Our franchising lawyers work extensively with franchisors and franchisees. Franchising your business for the first time can be a daunting prospect, which is why we’ve compiled these Franchising Your Business FAQs to help you get to grips with the basics.
Jump to individual Franchising Your Business FAQs:
- What does franchising your business mean in practice?
- Why franchise your business? What are the advantages?
- What are the disadvantages of franchising your business? Why shouldn’t you become a franchisor?
- Should you franchise your businesses, or just open another branch or outlet site that you own?
- How would you use franchising to develop your existing business?
- What state should your company be in to be suitable for franchising?
- When can you franchise your business? What stage should your business be at?
- Becoming a franchisor, and choosing franchisees
- Preparing for franchising your business
- What legal advice will you need when franchising your business? Do you need a specialist franchising solicitor?
- What qualifications and experience do Harper James Solicitors franchising solicitors have?
- What general business advice is available on franchising your business?
- What audits and analysis will you need to do before franchising your business?
- What are the steps in the process of franchising your business?
- What intellectual property work needs to take place before franchising your business?
- Can you create a completely new business specifically for franchising?
- Can you convert existing outlets into a franchise format?
- Do you need a business plan to franchise your business?
- How does the CRC Energy Efficiency Scheme (and its abolition from 2019) affect franchisors?
- What is the danger to a franchisor if no pilot operation is tested?
- What does it cost to franchise your business?
- How do you make money from your franchisees?
- How do you value your business when offering it to franchisees?
- What different charges should you ask your franchisees to pay?
- Can a franchisor dictate pricing and set prices?
- Does the franchisor have to do the franchisee’s accounting?
- Franchisors and employment law
- Types of franchise
- Franchisor rights, responsibilities and franchisor agreements
- What legal documents and agreements will you need for franchising your business?
- Why is a franchise agreement necessary for the franchisor?
- What are the franchisor’s rights and responsibilities during the sale of a franchise?
- What self-regulation options are available to franchisors?
- Can the franchisor compete with their franchisees?
- What legal protection is a franchisor entitled to?
- What is a franchisor’s obligations regarding errors and omissions?
- What does a franchisor have to do about commercial premises?
- Which laws and specific legislation apply to franchisors and their activities?
- What must a franchisor provide to franchisees?
- What is the franchisor’s right to repurchase (or right of first refusal) and what does it mean in practice?
- What are the franchisor’s pre-emption rights?
- International franchising
- Franchisor disputes, termination, exits and failure
- What happens to your business and franchise network if you, as the franchisor, fail, go out of business, liquidation or become insolvent?
- Is the franchisor liable for the actions or conduct of the franchise or franchisees? How can the franchisor’s liability be limited?
- Can a franchisor sue a franchisee?
- What if you want a franchisee to leave the franchise? Can the franchisor terminate the agreement?
- Should a franchisor have an exit strategy? What happens if a franchisor wants to sell the whole franchise network?
What does franchising your business mean in practice?
Franchising your business means that you give rights to another individual, partnership, LLP, or corporation (the ‘franchisee’), to run a copy of your business. The business is run by the franchisee will therefore be identical to the outside world, meaning the brand, tradename, image of premise, and employees of the business will be identical.
By franchising your business, you will be growing your business and making a profit from the arrangement by requesting a royalty fee (or royalties) for granting the franchisee the rights to your intellectual property (IP) and brand.
There are responsibilities attached to franchising your business. Whilst the franchisee will run and manage the franchise, you will have an obligation to provide ongoing support, know-how, and guidance on how to run the business. You’re also advised to regularly visit and check the franchises run by franchisees to ensure they meet the standard of your original business.
Why franchise your business? What are the advantages?
There are a number of advantages of franchising your business. These include:
- Growth – franchising your business can be a cost-effective way to grow your business because, by opening further franchises, you don’t incur the expense of buying stock and equipment, or paying employees and procuring new premises. These costs will be borne by the franchisee who will launch and run the franchise business.
- Profit – the franchisee will pay you a royalty fee for being granted the right to operate using your trade name. If this is a fixed amount, you will receive this income profit regardless of whether the franchise is in profit.
- Easier management – the franchisee will be managing the franchise business so if you are considering alternative ways to run an outlet in a territory, franchising allows you to achieve this without increasing your management demands.
- Development of brand – as there will be more ‘outlets’ running a business under your brand, your brand will become better known.
- Innovative ideas – if you select skilled franchisees to run your business, they may be able to contribute fresh and innovative ideas for the future success of the brand.
- Supportive network – by establishing a number of franchises, you will be able to build a network of franchises which can offer you support and advice.
What are the disadvantages of franchising your business? Why shouldn’t you become a franchisor?
There are also disadvantages of franchising your business. These include:
- Cost – preparing to franchise a business can be costly because whilst ensuring your business model is the best it can be, you must also prepare lengthy legal and financial documents to give effect to the franchise arrangement, as well as operation manuals to provide instruction and guidance to franchisees and marketing materials to support the franchisee’s business. You may also incur significant costs in recruiting a franchisee to run the franchise business.
- Time – franchising your business will demand a lot of time because whilst preparing that documentation, you also need to ensure your business model is stable enough to be a success when replicated by a franchisee. One way you may achieve this is by running pilot operations, such as a trial franchise. This will run for one to two years and enable you to identify areas of improvement.
- Training and support – you will be under an ongoing obligation to provide support and training to the franchisees and their employees. This will take up some of your time, which could distract you from running your own business.
