- What is franchising?
- Which types of business are suitable for franchising?
- Preparing a business for franchising
- The franchise agreement
- Fees and payments
- Recruiting franchisees
- Hints and tips
- Further information
Franchising can be an effective method of growing an existing business. In general terms, franchising involves one business (the franchisor) granting a licence to trade using its brand name and business model to another business (the franchisee). The franchisee pays the franchisor an initial licence fee and an ongoing royalty or service fee, and is responsible for financing and managing the franchised outlet. The franchisor plays a continuing role in supporting the franchisee but, in the right situation, can benefit from cost-effective expansion.
Several of the world’s biggest brands have built their business using a franchise model, including 7-Eleven, Subway, McDonalds and Burger King. Well-known brands that offer franchises in the UK include Costa Coffee, Stage Coach Performing Arts, Autosmart and Angela’s Swim School.
According to figures published in 2016 by the British Franchise Association (BFA, www.thebfa.org/external-relations-pr/franchise-industry-research), the UK franchise industry was worth around £15 billion in 2015 (an increase of 46% since 2005) and there were over 44,000 franchisee-owned businesses.
This factsheet explains what franchising is and how it works. It provides information on franchise agreements and how to recruit franchisees.
What is franchising?
There are several forms of franchising, but the most common is business-format franchising. In this form, the franchise is a legal agreement between a franchisor and a franchisee that allows the franchisee to trade using the franchisor’s brand name and business model. Typically, this enables the franchisee to open their own outlet from which to sell the franchisor’s products or services. When franchises are offered for sale, they are typically restricted to specific geographical areas to prevent competition between franchisees.
- The franchisor is the owner of the original business. They provide the franchisee with the information and resources they need to set up and operate their franchise outlet, for example operating manuals, training programmes, proprietary software, specialist equipment, point of sale items, livery and stock. They usually give the franchisee continuing support.
- The franchisee is the independent operator of a franchise outlet. They pay an upfront franchise fee and ongoing royalty or service fees to the franchisor in return for the resources and support they need to run the outlet. They are responsible for financing and managing the outlet. However, they must run the outlet in accordance with the business model specified by the franchisor, who will make requirements relating to such matters as quality control, pricing and customer service. Many franchisees take the opportunity to expand and operate several franchised outlets.
Other agreements that are sometimes referred to as franchising include:
- Licensing agreements, where a business allows another party to manufacture and sell their products but does not dictate the business model.
- Distribution agreements, where a business allows another party to purchase and re-sell their products.
- Agent agreements, where a business allows another party to sell their products on their behalf.
This factsheet focuses on business-format franchising.
Which types of business are suitable for franchising?
The franchise model will not suit every business. In order to build a successful franchise, a business primarily needs to be successful, replicable, and have a unique selling point. The business needs to be attractive to potential franchisees, and will need to generate a worthwhile profit for them. The franchise model depends on franchisees running successful individual businesses so both they and the franchisor make a profit.
A business that is suitable for franchising is likely to have:
- A product or service that is expected to have long-term demand.
- A healthy profit margin.
- A clearly defined business model, which can be communicated to franchisees and replicated by them.
- Proven sales and marketing techniques that can be applied to franchise outlets.
- A distinct selling point – for example, a brand name, a unique product or service, or a strong reputation.
- The resources, financial and otherwise, to deal with the demands of managing the franchise model and supporting franchisees.
In contrast, a business is unlikely to be suitable for franchising if:
- It requires specific skills that are difficult to transfer or learn.
- It is subject to regulation that makes the setting up of franchise outlets difficult.
- It is tied to a particular location and cannot be operated from other places.
- It particularly relies on unique attributes of the originator of the business, for example on their personal popularity with customers, or on a large network of contacts that they have developed over many years in the trade.
In addition, any business that can easily be replicated without the need for training or resources from the originator is unlikely to attract potential franchisees.
Preparing a business for franchising
Before the originator of a business can attract franchisees, they need to demonstrate that the business offers a viable way for them to make money. It is essential that the franchisor’s business is strong and profitable, but it also requires a clearly defined and replicable business model that franchisees can buy into.
It is not enough to offer just a business idea or concept; franchisees must be offered a proven method of operating the business. This business model will need to be carefully developed, focusing on three key areas – the brand name, the system and the support:
- The franchise brand needs to be distinctive and appropriate, and provide a benefit to franchisees operating under it, for example by offering a good reputation or established customer awareness. It is important to make sure that the brand and any associated trade marks have been formally registered with the Intellectual Property Office (www.gov.uk/government/organisations/intellectual-property-office). Potential franchisors may need to seek advice from a professional with expertise in intellectual property law.
- The franchise system is the way the business works. This may be second nature to the business originator, but it needs to be comprehensively broken down and clearly documented so that it can be transferred to and adopted by the franchisee. This will usually be done in the form of an operations manual, supported by training. Documenting the business system can be a complicated and time-consuming process and may be difficult to break down without professional assistance, for example from a specialist franchise consultant.
- The franchise support is the initial and continuing service the franchisor provides to franchisees to help them operate their franchise outlets. Typical support provided by franchisors to franchisees includes training programmes, administrative services and marketing assistance. The franchisor is also responsible for continued product and service development, quality control and the implementation of new processes. The aim is to ensure that franchisees are as successful as possible, because higher profits from franchise outlets mean a higher level of ongoing fees for the franchisor. It is important for the franchisor to emphasise the support and related benefits that franchisees will receive, and to make the support service vital to them, so that they remain as franchisees once the initial agreement period expires.
