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What is a franchise?

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Last editedDec 20202 min read

Are you thinking of expanding your business, but are unsure of how to handle the cost and logistics? Franchising may be a worthwhile solution, but what is a franchise and how does a franchise work? Here’s what you need to know about making your business a franchise.

Franchise business definition

What do McDonald’s and Clarks Shoes have in common? They both fit the franchise business definition. A franchise is a type of agreement or license between an established business (the franchisor) and a small business owner (the franchisee).

Franchisors gain the opportunity to expand in a rapid, cost-effective way, while franchisees have the security of using a business model that’s been tried and tested. Franchisees usually pay a start-up fee and annual licensing fees for the privilege, acquiring the franchisor’s business name, branding, trademarks, and processes in return.

Understanding the franchise model

The franchise model is used by a number of businesses both at a regional and international level. The franchisor’s original business sells the rights to use its name and ideas, while the franchisee purchases the rights to sell associated goods or services under the existing business’s name.

How does a franchise work?

Franchisors must provide franchisees with a disclosure document outlining all relevant information about this licensing deal. Typical information covered would include:

  • Franchise fees

  • Operating expenses

  • Operating procedures

  • Performance expectations

  • Trademark information

If you’re thinking about franchising your business, you’ll need to draw up this type of legal contract first. There’s no singular format for a franchise contract; its particulars will depend on your business needs.

In most cases, a franchise agreement will outline the three types of payment a franchisee must make to the franchisor:

  • Controlled rights or trademark as an upfront fee

  • Payment for start-up training and equipment

  • Ongoing royalties or percentage of sales

Franchise contracts are temporary, drawn up for a pre-specified time period.

Making your business a franchise: pros and cons

We’ve already outlined some of the potential perks involved with making your business a franchise, but there could be drawbacks as well.

Advantages of the franchise model include:

  • Lower costs: Franchisees bear the cost burden of expansion. Ongoing costs are also reduced, because the franchisees pay staff wages and maintain financial accounts. They also pay the original business licensing fees and a percentage of profits.

  • Faster expansion: Once you’ve worked out a franchise agreement, it offers the potential for rapid growth as more franchisees sign on board.

  • New talent: Franchisees are entrepreneurs who want to succeed with their new start-up business. Bringing fresh, new talent into the team can help your business grow. This can be fostered with a tightly knit, collaborative atmosphere across the franchise.

The pros of a franchise model aren’t limited to the original business owners. From the franchisee’s end, this type of agreement gives you the opportunity to start a turnkey business with established brand recognition, market-approved products, and even approved supplier lists ready to go. However, it’s important to keep in mind that no business model is guaranteed, so there is still some element of risk in launching any new business venture.

Potential drawbacks for the franchisee also involve the start-up costs and ongoing costs of royalty fees. While a unique start-up business requires capital to get off the ground, you won’t have to worry about paying out a percentage of your revenue to a franchisor. Franchisees have limited creative say over the business, as the franchise must adhere to current trademarks and branding.

Is franchising right for you?

As you can see, there are plenty of potential benefits to the franchise model, if you find the right fit. To qualify for franchising your business should have a proven idea or track record of success, sustainable profits, and an operational model that’s teachable to the franchisee. It should also be a transferable business model with long-term appeal in order to stand out to potential entrepreneurs.

At the heart of franchising is the franchise agreement you draw up, so be sure it makes sense for your business. A detailed business plan, existing trademarks, and a carefully crafted operations manual are all musts. With these in hand, you can use your materials as a blueprint for franchising success.

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