- Business suitability – only businesses which have proven they can succeed in the market should franchise. If your business is unstable or in difficulty, franchising will not remedy your businesses’ instability. Instead, you will likely have failing franchises which only damage your reputation and brand.
Should you franchise your businesses, or just open another branch or outlet site that you own?
When deciding whether you want to franchise or open another branch/outlet that you own, you should consider what your commercial objectives are.
If you wish to grow your business without increasing your management demands, franchising will allow you to achieve this.
However, you should also make sure that you have the qualities needed to grow your business by way of franchise. Firstly, you need to be committed. To successfully build a network of franchises, you must have the dedication, time, and energy to run your own business, frequently monitor the business of franchisees, and regularly improve the business model. Part of this will also require regular analysis of the market to ensure the manual is up-to-date, so the business remains successful in the market.
You also need business capabilities to identify areas of improvement. When you build a network of franchises, you will need to ensure the business remains stable. This can be done by analysing the performance of the franchise and recognising your businesses’ weakness. You must also have the business skills to turn this weakness into an opportunity.
Choosing to open another branch or outlet will not necessarily be less work than franchising. By opening another site, you will be faced with the responsibility of recruiting more employees, obtaining stock and equipment, and running another outlet. Whilst you’ll have a manager employed at the outlet to overlook the day-to-day management of the outlet, you’ll have to pay a wage to this manager, and will incur costs for process of recruitment and for obtaining sock and equipment for the outlet.
Opening another outlet would reduce the risk of your business acquiring a fragmented image due to different standards of service being provided across different franchisees. If a franchise does fall below the standards you impose on the franchisee, the reputation of your brand will be damaged. There is a lower chance of a branch or outlet falling below standards as you will be able to exercise greater control and supervision over the management and operation of the outlet.
How would you use franchising to develop your existing business?
Franchising can be used to develop your existing business by allowing your brand and tradename to carry on its business activity in another territory. As the franchisee will ensure the business appears identical to your existing business from the premise decoration, employee uniform, and quality of goods, products or service provided, the outside world will not be aware that the franchise business is run by a different individual to your original business. The positive experience provided by the franchise will therefore contribute towards your brand image, help increase your customer base and increase development of your existing business.
When choosing to franchise, you should be highly selective about the franchisee you enter a franchise purchase agreement with. You need a franchisee with business acumen, and who shares the same professionalism, vision, and passion as you. This will make cooperation between you and the franchisees much easier, and enable you to support each other. You may also be able to develop your existing business by listening to the feedback given by franchisees and by taking on any new ideas they have for the promotion and development of the brand and business.
What state should your company be in to be suitable for franchising?
To be suitable for franchising, your company should be stable. If a company is in financial difficulty, it is not viable to begin franchising because the time and money spent on finding and supporting franchisees would only detract your attention from your unstable business. This could lead to the company falling into further difficulty. In a worst case scenario, your company may end up in liquidation. For this reason, you should ensure your company is in a stable position as this indicates the business will continue to grow, and shows that you are more likely to be in a position to provide the commitment, time and money required to franchise successfully.
It’s important that the business run by your company has been stable for over 12 months. If your business is relatively new, your business model will not have been tested over the full season. You may therefore find that due to the seasonal nature of your business, you struggle during the particular times of year. If this is true for your business, this previous history allows you to make improvements to prevent this in the future years once you’ve franchised. However, if you haven’t yet proven that your business is stable through a full 12 months, you should consider delaying the procedure to franchise.
To test whether your company will succeed as a franchise, you should run a pilot operation. This involves running a franchise outlet for a short period of one to two years, to identify the strengths and weaknesses of the franchise. At the end of the piloting period, if you are happy with the level of commitment demanded from you and the performance of the franchise, you can begin development of your company by franchising. Alternatively, your pilot operation may have identified areas of weakness and improvement, meaning that you would be in a better position to begin franchising only after these improvements,
When can you franchise your business? What stage should your business be at?
You can franchise your business at any time. However ideally, your business should be at a stage where you are comfortable stating that the business is working. This can be established by running a successful pilot franchise (pilot operation), as we’ve discussed above.
Your business should also be sellable. This means it must be attractive to franchisees. Again, this would your business should have a history of financial success and show that that the business will continue to be a success. Providing a business plan can be an efficient way to demonstrate the potential growth of the franchise. A business will also be more sellable if the brand is credible and reliable. It’s therefore important you have a good reputation and a strong relationship with a media contact.
Your business must be easy to replicate. If the model is too bespoke for a franchisee to replicate, such as the business being based in a unique location, franchisees will not be able to run the franchise business with the same success.
One final consideration is whether your business is profitable enough to allow you and franchisees to make money. If there’s a very small profit margin, your business may not be at a stage where it can provide sufficient revenue for the franchisee. This would not only make the business less attractive to potential franchisees, but it could lead to franchisees falling into difficulty and acquiring a bad reputation.
Becoming a franchisor, and choosing franchisees
Can anyone become a franchisor?
Any individual, partnership, LLP or corporation can become a franchisor provided you have a stable business which is proven to be successful. In practice, to ensure you’re not taking a high risk, you should only become a franchisor if you have the commitment and dedication required to develop the brand and provide support to your franchisees.
You should also ensure your business has a central management system which allows you to monitor the performance of franchisees, and software which franchisees can navigate with relative ease.
What questions should you ask of potential franchisees?
To ensure you pick the best franchisee who can be an asset to your franchise, you should ask the following questions:
- “Why do you want to buy a franchise?” This will allow you to identify the motivation of the potential franchisee, and find out if it matches your motivations for the business.
