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What is Franchising?

Franchising is a method of distribution of goods and services. A franchise arrangement consists of the: (1) franchised business; (2) franchisor; and (3) franchisee. The "franchised business" is the actual business idea or concept that is the subject of the franchise arrangement. For example, franchised businesses include Taco Bell restaurants, Kinko's copy centers and Ziebart car maintenance shops. The "franchisor" is the legal owner of the franchised business concepts and ideas and, as owner, maintains the right to grant others a license to use the franchised business concepts and ideas. The "franchisee" is the individual or entity that purchases the right to use the franchised business concept and ideas from the franchisor (i.e. purchases a license).

Essentially, franchising works due to such things as shared advertising costs and economies of scale attained through increased purchasing power. The franchisee purchases the right to run a business (the franchise fee) which the franchisor has shown to be successful. A franchisor must have a concept, which is inherently franchiseable. This means that it must be possible to duplicate the business format in many different locations. This is not possible if the pilot's success depends on its totally unique location or a specific personality. Ultimately, a franchisee is hoping to purchase "risk reduction". The franchisor is providing the franchisee with the "know-how" to succeed. The franchisor benefits because he is using other people's money to expand his system.

There are many good reasons to think seriously about buying a franchise. For example, it is a type of employment you can "buy" where your hard work will generate equity, which you can sell in later years. But you must also work hard before you buy a franchise in order to see if there are going to be problems down the road. Problems can arise when, for example, after the franchise contract has expired (i.e. the license to use the business concepts and ideas has expired) and the franchisor wishes to take over the store. Company stores are often more profitable to the franchisor simply because the head office receives all the profits and not simply a percentage of the monthly gross. Will the franchisor make it difficult for you to profit from your years of hard work? Also, from the franchisee's point of view, it seems to be just human nature, four or five years into the contract, to start wondering why he or she needs the franchisor. You might start to feel that you know it all and begin to forget the initial fears of going into business alone. It is up to the franchisor to continually reinforce his importance to the franchisee with new research and development, innovative advertising campaigns, supportive and educational newsletters, etc.

While franchising has provided a successful means of expansion for many corporations, relationships between franchisors and franchisees are sometimes strained. One reason for this is that the franchisee typically owns only a limited-term license to operate a business according to the requirements of the franchisor's operating manual. An established franchisee may think that it has a right to continue to operate under the same terms, but a franchisee is only a party to a limited term contract. To the extent that franchisees are successful, the market values of their franchises are likely to increase. Thus, conflicts may arise between the franchisor and the franchisee at the time of contract renewal.

People always ask, "what's the best franchise?" The only way to really ask this is "What's the best franchise for me?" The answer is a combination of four things: (1) What is the kind of business you would like to be in? (2) What types of businesses are succeeding these days, with every indication that they will continue to succeed? (3) Is someone offering a franchise in your area of interest, that you believe will help you to succeed, and that you can afford? and (4) Can you work within the limits of a franchise system? There is no magic in franchising. It works for good economic and social reasons. If you fully investigate the franchisor, there is every hope that you can make a choice that will significantly increase your chance of success in business.

Purchasing a Franchise
The Federal Trade Commission requires franchisors in the United States to provide a disclosure statement to all the prospective franchisees before accepting any money from a franchisee and before a contract for a franchise is executed. Such disclosure statement is often called an Offering Circular and is very similar to a prospectus for a stock. The Offering Circular, among other things, will provide a prospective franchisee with a history of the company as well as a copy of the franchise agreement to be studied before anything is signed.

Sometimes people think that if a franchisor has prepared an Offering Circular and had it approved by applicable government agencies, that the documents amount to a stamp of approval by the government. This is false. Further, receiving an Offering Circular should be just the starting point for the prospective franchisee. The first thing a prospective franchisee should do is contact present and past franchisees listed in the document. The wise prospective franchisee should be looking for a franchisor who has been successfully doing business for several years and/or who can show that he will be doing a healthy business in the years to come. Franchising is essentially a "two-way street," with both parties entering into the franchise contract knowing that each has certain obligations to the other.

Here are some of the questions that you should have obtained answers to before signing the franchise contract. Some of these questions help to give you a general idea of the franchisor's ability, which is of use when comparing him with other franchisors who are offering the same type of franchise. It is important to COMPARE FRANCHISORS IF MORE THAN ONE HAS THE PRODUCT/SERVICE IN WHICH YOU ARE INTERESTED.

  • Does the franchisor have the proper financial backing?
  • Is the franchisor a subsidiary of another company? What are their assets?
  • Who is the parent company? Have they ever franchised other products or services?
  • Would they be in competition with you?
  • Was, or is, the other franchise operation successful?
  • Can you see any of the franchisor's recently audited financial statements?
  • When do you get to see the contract and disclosure document? Is there an earnings claim?
  • Is it based on company run or franchisee run outlets?
  • How long have each of the outlets, used as a basis for the projection, been in operation? Are they rural or urban?
  • How long has the franchisor been in business? How long has he been offering franchises?
  • What is the business experience of the franchise companies directors and officers?
  • Have any of the franchisors partners or company members ever gone bankrupt?
  • Have any of them been involved in litigation recently?
  • Is it a public company? (If it is a public company you can obtain copies of their annual reports and also get copies of the detailed 10K reports.)
  • Does the franchisor help you finance the purchase of the franchise?
  • Does the franchisor have the kind of reputation and credit rating which would help you to obtain the financial backing needed to purchase the franchise?
  • How many franchisees does the franchisor have? How many does he plan on having?
  • Where will these be located?
  • Does he have a good marketing plan?
  • Does he provide a useful initial training program? Who pays for this?
  • Does the franchisor provide post-opening training, if necessary, and other continuing assistance?
  • Does the franchisor have a system for the inspection of the franchisees?
  • Is he always available for on-the-spot counseling? Will he help recruit your personnel?
  • Who pays for the initial opening supplies?
  • Does the franchisor design store layouts and displays?
  • Does the franchisor exercise good quality control?
  • Does the franchisor provide inventory control?
  • Does the franchisor provide volume purchasing discounts?
  • Are the administrative and bookkeeping procedures simple and well run?
  • What is the advertising program? What do you pay towards local advertising? What do you pay towards national advertising?
  • Do you have any say in the advertising format?
  • Is the franchisor up-to-date in all his operations?
  • Are his sales techniques modern?
  • What innovations has the franchisor introduced since first starting?
  • Does the franchisor provide a helpful and fully explanatory manual for the training of the staff and the operation of the franchise?
  • Is the price of the franchise variable? If so, how? Can you purchase used equipment for a discount?

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