In a franchise business, a contract is drawn up between two independent parties, under which one party (the franchisee) is granted the right to market a product or service using the trademark or trade name of another party (the franchisor). Under this agreement, both franchisor and franchisee are bound by certain obligations towards each other. The franchisee has to pay a fee to the franchisor for the right to use their product/service, and the franchisor has to provide trademark rights and backing to the franchisee.
Franchising has adapted and evolved in the rapidly expanding world. Today, the franchise system can be seen in almost all sectors of business. From banking, to restaurants, clothing, cars and hotels, franchising has entered virtually every segment of an industry. This business has flourished as it offers a formula for running a successful business by providing customers with a standard, reliable quality of goods and services.
Over the last decade, multi-unit franchising has emerged and grown. Many franchises sell multiple units and in some cases, multiple brands. Giant corporations like McDonald’s, KFC, Subway, 7-Eleven, Denny’s, Pizza Hut, Dunkin’ Donuts, Burger King, etc., have become common household names.
TYPES OF FRANCHISE
Two main forms of franchising are common today.
Business Format Franchise
This is the most common type of franchise. Here, the franchisor sells the franchisee the right to market an established business, including the brand name and trademark. There is an ongoing relationship between both parties. The franchisor assists the franchisee in launching and running the business, supplies the product(s), provides training and marketing plans and helps with financing. In return, the franchisee pays royalties and fees to the franchisor.
This system allows individual businesses to receive training in business running and marketing from the franchisor. The drawback is that the franchisor will be bound to provide continued training and financing to the franchisee. Business format is a common arrangement among fast food chains such as McDonald’s, KFC and Burger King.
Product/Trade Name Franchise
Under this arrangement, the brand owner allows the retailer business to sell their products using their name and trademark. In return for these rights, retailers pay a fee or buy a minimum amount of products from the owner. This type of franchise network consists of a single owner/producer selling the product to the distributor/retailer who then resells the product to the end customers. This franchise is common in the vehicle industry, bottling companies and tire service stores.
BENEFITS OF FRANCHISING
For the Franchisor
- The franchisor gains an additional source of income from the payment of franchise fees and royalties. This additional capital provides improved cash flow and higher profit margins. It further means more funds allocated for research and development. There are also opportunities to gain economies of scale.
- The franchisor enjoys reduced advertising and distributing costs. These costs usually belong to the franchisee.
- There is a mutual contact between the franchisor and franchisee, which allows the franchisor to remain aware of how the franchisee is running the business.
- The franchisor can set quality control and service standards for all their outlets. Also, the franchisee is self-motivated to work hard as they have a stake in the success of the business. This leads to better workplace efficiency and productivity levels.
- There is a spreading of risk in having multiple outlets operating under your name. If one branch fails, there are others to fall back on.
For the Franchisee
- A franchisee avoids the hassle and risks of starting their own business. They have the backing of an established franchisor organization, which further lowers the risk factor. Profit margins are also expected to be higher as a known brand is being sold.
- They can be in control of the day-to-day operations and running of the business.
- Starting costs are paid by the franchisor. Further, the franchisor also provides for staff recruitment, training and financial backing.
- The franchisee benefits from a good reputation and strong standing associated with an established franchise business.
IS A FRANCHISE SUITABLE FOR YOU?
There are many things to consider before a franchise can be set up. You need to keep in mind that franchising is a chain reaction: the franchisor sells a business idea and name to the franchisee, who then sells end products to consumers. You need to consider if your business meets two specific requirements for franchising:
- The brand name and trademark has to appeal to potential franchisees. It must have a certain reputation and standard that makes it attractive to customers and franchisees alike. There must be a good prospect for earning high profit margins.
- The brand idea must be marketable among consumers. In other words, there must be a high demand for the product or service being franchised. In addition, the entrepreneur needs to consider their personal motivations. Running a franchise is nothing like running one’s own company. For one thing, it requires the owner selling their company’s rights to a third party that will bring in its methods of operations management. Another thing to keep in mind is that running a franchise requires a full-time commitment and not every business owner has the inclination or means necessary. You need to consider whether you are prepared to expend the required amount of time, effort and money that the franchise will demand.
FACTORS TO CONSIDER WHEN DECIDING UPON A FRANCHISE
Any business owner looking to start a franchise will be apprehensive about the risks and costs involved in the process. The following are aspects to be considered before a final decision can be taken:
- The business needs to have an exclusive concept that potential buyers (franchisees) will be interested in.
- The business must have a good potential for franchisees to return a high profit margin (even after paying royalty).
- The product(s) has to be of marketable value. There should be an increasing, or at the very least, a consistent market for the product.
- The franchisor must be able to provide extensive and thorough training to the franchisee.
- There needs to be a high enough demand for that particular product in other markets. Setting a franchise should offer a good opportunity for expansion and cost-cutting.
- You should have sufficient funds to launch new franchise outlets. You should also be in a position to oversee the smooth running of each outlet. It is important to keep in mind that franchising is a round-the-clock job. You need to devote your full time, efforts and resources to make your franchise successful and even then there can still be a risk factor. Initially, setting up a franchise will be very costly, and it will take a long while, maybe months or even years, before you recover these costs. You will have to work full hours, including weekends if you want to get your business off the ground. In addition, franchising is governed by strict federal and state laws. You will have to disclose and provide all confidential information regarding your company history, profitability and policy to the franchisee to allow for a working franchisor-franchisee relationship. You have to register your brand name and trade mark before you can sell your business to the franchisee(s).