- “Do you have the finances required to buy the franchise and launch the franchise business?” In addition to paying the cost of buying the franchise, the franchisee must pay royalties for the ongoing operation of the business, and will incur significant cost for launching the business.
- “What are your previous experience and qualifications?” It’s ideal to pick a potential franchisee with experience in the industry or with strong transferable skills, as this will ensure the franchisee has the business acumen required to successfully run the franchise business.
- “Do you understand what your responsibilities will be?” It’s important to ensure the potential franchisee is aware of the extent of the responsibilities involved. Having realistic expectations means the franchisee will be prepared to do to their best to ensure the franchise is identical to your business, and that the standards of your business are met and maintained. Similarly, the franchisee needs to be aware that they will be monitored, and the nature of the business can’t be changed.
What legal structure should you or your business hold for the business to be franchisable?
As with any business, your franchise may adopt the legal structure of a sole trader, partnership, limited liability partnership or corporation. To determine which legal structure is suitable for your franchise, consider how each is different in their features of liability, management, tax and finance:
|Sole trader||Partnership||Limited Liability Partnership||Corporation|
|Liability||You will be solely responsible if the franchise business incurs liability.||You and the partners of the business will be jointly and severally liable if the franchise business incurs liability.||The partners in the partnership will not be liable above their capital investment in their business. This means your liability towards the franchise business is capped at the amount you invest.||As you will be creating a separate legal entity, your personal assets are protected as only the corporation will be liable. As the shareholder, you will only ever be liable for any unpaid amount on your shares.|
|Management||You will not have to share decision making regarding the franchise.||You will have to work closely with the partner to ensure you make joint/shared decisions.||You and the partners will have to make joint decisions. The partnership agreement will detail whether this requires majority decision or unanimous.||If you are the sole shareholder, you can make all the decisions regarding the business. However, if you have other shareholders, these members can exercise control over the management of the franchise business.|
|Tax||The profit you make from the franchise business will be taxed by way of income tax.||Each partner will be taxed individually on their profit from the franchise business, by way of income tax.||Each partner will be taxed on their individual profit by way of income tax.||The corporation will be tax on its profits by way of corporation tax. Any profits you receive through the corporation by way of dividend or fee from the franchisee directly (royalties) will be taxed by way of income tax.|
|Finance||Whilst you may borrow money, you’ll be unable to create floating charges or raise money by way of issuing shares.||Whilst you may borrow money, you’ll be unable to create floating charges or raise money by way of issuing shares.||You may borrow money and create floating charges. However, you can’t raise money by way of issuing shares.||You’ll be able to raise finance by way of borrowing, floating charges and issuing shares.|
A corporation is generally the most common legal structure of a franchise business. This is because it has greater flexibility with regards to potential avenues of finance and greater control of management. More importantly, it also allows you to exit the franchise if you want to realise your interest in the franchise business, by selling the shares of the franchise business.
Preparing for franchising your business
What legal advice will you need when franchising your business? Do you need a specialist franchising solicitor?
Legal advice is strongly advised when drafting the documents needed to franchise your business. The key document which a lawyer will draft is the franchise agreement. To ensure you and the franchisee are adequately protected, we’d recommend that you seek advice from a specialist franchise lawyer. Such a solicitor may also help you with writing an operation manual and marketing material, as law restricts the content of your marketing.
The British Franchising Association (BFA) provides franchisors with an online database containing experienced franchise solicitors.
What qualifications and experience do Harper James Solicitors franchising solicitors have?
We have several expert lawyers who can advise you on your franchise arrangement and help you structure your franchise in a way that meets your needs. Our team of dedicated lawyers have experience of advising numerous companies on franchising, therefore have the requisite understanding of your commercial needs.
If you’re considering franchising your business, we can assist you with all aspects of franchising, including:
- Intellectual property and protection of your IP
- Law relating to franchise contracts
- Purchase or sale of an existing franchise
- Dispute resolution, including a procedure in the franchise agreement and complying with the procedure to resolve disputes
- Drafting legal documents such as franchise and development agreements, non-disclosure agreements, confidentiality agreements, trade mark agreements, pre-contractual disclosure documents and guarantee documents
- Negotiation of leases for business premises
What general business advice is available on franchising your business?
There is a great deal of general business advice on franchising compiled by the main franchising industry body, the BFA, which has published some useful advice here. The Which Franchise website, which is the official online partner of the BFA, also provides general business advice about franchising.
What audits and analysis will you need to do before franchising your business?
Before franchising your business, you should undertake detailed and thorough auditing and analysis of your business.
Potential investigation that you may undertake may include:
- Reviewing your accounting records and ensure they are complete and accurate.
- Having periodic internal audits which are complete and accurate. This should monitor the business, verify financial records, evaluate internal controls, increase efficient of operations, and detect fraud.
- Having consistent periodic audits completed by an independent third party who will ensure your accounting records are accurate and complete, prepared in accordance with relevant regulation, and that your accounts fairly represent your financial position.
Investigating the financial performance of your business in such a manner allows you to ensure your business is stable enough to be franchised. This financial information will also be disclosed to potential franchisees in order to allow them to make an informed decision as to the value of the franchise business. Having this accurate view of your businesses’ financial performance reduces the chance of you being sued for misrepresentation with regards to the performance of your business.
What are the steps in the process of franchising your business?
- You should assess if your business has franchising potential in terms of it being successful and also possessing the potential to grow in order to provide a profit for both you and a franchisee. You should also consider if you have the time and motivation to commit to building a strong franchise network.
- Protect your IP by complying with the relevant procedure we discuss in the question, What intellectual property work needs to take place before franchising your business?.
