What is a franchise?

Franchising is a system of expanding a business and distributing goods and service. In the simplest terms possible, franchising is product and/or service distribution method. What makes franchising unique is that it is not the product and/or service per se
that is being franchised but rather the business system that provide the product. The business that develops the franchise (the franchisor) licenses its trade name and its operating method to a a individual or entity (the franchisee) that wishes to distribute the product in accordance with terms and regulation as set forth by the franchisor.

What is franchise law?

Franchise law is not easily labeled. It is actually a collection of many different types of law –including agency law, ant-trust law, employment law, contract law, administrative law, trademark and patent law, debtor/creditor law, tort law, trade secrets law, financial services law, and international law. And, as with any business venture the prosecution of the rights under the contracts some times leads to litigation.

What are the advantages to franchising?

When a company chooses to franchise it necessarily gives up much of its day to day control over the operation of its business units. In return for transferring the revenue (and the risk) of the individual franchise units same store sales it requires the franchisee to pay to it a royalty. The franchisor in turn agrees to support the franchisee in its endeavors. At the heart of every franchise agreement is a symbiotic relationship. But why exactly is franchising a “good thing”? A few of the reasons are as follows:

1) Spreads capital costs of market expansion.
2) Allows for more rapid market expansion
3) Allows for a more rapid transmission of the trademark brand.
4) It makes individual business ownership more accessible and in some case more affordable.
5) It provides for the efficient transference of risk both horizontally and vertically in a marketplace.

What are some of the disadvantages to franchising?

From the franchisor perspective, a few of the disadvantages are: lack of control over individual units and the damage that can be done to the brand by same, and the burden of complying with the laws regulating franchising.

From the perspective of the franchisee, a few of the disadvantages of franchising are: not being able to operate the business with complete autonomy, and the payment of fees back to the franchisor.

To be sure there are more advantages and disadvantages of franchising. For a more comprehensive look at franchising–the good, the bad, and the ugly, the following books do a good job of providing a general overview of franchising.

Franchising for Dummies by Seid and Thomas
Street Smart Franchising by Mathews

What questions need to be asked of the franchise before one buys a franchise?

Franchising is an investment. It is an investment of time and it is an investment of money. One should not jump immediately on the first franchise that interests them. One needs to soberly and deliberately investigate the franchise. One needs to determine both whether the franchise is good fit for the individual and the fitness of the franchise itself. Once again, there are many ways to go about this process. A primer on what questions should be asked of the franchise are located at the FTC website at

http://www.ftc.gov/bcp/edu/pubs/consumer/invest/inv15.shtm

Along with other usual information the FTC sites gives this advice:

Protect Yourself. Buying a franchise is a big decision. Before you commit, take the following precautions:

—Read the company’s disclosure document. Review it carefully to learn more about your obligations, the litigation history of the franchisor and failure rates. This information will help you decide whether franchisees are dissatisfied with the franchise.

—Talk to other franchisees. Don’t rely only on the information the franchisor gives you. Talk to current and former franchisees about their experiences with the franchisor. Their names, telephone numbers and addresses should be in the company’s disclosure document. The franchisor may refer you directly to franchisees who are known to be successful. Don’t rely on references the company selects.

—Contact your state franchise administrator. If you live in California, Hawaii, Illinois, Indiana, Maryland, Minnesota, New York, North Dakota, Rhode Island, South Dakota or Virginia, your state has an office that regulates the offer and sale of franchises. Contact your state franchise administrator before you invest. Ask if the franchise you’re considering is registered to offer franchises in your state. If you live in Maryland, call the Maryland Attorney General’s Office at (888) 743-0023, or visit www.oag.state.md.us. If you live outside of Maryland, you can find the name of your state franchise administrator, by calling the North American Securities Administrators Association at (202) 737-0900 or visit www.nasaa.org. You also may contact your state Attorney General (www.naag.org) or Better Business Bureau (www.bbb.org) for more information.

—Get all promises in writing. If a salesperson tells you that the franchisor will give you accounts near your home, but the written agreement defines the geographic area more broadly, it’s what’s in the written agreement that counts. If a provision in the agreement is different from anything you discussed with the salesperson, demand that the written agreement be changed. If a salesperson tells you that you should be able to make $12 to $15 an hour, make sure that prediction is included in the disclosure document. If the salesperson or franchisor won’t agree, walk away from the deal.

—Review the franchise agreement carefully. It’s important to understand all the conditions of the agreement. It controls your relationship with the franchisor. Make sure the agreement spells out the details so there are no surprises.

—Understand your obligations. As a franchisee, you may have to pay royalties and other fees. Find out exactly what types of fees you’ll have to pay, how much you’ll pay and how often.

—Investigate claims about potential earnings. The estimated value of the package of accounts you buy may not reflect the income you’ll earn from servicing those accounts. Find out how the company assigns a value to the accounts. Ask how many franchisees made the represented income and where those franchisees are located.

—Be cautious when financing. While financing your purchase through the franchisor may seem appealing, the terms of the financing agreement may not be the best deal for you. For example, you may have to sign a note to secure the debt and agree to terms that could make it tough for you to sue the company if you wanted to cancel your agreement. Before you agree to franchisor financing, be sure you understand all the terms of the deal.

–Consider getting professional advice. Ask a lawyer, accountant or business advisor to review the disclosure document and franchise agreement. The money and time you spend on professional help may save you from a bad investment.