Professional Documents
Culture Documents
What is franchising?
How can franchising be used to develop a
business?
What are the advantages and disadvantages of
franchising?
How is franchising different to other third party
relationships?
How can a business be franchised?
How should a franchise be structured?
Should franchisors conduct an audit of their
Intellectual Property (trade names, logos, trade
marks etc.)?
Do franchisors need to have their know how
and methods of operations in written format?
i.e. do they need an Operations Manual?
Prior to entering into the franchise relationship
should the franchisor run a pilot franchise
operation?
How can franchisors select good franchisees?
What is franchising?
The General Concept
In simple terms it is the granting of certain rights by one party (the franchisor) to another (the franchisee) in return for a sum
of money. The franchisee then exercises those rights under the guidance of the franchisor.
The consumers perception should be that there is no difference between one of the franchisors corporate outlets and a
franchised one. The franchisor is licensing the franchisee the right to use its business format; hence the term business format
franchising. However that right to use the business format is for a limited period of time. The franchisee gains no interest in
the actual ownership of the format or the associated brand i.e. the trade marks. The rights he enjoys are similar to those of a
tenant when leasing a house. During the period of the lease the tenant has full enjoyment of the house, but the day after the
expiry of the lease he has no rights over the property at all.
The franchisor has to control and co-ordinate a network of semi-independent businessmen and ensure that they build and
maintain a favourable image for the whole franchised operation. This means that the franchisors own role changes drastically.
The policing and monitoring of standards by the franchisor is vital but can at times be difficult. The franchisor will sometimes
have to resort to the use of both carrot and stick to get franchises to try new techniques or improve their current performance.
The dynamics of the franchisor-franchisee relationship are such that a lack of trust will on occasions creep in, making life more
difficult than it should be. This may be due to personality clashes between the franchisee and members of the franchisors
team or because the franchisee realises that he/she does not find it easy to live within the restraints imposed by a franchise.
Conflicts between the franchisors corporately owned outlets and those owned by franchisees may occur. It is the franchisors
duty to remove/minimise these conflicts and ensure that they are satisfactorily dealt with.
An individual corporately owned outlet will be more profitable for the franchisor than an individual franchised outlet (although
the increased number of franchised outlets will probably mean that the franchised business as a whole will be more profitable
than one which is entirely corporately owned).
STEP 4: Funding
Once the concept has been piloted, or indeed before, the potential franchisor must decide upon how it will make money for
itself from the franchise business. Most banks will fund respectable franchisors with sound concepts.
The most common mistake made by new franchisors is to be in such a hurry to recruit the first few franchisees that, they
compromise upon the criteria that they have decided upon for their ideal franchisee profile. Obviously the ideal franchisee
profile needs to be realistic and flexible to a degree but it should not be totally ignored as soon as a potential franchisee
with money to invest walks through the door.
It is not unknown for new franchisors to give their first few franchisees sweetheart or honeymoon deals. It is
acceptable to recognise the great degree of risk that the first few franchisees take by investing in the franchise, but it is a
mistake to give too good a deal as there are likely to be the cause of friction between the franchisor and later franchisees in
the future.
It is important that the franchisors know where the franchisee get its funding from and the terms of any repayment, so
that he can be satisfied that the franchisees personal circumstances do not make the franchise an untenable business
proposition.
Most people have a comfort zone, a level of income above which they are not sufficiently motivated to increase the
turnover and profitability of their business. The franchisor should try to identify whether or not a franchisees individual
comfort zone is too low for the particular franchise.
If a potential franchisee is too entrepreneurial this can cause substantial problems for the franchisor. A real entrepreneur
will find the disciplines of franchising far too strict and conflict with the franchisor is inevitable. Energy and drive is
essential in a franchisee, but so is the ability to work within a system - a quality which few entrepreneurs possess.
details of the type of business(es) operated by the master/ developer/franchisee as the case may be
details of parent, subsidiary and group companies
its financial records, its accounts, balance sheets, loans, what assets it has, both movable and immovable and any charges
on them, types of creditors, details of bankruptcy/insolvency if it was ever faced with it
amount of capital it has and is able to outlay for the franchise operation
details on its directors, officers, shareholders and employees
access to a skilled/unskilled work force (including recruitment policy, training and operational standards)
ability to expand the business
types of services offered, in terms of marketing, advertising, distribution of goods, management skills and its ability to
obtain all the clearances from authorities to set up the franchise business or outlet
litigation history, if any
type of business, its corporate structure including whether it is a part of a group of companies or one company
business experience of the franchisor and its directors and officers domestically and internationally
type of franchise business format, product line etc
its accounts and financial status, along with information on any loans, charges on its assets, creditors, details, and any
bankruptcy/insolvency proceedings it has been involved in including directors and personnel involved
litigation it has been involved in, both in civil and criminal law
reputation of its brand name or goodwill and any public figure who may be associated with it
funds to be paid to the franchisor by franchisees e.g royalties, technical fees, lump sum payments, recurring fees that
would be required
obligations to purchase on the part of the franchisees, such as raw materials from the franchisor for goods in question,
products, equipment, real estate, services of the franchisor, signs, fixtures etc
restrictions on sale, tie-in and buy-back arrangements by the franchisor of the franchisees business
training programmes offered by the franchisor and level of supervision involved
site selection and design of the outlet, to what extent it needs the approval of the franchisor
what requirements are there for the renewal of the franchise agreement?