- Prepare the operation manual which will allow a franchisee to replicate your business. The greater detail and clarity within the manual, the more attractive you will make the franchise. This is because potential franchisees will be convinced by your expertise and will be reassured that the majority of the relevant information is clearly set out in an accessible manual.
- Run at least one pilot operation for a minimum period of one year. This allows you to test the operation manual and the business format. Before fully franchising your business, a pilot operation allows you to gather information about the performance of your franchise and its viability. Not only does this reduce the risk of a failed franchise, it also increases the credibility and attractiveness of the franchise.
- Based on the profits and costs involved when running your pilot operation, calculate the fees you expect from franchisees. This should consider the premise costs, supplies, vehicles, office systems, advertising, training, and the right to use the brand and other IP.
- You can now draft a franchise agreement. It is important to get assistance from a specialist franchise solicitor when drafting the agreement to ensure adequate protection is included for both parties.
- Recruit franchisees for your business. When selecting a franchisee to enter an agreement with, you should ensure the potential franchisee shares your passion, values and vision of the business. Key questions to ask to assist in this process can be found in the question, What questions should you ask of potential franchisees? Once you’ve selected your preferred franchisees, you can sign the franchise agreement
- You can now begin performance of your obligations. At the outset, this requires you to provide initial training to the franchisee and potentially also assist the franchisee to obtain a business premise for the franchise and goods to trade for the business.
In exchange for the right to run a business under your brand and using your other IP, the franchisee will pay you numerous fees, the key fee being the royalty fee.
What intellectual property work needs to take place before franchising your business?
Before you franchise your business, it’s essential you protect your intellectual property (‘IP’).
To identify which protection you need for any product or concept you’ve created, this table can provide a rough guidance.
|Intellectual property||Protection||Time limit for application||Procedure|
|Writing and literary work, art, photography, films, TV, music, web content and sound recordings||Automatic copyright|
|Shapes of objects||Automatic copyright|
|Product names, logos and jingles||Trade marks||4 months||Apply to register a trade mark here.|
|Appearance of a product including shape, packaging, patterns, colours and decoration||Registered designs||1 month||Apply to register a design here.|
|Inventions and products such as machines and machine parts, tools and medicine||Patents||5 years||Apply for a patent here.|
Since your single product may be a unique tool which is a particular shape, you may need multiple protections for that single product (such as patent and registered design). You should therefore get comprehensive legal advice from an IP solicitor to ensure you have adequately protected your IP.
Once you’ve protected your IP, you can licence the IP to the franchisee, so the franchisee can properly run the franchise business.
Can you create a completely new business specifically for franchising?
All businesses can be franchised. However, this does not mean that all business will be suited to franchising. You can indeed create a completely new business to franchise, but you will not have the data and information to prove its success to potential franchisees, so this would be an unlikely scenario.
If you have an idea for a business to franchise, for it to be suited to franchising, it must be proven to be successful. You must therefore have run this new business long enough for it to be viewed as successful. One way to show this is to run a pilot operation, which we’ve discussed above in What state should your company be in to be suitable for franchising? and also When can you franchise your business? What stage should your business be at?. This pilot operation will test your business idea in the market, and allow you to identify any weaknesses in the business such as its seasonal nature. Whilst improving the business and increasing the chance of success, this also attracts potential franchisees by providing information and data which proves the success of the franchise format.
Can you convert existing outlets into a franchise format?
Yes, it’s possible to convert existing outlets into a franchise format by entering a franchise agreement with the franchisee. As you will not want disruption to be caused to your outlet, you should ensure the franchise agreement is tightly drafted to limit the changes the franchisee can impose with regards to the employees working at the outlet for example.
If the converted outlet is the first franchise of your business, then it is important this franchise is run as a pilot operation. This is because you will not have proven your business model as successful in a franchise format. To limit the risk, and to identify any weaknesses in the business model, ensuring your outlet is a pilot operation running only for a short period of one year is advisable.
However, if you have already established a few franchises alongside outlets that you own directly, converting existing outlets would be a convenient and cost effective way to build your franchise network. As the outlet will already be trading, you won’t need to train any new employees for the incoming franchisee. This saves you time and costs as you will only need to train the franchisee.
An additional benefit from also having an outlet with a manager is that the manager and senior employees at the outlet can provide the franchisee with support and expertise of your business.
Do you need a business plan to franchise your business?
A business plan is particularly useful if you wish to obtain financing for franchising your business. As mentioned in the questions What are the disadvantages of franchising your business? Why shouldn’t you become a franchisor? and What does it cost to franchise your business?, this process of preparing to finance your business can be costly. To increase the chances of obtaining finances, your business plan should explain your business objective, the market condition in which you will operate your business, the amount of money you need to achieve this (ie, your costs), projections of the franchise network, and how you intend to repay the borrowed amount.
Even if you don’t intend to obtain finances, producing a business plan will help you set out your plan for the business. This can help you create a clear vision of your business and focus your efforts on all the right elements needed to succeed.
How does the CRC Energy Efficiency Scheme (and its abolition from 2019) affect franchisors?
If your business meets the criteria for participation in the Carbon Reduction Commitment (CRC) Energy Efficiency Scheme, you must buy an allowance for every tonne of carbon you emit. As your business consists of a franchise network, you will need to buy an allowance for the total carbon emitted by the entire franchise network. For this reason, you need information from franchisees about their electricity and gas supply.
