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If you are new to the world of franchising, there are some terms that may be unfamiliar to you. In this article, we outline some of the most commonly used terms in the franchise industry and what you need to know about each of them!
Advertising Fee/Advertising Levy
The advertising levy covers the franchise system’s advertising and promotional activities. It is usually calculated as a percentage of the franchisee’s total revenue. Compared to a 5% average levy in the USA, where advertising is highly credited in the market, in the UK (according to a recent franchise study by NatWest/BFA), the average advertising fee is 3.5%.
Agreement
The franchise agreement is the legal written document that governs the relationship between the franchisor and franchisee. It specifies the terms of the franchise contract such as rights and responsibilities of the parties, fees and payments, territory and the duration of the agreement.
Approved Site
The approved site is the location that the franchisor chooses for the franchisee’s set-up. It has to meet the criteria of the franchise unit.
Area Franchisee/Area Developer
An area franchisee purchases the right to open and operate a specified number of franchise locations, in a defined geographical area, during a defined period.
British Franchise Association
The bfa are a voluntary self-regulatory body for the franchising sector in the UK. They advocate for ethical franchising by representing their members within the industry and beyond it also. They offer a wide range of information and advice to businesses planning to franchise or anyone considering owning a franchise. They help their members to develop good business practices within the world of franchising.
Business Format Franchise
A business format franchise is where the franchisor grants a franchisee more than just the right to sell goods or services. The entire business format is provided, including (where relevant) the operating system, accounting systems, trademark, marketing and training. This type of franchising is typically found in automobile services, catering and hotel services, business services, home services, and educational services.
Business Plan
A business plan is a document prepared by a franchisee which summarises the franchise's operational and financial goals, and contains detailed plans and budgets showing how these objectives are to be achieved.
This document is central to any application for finance, and should be considered carefully before it is submitted to a financial institution. Bank managers look first and foremost at the potential business owner's characteristics, ability, and experience; and the cash-generating criteria of the business itself.
In this respect, a well-thought out and structured business plan is central for the approval of a grant or loan.
Capital
Capital is the wealth required by a franchisee. Human capital consists of the experience, leadership, and knowledge the franchisee will bring to the franchise. The financial capital needed for the initial investment includes the licensing fee and the initial working capital of the franchise.
Working capital is the money needed for the running and operation of the franchise until it becomes profitable. This includes legal costs, salaries, insurance, advertising costs, leasing costs, and living expenses. The franchisee also needs to consider raising capital to secure financing for future investments.
Collateral
Collateral is a form of security that a borrower may offer a lender to guarantee a loan or other credit. Collateral can be resources, belongings, or something of wealth and value to the borrower. If the borrower fails to pay back the credit, the asset acting as collateral may become subject to seizure. The lender can then sell this to comply with the original contract. This ensures payment or performance of the obligations stated in the lending agreement.
Many borrowers take out a loan of the same value as the asset being purchased. This option is generally used when purchasing equipment. When taking out a mortgage, the borrower can offer the house as collateral. Borrowers who offer a personal residence or real estate as collateral are usually requesting a long-term loan of significant size.
A business may use its inventory as security, including all the assets that could be liquidated to repay the loan, such as merchandise, equipment, stocks and bonds.
A borrower can also secure a loan by using another person as an endorser of the contract. This person signs a note promising to back up the obligations of the borrower. If the borrower defaults, the endorser is liable for the contract, and must pay the funds to the lender.
Copyright
Copyright is the exclusive right of a person to use, and to license others to use, works of art, music, or literature, and to protect these works from any unauthorised use. This statutory right prevents others from copying or exploiting a person’s work without permission.
A copyright, or aspects of it, may be transferred from one party to another. The original copyright holder can sign an agreement with another party, granting rights to the work, in exchange for royalties and other considerations. In this way the original copyright holder may benefit from the exchange. The author may also grant a non-exclusive licence to the work, on specified terms in relation to a particular region or for a definite period of time.
Copyrights expire after a set period of time, usually lasting for the duration of the holder’s life plus 70 years thereafter, or 120 years from the date of creation.
Copyright in franchising relates to operations manuals, business models, and promotional and advertising material pertaining to the particular franchise brand name and logo.
The symbol for copyright is ©.
Disclosure Document
This is a document provided by a franchisor when they are approached by a potential franchisee and both like each other. It contains key information about the franchise such as the history of the franchisor, the annual turnover that a franchisee can expect, the investments required, and the franchisee's obligations.
Under the European Code of Ethics, Section 3.3, the following guidelines must be applied by franchisors offering a franchise opportunity for sale to potential franchisees: “In order to allow prospective individual franchisees to enter into a binding document with full knowledge, they shall be given a copy of the present Code of Ethics as well as full and accurate written disclosure of all information material to the franchise relationship, within a reasonable time prior to the execution of these binding documents."
