January 19, 1998Legal Focus: Franchise
Franchising offers alternatives for growth
Richard Farrell
Franchising is a huge force in our economy today. It provides many potential opportunities, and presents several pitfalls as well, for existing and potential franchisors as well as franchisees.
Today, franchising represents approximately one-third of all retail sales made in the United States -- more than $200 billion per year. There are now almost 400,000 retail franchised locations doing business throughout the United States, with more businesses forming franchise networks and opportunities every day. In the next 10 years, franchising is expected to grow to nearly 50 percent of all retail sales made in the United States and 25 to 35 percent of European retail sales.
Despite the dramatic growth in the size and importance of franchising, today's entrepreneurs and potential entrepreneurs remain remarkably unaware of the benefits and opportunities that franchising represents as an alternative to traditional methods of expanding their businesses. Similarly, potential entrepreneurs exploring the possibility of becoming franchisees too often have little or no information to guide them in the important choices and investments of money, time and energy they will be making.
Where better to start than at the beginning?
What is franchising? Stated simply, franchising is a marketing system for the distribution or sale of products or services under a tradename or trademark, and in accordance with a prescribed system or format for marketing those products or services.
A franchisor grants others the right to sell its products or services under the franchisor's trademark or tradename. The franchisor also establishes the marketing systems for the sale or distribution of its products.
A franchisee is the person who will sell the franchisor's products or services. Franchisors and franchisees reach a franchise agreement that defines the respective rights and obigations of both parties.
Federal law requires franchisors to provide a detailed document known as a Uniform Franchise Offering Circular (UFOC) to prospective franchisees before a franchise agreement can be signed. The UFOC disclosure contains both general and specific information concerning the franchisor, the franchise concept, amount of investment and the network of franchises. If a franchisor fails to provide a prospective franchisee with the required UFOC information, severe legal penalties can result.
In many cases, franchisors require a franchise fee, which is generally a one-time payment and is usually paid by franchisees when the franchise agreement is signed. The franchise fee represents one of the income streams that are realized by franchisors.
Franchisors also require royalties, which are continuing payments by the franchisee to the franchisor, generally on a monthly basis. These royalty fees generally range between 3 percent and 8 percent of gross sales, depending upon the type of franchise being granted. The franchise royalty usually represents a franchisor's most important continuing income stream from its franchise network.
The franchisor will also prepare an operations manual, which sets out, often in great detail, the prescribed marketing system that must be followed at each location. The requirements of the operations manual establish the performance standards that insure both quality and uniformity in the sale of the franchisor's products or services to the public.
Having reviewed what a franchise is, future articles will cover the following topics: what to look for when buying a franchise, franchising your business, making money as a franchisor, and laws franchisors have to follow. We also will review some "tales from the franchising crypt" that provide important advice for both franchisors and franchisees.