A Brief Introduction to Franchising

Generally speaking, a franchisee is someone who pays a franchisor an initial franchise fee, averaging close to £30,000 in today’s market, for the right to operate a business under the franchisor’s name using the franchisor’s business model. The franchisee furnishes all the capital required for opening the business and assumes full financial and operational responsibility for running the business. The franchisee generally will also pay a continuing royalty (usually between 4 and 10 percent of gross sales, or even higher) to the franchisor, and often the franchisee will buy products from the franchisor.

The franchisor, for its part, will allow the franchisee to use its trademark. The franchisor trains the franchisee to run the business according to its standards. The franchisor will generally assist the franchisee during the startup period, and provide ongoing support and assistance to the franchisee. The level, type, and quality of this ongoing support will often differ, but for many franchisors, it will take the form of advertising assistance, purchasing power, brand maintenance, financial guidance, and ongoing operational support. Generalities aside, it is important to understand exactly what constitutes a franchise. Most people probably have a good idea of what a franchise is—at least we think we know one when we see one, even if we cannot define it. That said, the term “franchise” has a very specific legal definition within the U.K. and in other countries in which they are regulated.

The primary advantages for most companies entering the realm of franchising are capital, speed of growth, motivated management, and risk reduction—but there are many others as well. We often see companies that choose to franchise for a variety of other reasons. Some business owners choose to franchise because they want to create opportunities for their heirs. Some want to provide additional opportunities to their employees. Some want to build a legacy that will last beyond their lifetime. Some do it purely out of opportunism, because someone has come to them asking to buy a franchise (while it does not happen often, it does happen). And some simply enjoy the challenge of building a business.

Of course, none of those reasons are wrong. Ultimately, your business should be designed to do one thing: to meet your goals (and the goals of your shareholders, if you have them).

And yes, there are disadvantages as well. We’ll discuss those later in the chapter. So ultimately, any decision you make on franchising your business should start with your goals and take both advantages and disadvantages into account.

The most common barrier to expansion faced by today’s small businesses is lack of access to capital. Even before the credit-tightening of 2008-2009 and the “new normal” that ensued, entrepreneurs often found that their growth goals outstripped their ability to fund them. When thinking about financing the growth of company-owned locations, entrepreneurs have typical choices for capital formation: debt or equity. Debt can come from a variety of sources, ranging from banks, leasing companies, friends, relatives, and angels. Even credit cards have provided nervy entrepreneurs the capital they have needed to grow their business—at substantial cost, I hasten to add.

Anyone who has been to a bank recently knows how difficult it is to secure a loan for a new business venture. Unlike the “go-go” days of the 1980s, when banks would often lend a company several times its net worth on little more than a cursory review, banks today are often reluctant to lend even in situations in which they are fully secured. It is tougher than ever for most entrepreneurs to obtain the expansion capital they need from a bank.

Another stumbling block facing many entrepreneurs wanting to expand is finding and retaining good unit managers. All too often, a business owner spends months looking for and training a new manager, only to see them leave or, worse yet, get hired away by a competitor. And hired managers are only employees who may or may not have a genuine commitment to their jobs, which makes supervising their work from a distance a challenge.

But franchising allows the business owner to overcome these problems by substituting an owner for the manager. No one is more motivated than someone who is materially invested in the success of the operation. Your franchisee will be an owner—often with his life’s savings invested in the business. And his compensation will come largely in the form of profits.