This ensures a potential franchisee is made aware of the financial implications and legal requirements of any franchise agreement, before signing on the dotted line.
Earnings Claims
Earnings claims are the actual or forecasted franchise sales, profits, or earnings stated by a franchisor. If a franchisor is a member of the bfa (British Franchise Association) it is required by law to state its financial earnings. If a franchisor is not a member of the bfa, then you should insist upon a written substantiation for any earnings projections or suggestions about the franchisor’s potential income or sales.
Another means of finding out the financial credibility of a franchisor is to approach past franchisees of the franchise network and ask them questions about their experiences.
Equity
Equity is the total value or worth of an asset. It is the ownership of an asset after all debts associated with that asset have been paid, and the asset liquidated.
On a balance sheet, equity is calculated as the total assets minus the total liabilities. In real estate, the owner’s equity is the value of the house minus the remaining mortgage or loan amount due. In a company, the ownership interest takes the form of stocks or shares in the company.
Feasibility Study
A company that is thinking about becoming a franchisor carries out a feasibility study. This is a study of market factors and business issues that may influence a business or franchise opportunity in the future.
A potential franchisor expanding their business must conduct a feasibility study in order to learn about:
- current and emerging competitors
- current business conditions
- legal or licence prerequisites for conducting business
- current consumer demands
The purpose of the feasibility study is to uncover any hidden material not yet discovered by the potential franchisor, and enables a franchisor to critically assess the future success of their business expansion.
Franchise
A franchise is an agreement in which a firm (franchisor) enters into a contract with other businesses (franchisees), granting them the authorisation to operate in the distribution of goods and services under the franchisor's trade name and guidance, in exchange for a fee. The franchisor has a method of doing business, including knowledge, experience, logos, secret formulae, trade secrets, business styles, and house marks, all of which will be licensed to the franchisee.
The franchisee can purchase the rights to a single-unit or a multi-unit franchise. A single-unit franchise is an agreement where the franchisor grants the franchisee the rights to operate one franchise unit. This is the simplest and most common type of franchise.
A multi-unit franchise is an agreement where the franchisor grants the franchisee the rights to operate multiple units. This can be be in the form of either an area development franchise or a master franchise.
If granted the rights to an area development franchise, the franchisee can operate multiple units during a specific period of time, within a specific territory. A master franchise agreement is similar to the area development franchise, with the additional right to sell franchises to other franchisees within the territory, known as sub-franchises. In this way the master franchisee takes over the role of the franchisor: providing support and training to the new franchisees, and receiving fees and royalties for their duties.
Franchise Attorney
A lawyer who specialises in franchising law is known as a franchise attorney.
An attorney with expertise in franchising can alert a potential franchisee to unfair or problematic provisions outlined within a franchise agreement. It is advisable to have such an attorney look over all franchise documents before deciding to sign a franchise agreement.
Franchise Consultant
A franchise consultant is a business guide with knowledge of the franchising industry. They give advice on topics such as franchise operations, companies, and relationships. A reputable franchise consultant will have years' experience in advising potential franchisors and franchisees on expanding a business as a franchise opportunity, or on buying into a franchise industry.
Therefore, franchise consultants can help individuals select and evaluate a franchise opportunity and also help them negotiate the franchise agreement. While a franchise consultant's skills are deemed invaluable, it is still wise to consult a franchise attorney when it comes to reviewing the franchise agreement.
Franchisee
A franchisee is an individual, partnership, or corporation who purchases the right from the franchisor to conduct business under their trade name. The franchisee pays upfront and ongoing fees to the franchisor, in return for the licence to market their product or service using their operating methods. The franchisee has the obligation to keep any commercial secrets confidential. With the support, guidance, and experience of the franchisor, the franchisee helps to expand the business.
Franchise System
A franchise system refers to the different types of franchises operating within the UK, Ireland and the rest of Europe. Subway, for example, would be considered a franchise system. The term also involves the administrative centre of the franchise and franchised units, much like a company’s head office.
A franchisee must research the franchise industry in order to assess what franchise system best suits their individual requirements.
Franchise Unit
The term 'franchise unit' refers to each individual outlet, whether company-owned or franchised.
Franchisor
A franchisor is an individual, partnership, or corporation who grants an investor (the franchisee), the right to conduct business under their trade name, using their operational methods and organisational systems. The franchisor has developed their own business methods, and aims to expand the business by offering franchisees the right to use these methods. The franchisor provides support to the franchisee through training, and by assisting them in advertising, marketing, and financing.
Initial Franchise Fee
The initial fee is a once off lump sum, paid by the franchisee to the franchisor, upon signing the franchise agreement. This payment acts as compensation for the experience, training, recruiting, and the right to use the brand name of the franchise.
