Franchisors license their business concept and marketing plan, and provide assistance to franchisees in implementing the concept in exchange for an initial franchise fee and ongoing royalty payments. Franchisors often view franchising as a way to exploit their business concept and expand using other people’s (franchisees’) money and manpower while the franchisor collects the money.

Increased franchisor obligations

While franchising avoids franchisor’s directly providing financial and manpower resources to individual operations, it still requires substantial capital and management resources to:

  • sell franchisees
  • train and support franchisees
  • comply with disclosure and other franchise regulatory requirements

Repeatable / teachable business concept

Franchising can be a good “match” for some but not all business concepts. The business concept must be capable of being duplicated and susceptible of persons being trained to operate it. Some business concepts depend on a particular location or other circumstances, or require certain expertise or experience, education, knowledge or entrepreneurial talent not easily duplicated or trained for.

The franchise relationship

Franchising is a long term relationship and needs to benefit both parties to be successful. Initial franchise fees may be largely consumed by costs of the sale and training and assisting the new franchisee to become operational, and franchisors earn their income through royalties from ongoing franchisee operations, and so franchisors depend on franchisees being profitable and continuing in operation.

Franchisees are often happy early in the relationship, feeling the initial fee was worth the head start that franchising provided. But royalties continue throughout the franchise relationship and are paid to franchisor “off the top”, whether or not franchisee makes a profit. Franchisees not infrequently become discontent after several years as they continue to pay royalties and question what the franchisor is doing on an ongoing basis to provide value in exchange for the continuing royalties, e.g.:

  • advertising or promotions to “drive” customers to franchisee
  • research into new or improved products or services
  • research consumer trends
  • substantial system leverage in purchases required to operate the franchised business not available to non-franchisees

Franchisees are looking to build and own their own business, and franchising may NOT achieve this and can be a source of friction in the relationship.

Starting up a new franchise operation

Start up franchises generally must demonstrate viability of their business concept to be able to attract potential franchisees. This generally requires several “company” franchise operations in various settings, e.g., large cities, small college towns, urban and suburban locations, etc. These company operations also serve to “fine tune” operating procedures.

Franchisors must deal with various legal considerations, e.g., preparing the franchise agreement and other agreements, and meet a number of regulatory requirements, most specifically preparation and furnishing of the “disclosure document” or “offering circular” to potential franchisees (required in all states). Registration is required in a number of states prior to even “offering” to sell a franchise in the state. Numerous other matters must be considered such as whether special industry laws apply.

Disclosure requirements mandate that franchisors have certified financial statements, starting at least from the time the franchisor starts offering franchises. This results in significant additional costs and must be planned for, or franchise sales will have to be suspended until the certified financials can be obtained.

Weak financial status may also trigger “impound” requirements for initial franchise fees, resulting in franchisor’s inability to use those funds for operations until all franchisor’s obligations in setting up the new franchisee are fulfilled, or providing a bond which is an additional expense and may be difficult to obtain.