The franchise agreement
The franchise agreement is the written document that sets out the terms of the arrangement between the franchisee and franchisor. It covers in detail the rights and obligations of each party. It is important that the agreement is fair to both parties, ensuring that franchisees are properly supported, and that the franchisor can act in the best interests of the business as a whole and protect their intellectual property.
Key terms a franchise agreement should cover include:
- The rights afforded to the franchisee, including use of brand names and trade marks and the right to sell specified goods or services.
- The rights retained by the franchisor, such as the right to dictate how the franchisee operates their outlet, for example in terms of quality or customer service.
- Territory restrictions, detailing the geographic area in which the franchisee is entitled to operate and any exclusivity that exists in this arrangement.
- The initial resources and information that the franchisee will receive, such as the operating manual and training.
- The support services that the franchisor will provide to the franchisee, such as administrative and marketing support.
- The initial and ongoing fees the franchisee will pay the franchisor and the payment schedule.
- The length of the agreement and arrangements for renewal, or otherwise, once the agreement ends.
- A termination clause specifying the grounds on which either party can terminate the agreement, and the consequences of such a termination.
The franchise agreement can be a lengthy and complex document and it is important that it is clearly drafted in order to protect the interests of both the franchisor and the franchisee. It is essential to have a solicitor draft or review the agreement to ensure that it is fair and legally watertight.
Fees and payments
Most business originators that operate a franchise model charge franchisees an initial fee plus continuing fees such as service charges and royalties. There may be some extra charges for services that fall outside of the agreed initial and continuing fees. For example, some franchisors may require franchisees to purchase goods or supplies from them at prices higher than the wholesale cost to the franchisor.
- Franchise fee. This is the initial fee paid at the start of the franchise agreement. It may be paid upfront or in instalments during the franchise set up. The fee amount can vary greatly depending on the type of business and customer awareness of the brand. For example, in 2018, the initial franchise fee for a domestic cleaning business was typically around £2,000 to £20,000, while the initial fee for a Domino’s pizza franchise was £280,000. It is important that the initial franchise fee represents good value for money to franchisees and does not act as a deterrent, particularly considering the fact that they will probably need to make other investments when starting their business. However, the fee must also be worthwhile for the franchisor, covering all costs and generating a decent return.
- Continuing fees. Most franchisors charge a monthly service fee to cover the ongoing support services provided to the franchisee. This can be a set monthly amount, a royalty based on the franchisee’s turnover, or, more typically, both. The amount will vary according to the support services provided. For example, for the Subway franchise chain the calculation of fees is based on gross sales minus applicable sales tax. Franchisees pay an 8% royalty plus 4.5% to cover marketing, advertising and PR. Continuing fees represent the main income stream for franchisors. Fees that are based on turnover can benefit both parties because the franchisor has a clear incentive to ensure that the franchisee is successful.
In order to recruit franchisees, a franchisor needs to produce a prospectus detailing the business opportunity, the franchise offer, the fees involved and the potential profit. The prospectus should promote the franchise opportunity to prospective franchisees, but must also provide a fair representation of the opportunity and of the commitments that franchisees will be required to make. Handling franchise enquiries from unsuitable candidates can be time consuming and costly. According to the BFA, high-profile franchisors can have an enquiry to conversion ratio of more than 100:1. However, on average franchisors interview seven to eight candidates before finding a suitable franchisee.
Once the prospectus has been created, the franchise offer must be promoted to potential franchisees. There are several methods available for promoting and marketing franchise opportunities, including:
- The franchisor’s website.
- Franchise directory websites – for example, the BFA’s franchise directory (www.thebfa.org/members) or www.whichfranchise.com, which is one of the BFA’s official online partners.
- Franchise exhibitions – for example, the National Franchise Exhibitions (www.franchiseinfo.co.uk/exhibitions-across-the-uk) and the International Franchise Show London (www.thefranchiseshow.co.uk).
- Print publications, such as The Franchise Magazine (www.thefranchisemagazine.net), Franchise World (www.franchiseworld.co.uk) and industry-specific trade journals.
- Franchise recruitment consultants. Some consultants provide franchisee recruitment services, although the BFA warns against arrangements that offer financial incentives for recruitment.
Hints and tips
- Not all types of business are suitable for franchising. Some may be more successful by opening new branches under the direct ownership of the business originator.
- Franchisors need to consider the competition, both for customers and for franchisees. For example, could a new burger franchise compete with McDonalds and Burger King?
- The most successful franchises produce high-standard products or services and it is important that quality controls are in place to ensure that all franchisees’ operations meet the franchisor’s standards.
- A well-developed and protected brand name or trade mark can increase customer confidence and awareness of a business, increasing the value and profitability of the franchise.
- The way the business operates must be replicable and all necessary skills and knowledge must be transferable to franchisees in order for them to be successful.
The British Franchise Association (BFA) is a trade association representing franchisors. It provides information and guidance about franchising.
Tel: (01235) 820470
TotalFranchise provides news, case studies and research about franchising, and a directory of franchise opportunities.
Whichfranchise.com is a BFA partner website that provides an online franchise directory and franchising advice.
Franchise Direct is an online franchise directory that also provides news and information.
The UK Franchise Directory is an online resource listing franchise opportunities. There are also print and app-based editions.
Franchiseinfo provides listings, news, advice, and information about BFA-accredited National Franchise Exhibitions.
The Franchise Magazine is an online and print publication providing UK franchise news, features and opportunities.