You can include a clause in the franchise agreement requiring franchisees to indemnify you for a ‘fair and reasonable’ proportion of the costs you incur. To prevent franchisees from hindering your participation in the scheme, you should also seek a clause requiring the franchisee to indemnify you for any failure to provide the requested information.
There are some circumstances in which you will not be responsible for buying the allowance for carbon emission on behalf the franchisees. These include circumstances when:
- The franchisee is a tenant at the premises and the landlord is responsible for procuring the franchisee’s energy supplies. In this event, the landlord is responsible for the carbon emission; and
- The franchisee carries on the franchise business and another unconnected business from the same premise, and a franchise agreement does not exist. In this event, the franchisee is directly liable for its carbon emission.
However, this is changing. The Government plans to abolish the CRC Energy Efficiency scheme from 2019. This means businesses will be required to surrender their allowances for the final time in October 2019.
What is the danger to a franchisor if no pilot operation is tested?
We’ve discussed pilot operations in the questions above,Can you create a completely new business specifically for franchising?, What state should your company be in to be suitable for franchising? and What does it cost to franchise your business?, A failure to run a pilot operation will reduce the credibility of your franchise because you’ll struggle to show potential franchisees that your business is a proven format. Whilst your business may be successful when operating through branches, opening a franchise outlet is very different. If you haven’t proven that you have tested and seen the success of your central management systems, a potential franchisee will not consider your franchise business as credible or attractive.
More importantly, a franchise which does not have a pilot operation is more likely to fail and face difficulties. A pilot operation usually runs for a period of a year or two. This is sufficient time for you to identify whether there are points of weakness in your business when moulded into a franchise format. This may include greater insight into your ability to preserve personal relationships with multiple franchisees, as well as enabling you to determine if you can give the necessary time and commitment to support franchisees whilst also running your own business. The experience will also allow you to ascertain whether your business is easy to replicate and whether you have the systems in place to ensure consistency across the franchise network.
If you have never tested any of these elements of the franchise business, you increase the chance of these problems arising and leading to your franchises becoming inconsistent. This could lead to significant damage to your brand, leading to a failure of your entire business. It is therefore advised that at least one pilot operation is undertaken.
What does it cost to franchise your business?
The cost of franchising will depend on the nature of the business and its size. It is not uncommon for costs to reach around £50,000. Of course, this will vary from each business.
The cost of franchising usually arise from the costs of:
- General development
When preparing to franchise, you will need conduct market research and will likely test your systems and procedures before running a pilot operation. Part of this will also mean you incur consultants’ and solicitors’ fees.
- Franchise package development
To provide the necessary support to franchisees, you will need to prepare a package containing the systems, procedures, training, sales literature, and operation manuals.
To find and attract franchisees, you will need to make some investment in your prospectus, advertisement, franchise exhibitions and time spent on selection interviews.
How do you make money from your franchisees?
The main purpose of franchising will be to develop and grow your brand, and to make a profit.
There are three ways to make money from a franchise:
1. Receive a mark-up of each product sold
2. Receive a levy of a fixed royalty fee meaning you make money even when the franchisee is in loss
3. Receive a percentage of the turnover
Although this income will not be a large profit, if the franchisee business remains successful, the long-term operation of the franchise will make growth by franchising a profitable venture.
How do you value your business when offering it to franchisees?
To obtain a realistic valuation of your business it is important to take proper accredited advice from finance industry professionals.
One potential way in which a professional may value your business is by estimating the entry cost. This will require consideration of the costs of creating the business such as buying equipment, employing staff, developing products and marketing. On the basis of this, and the prospect of future growth, you can reach a realistic value for your business.
An alternative method may be to consider the cash flow. This process considers the business’ cash flow over a period of time and adds a terminal value (value at the end of the period), and then discount this to provide a current business valuation.
What different charges should you ask your franchisees to pay?
There are several fees that you may ask a franchisee to pay. This includes:
- Development fee’, exclusivity fee, initial franchise fee
Development fees and exclusivity fees are usually charged for granting the franchisee the right to use your brand and intellectual property (‘IP’) usually exclusively within a specified territory. The initial franchise fee is a sum charged for the initial right to operate the franchise.
- Store opening fee
This is usually an upfront fee you can charge the franchisee for each outlet it opens.
- Service fee or royalty
This is the primary way in which you will profit from the franchise as it is a regular fee paid by the franchise. The amount of this fee will either be a percentage of each product sold, a percentage of the turnover or a fixed amount.
- Training fees
You can charge this fee to indemnify you for the cost you incur when investing time and resources to train the franchisee and its employees. If you arrange for regular training of the franchisee, this fee will be charged on each training session.
- Marketing contribution
You can charge the franchisee for any costs you incur when advertising the franchise network, as the franchisee will also benefit from such marketing campaign. Usually, this fee will be a percentage of the cost you incur, or a percentage of the gross turnover. In addition to charging the franchisee for advertisement, you may also request the franchisee to set aside a minimum amount to spend on its own local marketing.
- Other fees
These fees may include lease rentals, software licences and support fees.
Can a franchisor dictate pricing and set prices?
You cannot control the pricing of the franchisee because this can constitute a breach of competition law. Having said this, you can dictate short-term price promotions and place restrictions on excessive prices used by franchisee.
Does the franchisor have to do the franchisee’s accounting?
No, you don’t need to do the franchisee’s accounting. It’s more common for franchisors to require franchisees to complete their own accounting, and to provide their audited accounts to the franchisor. This makes the arrangement more convenient for you as it would be difficult for you to undertake the accounting obligations of every franchisee.
You should note however that a franchisee may still request your advice on the accounting procedure.