what sorts of activities or breaches would result in termination of the franchise contract
Development Fee or Exclusivity Fee an upfront fee typically in consideration for granting to the franchisee territorial
exclusivity
Store Opening Fee an upfront fee payable on opening each franchised outlet
Service Fee a percentage of gross turnover, usually payable monthly over the term of the relationship
Mark up on products and equipment supplied by the franchisor to the franchisee
Marketing Fee usually expressed as a percentage of gross turnover, this is a contribution to any local, regional or
international marketing campaigns that the franchisor will run and that will also benefit the franchisees business. In
addition, the franchisee may be required to commit to a minimum spend on its own local marketing campaigns
Training Fee an amount charged from time to time by the franchisor for training the franchisee to operate the business
and provide ongoing assistance and support.
Confidentiality
A franchisor will be forced to disclose a considerable amount of confidential information to each of its master franchisees/
developers/franchisees and they in turn will have to disclose some of that information to their employees. The franchisor
therefore needs to make quite sure that it has done all that it possibly can to prevent these parties from disclosing the
confidential information and/or using it to compete with the franchisor.
One method is for the franchisor to receive a direct confidentiality and non-competition undertaking from each of its master
franchisees/developers and franchisees. These must agree that they in turn will obtain similar undertakings from their
employees and enforce those undertakings if required to do so.
Once an employee has left, he may not disclose any genuinely confidential information which he might have obtained while
working. In practice, this is a very difficult rule to enforce. It may be hard to prove that any employee is using secret information
or disclosing it to others.
In any event, the courts have to be convinced that the information which has been disclosed is genuinely secret. Merely
labelling something as secret will not do. For example, it is no use labelling a recipe as a secret recipe if the ingredient list and
the method is set out in a poster which is on the wall of the franchise restaurants kitchen, particularly if members of the public
can easily read it from the restaurant area. It would be hard to convince a court that it was a genuine secret if thousands of
employees knew it. At some stage, a court will decide that the matter is no longer secret and has become public knowledge
and not through the fault of the franchisee.
Non-competition
Due to the difficulty of showing that secrets are genuine and that they have been disclosed, franchisors frequently attempt to
get round the problem by putting in specific non-competition clauses. That is to say, clauses which oblige the franchisee not to
operate a competing system within a certain period after the termination of the franchise agreement or within a certain radius.
The enforceability of such clauses varies greatly.
Great care has to be taken drafting a restrictive covenant because, if it is drafted too widely, the court will refuse to enforce the
whole covenant.
For example, a restriction on operating a competing restaurant within a one mile radius of an existing restaurant might well
be reasonable in a small town but may be unreasonable in central Rome. A restriction might well be reasonable if it could be
shown that it was almost certain that trade secrets were being used in order to operate the competing business.
Rather than a non-competition clause, which the courts do not like, a franchisor may be able to achieve similar ends by
prohibiting former franchisees and their employees from poaching customers and from enticing former staff colleagues. The
object is to prevent the former franchisees or ex-employees from using their personal influence over customers or employees
to the disadvantage of the franchisor. This type of restriction may be particularly useful if the former franchisee is to be
allowed to continue to exploit the franchise in a limited territory rather than a full scale termination. There must, however, be a
legitimate reason for restricting competition. It would not be reasonable to restrict an employee from contacting old customers
when, in his old job, he had no contact with customers anyway.
Protection of confidential information and both in term and post-term restrictions on competition, are issues that the
franchisor must consider very carefully before finalising the form of a franchise or development/master agreement. Local laws
may greatly restrict the scope and enforceability of such clauses and it is therefore essential that timely advice is taken from
experienced local lawyers.
Contacts
Gordon Drakes
Shelley Nadler
David Bond
e gordon.drakes@ffw.com
t +44 (0)207 861 4525
e shelley.nadler@ffw.com
t +44 (0)207 861 4655
e david.bond@ffw.com
t +44 (0)20 7861 4079
Associate, London
Director, London
Partner, London