Initial Investment
The total investment is the capital required to start the franchised business. It includes the initial fee, plus other costs such as property, inventory, equipment, personnel, and the working capital required for the operation of the franchise until it becomes profitable.
International Franchise Association
The International Franchise Association is a non-profit trade association of franchisors, franchisees, and suppliers. Founded in 1960, the IFA’s office is based in Washington, D.C.
As a membership organisation, it promotes good franchising practice by ensuring all members follow a rigid code of ethics. The IFA helps to support and develop the franchising industry by organizing events and meetings, publishing articles and books, and by its online database. It offers a range of educational programs for those interested in the franchise field. The association’s website is an important franchise resource centre, and supplies a full directory of franchises. It provides information on buying and selling franchises for both franchisors and potential franchisees alike.
The IFA organises the Franchise Appreciation Day, an annual march that brings all aspects of the franchise industry together.
Licensing
Licensing is the legal act of the franchisor granting rights to a franchisee to a legally protected property in exchange for a fee or royalty. The franchisor reaches a lease agreement with a franchisee permitting them to produce and market its product, service or trade name.
Licensing benefits both the franchisor and the franchisee. It enables the franchisor to profit from the capabilities of the franchisee, such as special technical or sales skills, resources, or the expanding markets and distribution channels. The success and name recognition of the product helps the franchisee to reduce development costs and get a faster start in an industry.
Marketing
This business activity attempts to grab the attention of customers by using slogans, packaging, and celebrity support. Marketing manages the relationships with the customer and stakeholders in a way that will benefit the organisation.
The classic elements of marketing are the four Ps of the marketing mix:
- The ‘Product’ aspect of the marketing mix deals with the selection and development of the product including the supporting factors such as warranties and guarantees.
- ‘Price’ relates to the determination of the price of the product.
- ‘Place’ refers to the selection and design of distribution channels. This includes the channel by which a product is sold, the industry, the geographic region, and the audience.
- ‘Promotion’ encompasses all aspects of promoting the product to create demand, including advertising, sales campaigns, and publicity.
Master Franchisee
A master franchisee is an individual who assumes the rights and obligations of the franchisor in a defined territory (usually a country). The master franchisee purchases the rights to sell franchises to sub-franchisees, and provides them with some of the services provided by the franchisor. The master franchisee pays the franchisor both initial and ongoing fees based on the number of franchisees operating in the territory. Master franchising is most common in international franchising.
Multi-Unit Franchisee
A multi-unit franchisee is one that owns and operates more than one unit of the franchise, but does not have the rights to a defined territory.
Operations Manual
The manual contains instructions advising a franchisee how to operate the franchise. It covers general business procedures such as accounting, advertising, personnel, promotion, and maintenance. It is an integral part of the franchise system, and it clearly spells out the logic of why a franchisor wants a franchisee to run their business in a certain way.
Pro Forma
The pro forma document is a description of financial statements which rely on historical data to assume levels of revenue, expenditure, assets, liabilities, and net worth.
Royalty Fee
Also referred to as the 'management service fee', these fees are the continuous payments the franchisee gives the franchisor to stay part of the franchise system. They are usually based on a percentage of the gross revenue of the franchise unit, ranging from 3% to 25%.
Supplier
A supplier is the authorised individual or company who has been approved by the franchisor to supply products or services to the franchisee.
Territory
Territory is defined as a specific area in which the franchisee has the exclusive right to conduct business without the threat of competition from fellow franchisees. The area of territorial rights can be based on a number of factors such as population, geographical area, business potential or neighboring franchisees.
The population criteria used for determining the boundaries of the territory include the population base, the density of population, and growth trends of population.
A large market territory would be based in an area of high population density, where demand for the product or service is strong. The ideal geographical location for this is based in or near a city, in which traffic patterns are high. Granting a protected area means the franchisor is able to penetrate market areas for maximum sales and profits, while franchisees are afforded a defined territory to achieve desired results without being particularly vulnerable to local competition.
Territorial rights are one of the leading causes of conflict, dispute, and litigation in the franchise industry. In some cases, franchisors may choose a location for new franchisees close to existing franchisees. This can result in a decrease in sales and profits for the existing franchisee due to the diminished territory and increased competition. To prevent these conflicts from arising, all information regarding the territory is stated in the franchise agreement. The contract should document legal details about the territorial rights and exclusivity of the franchisee. This includes the boundaries of the territory, and information on the right to renegotiate territorial boundaries after a specified time span.
Trademark
A franchise trademark is a form of identification such as a brand name or logo, which is associated with the franchise. Trademarks are protected by law and are distinguished by the symbol â„¢.
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