- It is important to start a franchise keeping the potential risks in mind. While a successful franchise offers many advantages such as economies of scale and huge expansion opportunities, a new franchise being set up can go both ways; either be successful or end up a failure. Therefore, a good business owner will always move with the risks and drawbacks firmly in mind.
- Contracting a franchise agreement will also bring its own risks and hurdles since you, as the franchisor, will have to give financial support, provide training and infrastructure development costs and lay down the basic rules and policies. You need to have a good working relationship with the franchisee since franchising is a connected system and works well only if all parties work cooperatively and efficiently.
STARTING A FRANCHISE
Steps involved in starting a franchise
Once you have made the decision to start a franchise, this is where the hard work starts. When starting a franchise, there are certain steps you will have to go through. You will need to:
- Have a strong marketable brand that is appealing to prospective buyers (franchisees), has an established reputation among consumers, and will have potential for returning a high profit margin. Your concept has to have a unique distinguishing feature that sets it apart from the countless other brands out there. You also need to set a unique image for all your franchise units.
- Set up a system of operations for all the franchise outlets. This includes the standard you set for operations, the quality of service you will provide the consumers and underlying rules and policies you lay down that you need the franchisee to adhere to.
- Arrange a huge amount of start-up capital to get the franchise up and running. The exact amount will depend on the type of business you expect to run. Start-up costs may take a long while to recover. If your efforts are successful, you will begin to recover these costs quickly.
- Launch an efficient training program for the franchisee(s). In most franchise systems, the franchisee does not have prior experience in any particular industry, so it is up to the franchisor to provide that experience. You need to train the franchisee in running and managing the business in a way that meets your standards. The training usually involves a short course in running a franchise. The duration of a training course can vary from a few days to several months, depending on the type of business. You also need to teach staff the required computer software and to operate on-site equipment. Some training programs may involve the use of PowerPoint presentations and training videos.
- Deal with a whole host of legal issues involved in setting up a franchise. You will need to register your name and trademark as required by state and federal law. Franchise regulation authorities will require detailed financial statements, backed by an independent certified public accountant, to be submitted for review. It is also recommended to hire a reputable corporate lawyer and set up various sorts of contracts and agreements to protect your brand concept. This includes confidentiality agreements and non-competition agreements with all the parties with whom you share classified company information.
- Should have experience of running an actual franchise outlet. This experience will help you keep better track of the franchisee’s methods and improve them if necessary. You will be in a better position to refine and improve your original concept. It will also help you improve the training program you offer and also allow you to set up competent and efficient staff and mangers. While experience is not a requirement, it is definitely a plus and is recommended as it helps your selling and expansion power.
- Have a comprehensive and detailed operations manual. The franchise agreement states that the franchisee is bound to follow the policies and standards laid down in the manual. Therefore, obviously a lot of thought and planning needs to go into its preparation. Usually the company background, management and aims and objectives are listed. Areas such as sites selection, layout and design, furnishings, equipment, supplies etc., are handled. In addition, the manual also lays down operating standards such as staff recruitment, fees, customer service, advertising, pricing, purchasing policies, insurance, inventory, etc. Since manuals change over time as standards change or modify, you need to make sure the franchise contract allows you to make the necessary changes in the manual.
- Arrange initial and on-going support for the franchisor. This needs the availability of competent staff. This support extends to various business areas such as site location, infrastructure setup, human resource management, marketing, customer service etc. you will also have to monitor your franchisees to make sure they are working to your set standards.
- Set up a new business entity to improve your business’s market standing. This may take the form of changing your company into a private limited company as it will help you protect your assets under a franchise agreement.
- Come up with a plan to sell franchises. There are many techniques available that can be used in selling franchises, so you need to select the best way for you, depending on your budget, your marketing plan and the target consumers of your product. In some places, advertising is regulated or even banned, so it is best to hire a competent corporate lawyer from the get-go to assist you in this and other franchising details.
Factors for franchisees to consider
Franchising is not a one-sided arrangement. It involves two parties, and both parties have their set of risks to consider. While the franchisor has the largest stake in the enterprise, the franchisee’s job is not exempt from worry. They are responsible for running the public front of the business, and this is no small challenge. The franchisee must ask themselves certain questions before buying an enterprise.
- Cost accommodation. Buying a franchise can require paying a large amount of start-up fee to buy a brand name and trademark. In addition to the license fees, many other costs arise such as location fees and payroll financing. The franchisee needs to know whether they can accommodate these large sums easily.
- Success or failure options. Franchising involves not just contracts with the franchisor, but a host of other long-term contracts, such as agreements with suppliers, employee contracts, etc. All these combined make for a hefty amount for the franchisee to pay, in case the business fails. The franchisee needs to find out how much the franchisor will cover in case of business failure. There might be a clause in the contract stating that the franchisor will help the franchisee recover surplus costs to keep them in business. Alternately, if the franchise is successful, the franchisee might wish to sell it and retire or pursue some other venture. It is best to find out about the success or failure policy of the company before signing any contracts.
Ultimately, just like any other business decision, franchising involves a fair share of risks and rewards. Whether you are a franchisor or a franchisee, you will need to do thorough research before making any binding legal agreements. Franchising brings with it both big rewards and big risks, which both parties should be aware of. For the franchisor, it will provide opportunities for expansion and large-scale economies of scales. For the franchisee, starting a franchise will bring a pre-established reputation and reduced risks. Before making the ultimate decision, it is important to remember that franchising entails full-time commitment so you need to ensure you can devote the required amount of time, effort and resources to this enterprise.
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