Franchisors and employment law
Are franchisors subject to employment law relating to their franchisees? Are franchisors employers? What employment responsibilities does a franchisor have towards a franchisee?
There is no law to indicate that franchisee is an employee of a franchisor. The law states an employee is an individual who works under a contract of employment. Because the contract can be express or implied, the law could interpret an individual franchisee as an employee. This would only be likely where you exercise significant control over the employee – such control would be distinguished from the control you exercise over the franchise business.
Types of franchise
Which type of franchise model should I choose to franchise my business in? What are the pros and cons of each format, for you as a franchisor?
There are three key formats for your franchise model, and advantages and disadvantages to each model.
|Type of franchise format||What’s involved?||Advantages||Disadvantages|
|Franchise||A franchise would involve selecting a franchisee (also known as a unit franchisee) to run your franchise business from another franchise outlet. The franchisee would have the rights to use the brand, tradename, other IP necessary in the course of the franchise business including software.||
|Master Franchise||If you use a master franchise, you will be the master franchisor. By entering a master franchise agreement, you grant the master franchisee the same rights as a unit franchisee, such as the right to use the brand. However, the master franchisee can also grant sub-franchises to third parties within a territory. It is common for the master franchise agreement to specify the number of sub-franchises the master franchisee must establish within a specified period.||
|Franchise Development||Franchise development is when you grant the franchisee (developer) the right to open a number of franchise outlets in a territory but cannot sub-franchise. This means that the outlets must be operated and funded by the developer, instead of finding third parties to establish a franchise outlet.||
Franchisor rights, responsibilities and franchisor agreements
What legal documents and agreements will you need for franchising your business?
To franchise the business, you will need to enter a franchise purchase agreement with selected franchisees. Alternatively, you may enter a master franchise agreement or franchise development agreement.
If you lease or own a premise which you will provide to the franchisee as the business property, you’ll need to enter a lease/sub-lease or a licence, depending on whether you will be leasing or licencing the premise. You may need advice from our commercial property solicitors.
You may also need to enter a separate licence granting the franchisee the right to use your IP. If a separate licence is entered into, you can charge a fee under this licence for the continued use of IP.
Why is a franchise agreement necessary for the franchisor?
The franchise agreement is necessary for you because it includes important protections. In addition to setting out the fees, the agreement will also contain the calculation of interest which may be charged on any delayed payment. The agreement also sets out the liability of the parties via a limitation of liability clause.
In addition to this, the franchise agreement requires the franchisee to exercise the rights granted in accordance with the conditions imposed by the agreement. In particular, the franchisee is under an obligation to ensure the business standard is the same as the standard of the original business. A specification will usually be provided to give the franchisee insight into the requisite standard.
The franchisee must also protect the goodwill and reputation of the brand, as well as promote and develop it. Preventing the franchisee from damaging the brand image and reputation, there is a positive obligation to build the image.
What are the franchisor’s rights and responsibilities during the sale of a franchise?
During the sale of a franchise, you must review your business and collate sufficient financial information to provide to potential franchisees. This will allow the franchisee to complete due diligence and to gain an accurate representation of the financial progress of the business.
When entering negotiations with a franchisee, you may ask the franchisee to enter an exclusivity agreement to prevent the franchisee from entering talks with another franchisor. This will save you time and cost by reducing the chance of you investing in a potential franchisee, only to have the franchisee withdraw from negotiations due to finding an alternative franchisor to enter an agreement with.
You are also entitled to require the potential franchisee to enter a confidentiality agreement. As you’ll be revealing confidential information to the potential franchisee during the pre-contractual disclosure and negotiation process, it’s important to ensure you enter a confidential agreement to prevent the potential franchisee from using and exploiting this information.
What self-regulation options are available to franchisors?
There are a number of options available for self-regulation.
The first option is to apply for membership with the British Franchise Association (BFA). The BFA is a self-regulatory body which gives credible franchises membership status. As you will be tested against a strict criteria, having this membership status will make your franchise more attractive to franchisees.
If you do become a member of the BFA, you will commit to certain codes and procedures attached to it, such as:
- Code of Ethical Conduct
- Disciplinary Procedure
- Complaints Procedure
- Appeals Procedure
You will also be required to provide the BFA with non-confidential information regarding the franchise. Once your membership has been offered and accepted, there are fees payable for the subscription to the BFA.
A second option is to simply comply with the European Code of Ethics for Franchising. This code is interpreted by the BFA to produce the BFA Code of Ethical Conduct. Because you adopt this independently of the BFA, you can provide greater security for franchisees whilst avoiding the subscription rates associated with subscribing to the BFA.
A third option is to join the International Franchise Association (IFA). This self-regulatory body is similar to the BFA as it requires you to comply with IFA Code which is enforced by a Code mechanism, an ombudsman program, and an educational program. Like membership with the BFA, subscription with the IFA would make your franchise more credible and attractive to franchisees. This is because the code and ombudsman program provide franchisees with reassurance that their interests will be protected in the arrangement. However as with the BFA, you would need to pay a subscription fee in order to join the IFA.
Can the franchisor compete with their franchisees?
If you and the franchisees are in the same territory, you will be in competition with the franchisees. Whilst competition is permitted (if the franchise agreement doesn’t impose unfair restrictions such as a maximum price for each product sold), it would not be sensible to compete with your franchisees.
As the franchisee is using your brand, it is important that there is consistency in the image of the franchise network and the success of each franchise. Promoting your own business and leaving the franchisee to appear less successful and attractive will cause inconsistency in your brand. Considering you will profit from the success of the franchisees through a royalty fee, it’s actually in your interest to ensure your franchisees are not hindered in their performance by unnecessary competition from yourself or other franchisees you own.
What legal protection is a franchisor entitled to?
There are numerous legal protections which you as a franchisor are entitled to.
One way you are protected is through the obligation on franchisees to maintain the franchise business at the standard specified in the franchise agreement. This ensure the brand is not damaged by one franchise in the network having low standards.
You are also protected by restrictions on the franchisees’ use of trademarks and IP, such as the franchisee only being entitled to use it in the course of franchise business for the duration of the franchise agreement.
When drafting the franchise agreement, you should specify the key events in which you would like to reserve the right to terminate the franchise agreement. These events will usually include a breach of franchise agreement by the franchisee, a key IP or trade mark no longer being available due to a successful claim of infringement of IP by a third party, a non-payment by the franchisee, persistent complaints against the franchisee, and change of control of the franchisee (if it is a corporation). In the case of non-payment, you may grant a grace-period, in which interest will apply on the delayed payment. If the payment is made outside this grace-period, you reserve the right to terminate the agreement.
To protect yourself from the cost of running the franchise network, you may impose an advertisement levy on the franchisee for the costs you incur when advertising the franchise. Considering the franchisee will benefit from such advertisement campaign, a fair proportion of this cost can be transferred to each franchisee.
You may also include a step-in right. This clause would allow you to give written notice to the franchisee and take the franchisee’s place in the management of the franchise. Such a right would be limited to circumstances where there is early termination for reasons not caused by your breach of the agreement, and where the franchisee is selling the franchise business to you. The advantage of such a right is that it enables you to take control of the franchise business with minimal disruption to its day to day operation.
A connected right would be to include a right which entitles you to be offered the opportunity to buy back the franchise business before the franchisee offers to sell the business to a third party. This may be limited in scope to situations where there is early termination, or may be wide in scope to apply to any circumstance in which the franchisee wishes to sell the franchise.
In addition to this, you may also include a term which entitles you to buy back any goods, equipment, plant and fixtures which you sold to the franchisee.
It is important to also include restrictive covenants which prevent the franchisee from soliciting your customers and suppliers, competing with your business during and after the franchise agreement, and using/exploiting confidential information and know-how during and after the franchise agreement.
When drafting these restrictive covenants, you should seek legal advice to ensure they are reasonable in scope and necessary to protect your franchise’s legitimate interest. Generally, limiting the scope of restrictive covenants to apply only until 6 to 12 months after termination, and within a specified geographical territory will be sufficient for the clause to be valid.
A final way to protect yourself is to include the general standard clauses which protect your interest. This includes a limitation of liability clause which prevents you from being liable for acts of negligence by the franchisee and its employees, and states each party is responsible for its own compliance with relevant laws concerning accounting, tax, anti-bribery, and trading scheme.
What is a franchisor’s obligations regarding errors and omissions?
If the franchisor has discovered errors and omissions in the information it has provided to the franchisee, then it must disclose this to the franchisee immediately.
A failure to do so would lead to your representation of the franchise being false. The franchisee could therefore take action against you for misrepresentation. A successful claim would lead to you having to pay compensation to the franchisee, or even the franchisee being entitled to terminate the agreement.
What does a franchisor have to do about commercial premises?
When you franchise your business, the franchisee will need a commercial premise to operate the business. You can therefore agree with the franchisee whether the franchisee will be provided with a premise by way of a lease or licence from you, or whether the franchisee is required to procure premises from a third party independently, or will be using a premise the franchisee already owns.
If you are providing a premise, you can choose to lease or licence the premise. Whilst sub-leasing is an option, it may be difficult to enter a sub-lease due to restrictions contained in the lease you have entered into with your landlord.
The difference between licensing and leasing a premise you own is that legally, a lease will create an interest in the premise for the franchisee, whereas a licence will only grant the franchisee rights exercisable over the premise.
The practical difference includes:
|Licence||You can control the arrangement
Greater flexibility particularly with regards to terminating the licence
If you do replace the franchisee, under an early termination for example, a licence is easier to grant a new franchisee. However entering a new lease is more difficult and time consuming
|If you don’t own the premise you are licencing (for example, because you are a lessee), the landlord may have restricted your ability to licence the premise by requiring its consent before a third party (the franchisee) occupies the premise|
|Lease||You can create more permanent interest for the franchisee – ideal if you intend for the franchisee to remain at that premise for a long period||If you do not own the premise (for example, because you are a lessee), you may need to provide a personal guarantee to the landlord. If the franchisee subsequently defaults under the sub-lease, you will be liable for the default.
You need to contract out of the security of tenure protection to prevent the franchisee from being entitled to continue occupation of the premise after the lease period has expired. This can take up time and prevent you and the franchisee getting started immediately
Which laws and specific legislation apply to franchisors and their activities?
Whilst there are numerous laws which apply to franchisors and their activities based on the discipline, the following laws apply generally to all franchisors.
- Trading scheme – this act restricts your activity in numerous ways such as restricting the content of your advertisement.
- You might want to read our Mergers & Acquisitions FAQs for more information here.
What must a franchisor provide to franchisees?
To ensure the franchisee is in a position to run the business efficiently and to adequate standards, you will need to provide the following to the franchisee:
- Operation manual
- Advertisement material
- Ongoing support
- Training & ongoing training
What is the franchisor’s right to repurchase (or right of first refusal) and what does it mean in practice?
The franchisor’s right to repurchase (or right of first refusal) means that if the franchisee wants to sell the franchise, the franchisor is entitled to be offered the franchise before the franchisee offers the business to a third party.
In practice, this means that you can take ownership of the franchise business if you don’t want a third party to enter your franchise network and operate a franchise.
You should be aware that where the franchisee is a corporation, it may transfer the ownership of the franchise business by way of selling all the shares in itself (sale of the corporation). This would mean a new franchisee is running the franchise business.
What are the franchisor’s pre-emption rights?
The franchisor’s pre-emption rights are your rights to deny the franchisee the right to sell the franchisee business, and to deny approval of the buyer of proposed by the franchisee. These pre-emption rights are limited in scope because you must be reasonable when considering whether to grant consent and approval for a sale.
If you do unreasonably withhold consent or approval, the franchisee can take action for breach of contract which could lead to you paying damages, in addition to the court sanctioning the sale.
What are the methods of franchising your business for overseas expansion?
To franchise your business overseas, you may enter an arrangement with a franchisee based in an overseas territory.
If you enter a master franchise agreement, you would be able to grow rapidly in an overseas location because the master franchisee will be able to sub-franchise in the foreign territory.
Alternatively, you may establish a subsidiary in an overseas territory. This subsidiary would then enter franchise agreements with franchisees in the overseas territory. Such an arrangement would have the added benefit of the subsidiary being able to provide support to the franchisee instead of a long distance relationship.
Franchisor disputes, termination, exits and failure
What happens to your business and franchise network if you, as the franchisor, fail, go out of business, liquidation or become insolvent?
When your franchise network begins to fail, you may choose to sell the business to a franchisee with sufficient funds or a third party. The new buyer may succeed in turning the business around. Alternatively, if you sell the business as an ongoing concern, you may be able to sell parts of the business to numerous buyers, and successfully pay off the debts.
Another option you have when your business fails is to put the entire franchise network into administration. The administrators will run and manage the business to turn the company around, to increase the assets of the business for the purpose of repaying creditors. The franchisees will continue operating under their franchise agreements whilst the administrators are running the business.
If administration fails or isn’t appropriate, you may enter liquidation. This will lead to the franchise network being wound-down and the assets being sold to the highest bidder. The proceeds will then be distributed according to the statutory priority which prioritises creditors. Unlike with the sale of the franchise network to a third party, the franchisees would not continue operating the franchise because the franchise agreement would be void.
Is the franchisor liable for the actions or conduct of the franchise or franchisees? How can the franchisor’s liability be limited?
In the UK, a franchisor will not usually be liable for the action or conduct of the franchisee. This is because the law generally does not consider franchisees as an employee of the franchisor. As we mention in the question Are franchisors subject to employment law relating to their franchisees?, it’s unlikely the franchisor will exert the necessary amount of control over an individual franchisee in order to give rise to an employment relationship. Therefore, any liability arising from the action or inaction of the franchisee or its employees will not lead to you being liable.
To clarify this position, you may also add protections in the franchise agreement. Firstly, you may include a clause expressly stating the franchisee is not an employee. Secondly, you may include a limitation of liability clause.
You may incur liability for breach of terms when you supply goods for the franchisees. However, the limitation of liability clause can specify that the liability for such breach is set out in the separate supply agreement. Similarly, any liability to the franchisee for any loss or damage under the franchise agreement (such as breach of statutory or contractual duty) can also be limited to a maximum amount.
Can a franchisor sue a franchisee?
If the franchisee breaches the terms of the franchise agreement, you may sue the franchisee. Common reasons you may wish to take action against the franchisee include:
- Failure to maintain the specified standards in the premise of the franchise business
- Failure to protect the franchise brand and its goodwill
- Failure to promote the franchise brand; potentially by not complying with the obligation to use a minimum amount for local advertising
- Failure to pay any fees under the franchise agreement
- Failure to train employees to adequate standards
All of the above reasons constitute a breach of contract. If the breach is expressly stated as a breach in the franchise agreement entitling the franchisor to terminate the agreement, or if the breach is fundamental (for example, the franchisee uses your brand to run a business completely different in nature from your franchise), you would be entitled to terminate the agreement.
However, for most breach of contracts, you will be entitled to damages. These damages will put you in the position you would have been had the breach not occurred. The damages would therefore be compensatory in nature.
What if you want a franchisee to leave the franchise? Can the franchisor terminate the agreement?
In order to terminate the franchise agreement, you must identify whether the termination clause in the agreement entitles you to do so. This means you must have a good reason because the circumstances in which you are entitled to terminate the agreement require a reasonable reason.
Potential reasons which a termination clause may entitle you to terminate include:
- Persistent complaints against the franchisee
- Franchisee’s inability to repay its creditors
- Change of control of the franchisee
- Material breach of the franchise agreement by the franchisee
- Failure to pay under the franchise agreement
If you do terminate the agreement for a reason not expressly permitted in the franchise agreement, the franchisee will be entitled to sue you for breach of contract.
Should a franchisor have an exit strategy? What happens if a franchisor wants to sell the whole franchise network?
A franchisor doesn’t need an exit strategy because you will franchise your business in order to grow the business and increase your profits. However, if you do wish to capitalise on the growth of your business by selling the franchise network, you can sell the business by way of share sale or an asset sale. When doing so, you may be under an obligation to consult franchisees before selling, in order to give franchisees notice of your intention. The franchisees can then make a decision as to whether they wish to remain in the franchise network.
If you are subject to such a consultation duty, you should ensure transparency because if a franchisee leaves the franchise network before you sell to a third party, it can affect the value of the franchise network.