K. Franchising vs Licensing

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This topic will assist you in understanding Franchising/Licensing and how it may benefit you. Also, Franchising vs. Licensing will be discussed and the rules that apply to each.

1. Franchising is the practice of using another firm’s successful business model.
2. For the franchisor, the franchise is an alternative to building ‘chain stores’ to distribute goods that avoids the investments and liability of a chain.

• Success of the franchisor depends on the success of the franchisees

1. In terms of distribution, the franchisor is a supplier who allows an operator, or a franchisee, to use the supplier’s trademark and distribute the supplier’s goods. In return, the operator pays the supplier a fee
2. Two important payments are made to a franchisor: (a) a royalty for the trademark and (b) reimbursement for the training and advisory services given to the franchisee.

• These two fees may be combined in a single ‘management’ fee. A fee for “disclosure” is separate and is always a “front-end fee”.
  

1. A franchise usually lasts for a fixed time period and serves a specific territory or geographical area surrounding its location
2. Agreements typically last from five to thirty years

• Premature cancellations or terminations of most contracts may have serious consequences

1. A franchise is not the purchase of a business for the purpose of ownership. It is a temporary business investment involving renting or leasing an opportunity.
2. A licensor may grant a license under intellectual property laws to authorize a use (such as copying software or using a (patented) invention) to a licensee, sparing the licensee from a claim of infringement brought by the licensor.
3. A license under intellectual property commonly has several components beyond the grant itself, including a term, territory, renewal provisions, and other limitations deemed vital to the licensor. 

• Term: many licenses are valid for a particular length of time. This protects the licensor should the value of the license increase, or market conditions change.
• Territory: a license may stipulate what territory the rights pertain to.

1. Intellectual property licensing plays a major role in today’s business and economy.

• Business practices such as franchising, technology transfer, publication, and character merchandising entirely depend on the licensing of intellectual property.
• Licensing has been recognized as an independent branch of law. It is born out of the interplay of the doctrine of contract and the principles of intellectual property.

Contributor: Greg Noe greg.noe@probizservices.com

Why Franchise?

In general, companies franchise for one of three reasons: time, people, or money. 

Benefits of Franchising

Franchisee Capital Investment

The primary barrier to expansion faced by today’s businessperson is capital.  Franchising allows companies to expand without the risk of debt or the cost of equity. Since the franchisee provides the initial investment at the unit level, franchising allows for expansion with minimal capital and shared risk. This also allows for faster expansion of the franchise network and allows the franchisor to realize a higher return on initial investment.

Motivated Owner Operators

Another barrier to expansion facing many of today’s businesses is finding and retaining good unit managers.  All too often, a business owner spends months looking for and training a new manager only to see that manager leave — or worse yet, hired away by a competitor.

Franchising allows the business owner to overcome many of these problems by substituting a motivated franchisee for the unit manager.  Interestingly enough, since the franchisee has both an investment in the unit and a stake in the profits, unit performance will often improve.  And since a franchisor’s income is based on the franchisee’s gross sales, and not profitability, monitoring unit level expenses becomes significantly less cumbersome. 

Finally, opening a unit takes time.  Hunt for sites. Negotiate leases. Arrange for design and build-out.  Secure financing. Hire and train staff. Purchase equipment and inventory.  The end result is that the number of units you can open in any given period of time is limited.

For companies with too little time (or too little staff), franchising is often the fastest way to grow.  That’s because it is the franchisee that performs most of these tasks. The franchisor provides the guidance, of course, and the franchisee does the legwork.  Thus, franchising not only allows the franchisor financial leverage, but it allows him to leverage his resources as well.

Recurring Revenue

Franchisees typically pay royalties to franchisors based on gross revenue for the term of the franchise agreement. Royalties are typically 4% to 8% of gross revenues. Franchisees also contribute to the marketing efforts of the brand with both local advertising requirements and contributions to regional and/or national advertising. There are also other revenue opportunities such as sale of goods and services to franchisees and vendor relationships. These must be disclosed.

Is my Business “Franchisable?”

Franchising is a relatively flexible format, and just about any type of business can be franchised, provided it meets some basic characteristics:

• It needs to be credible.  Does it have experienced management?  A track-record over time? Is the concept proven?  Has it achieved good local press or public acclaim?

• It needs to be unique.  Is it adequately differentiated from competitors?  Is it marketable as a business opportunity? Does it have a sustainable competitive advantage?

• It needs to be replicable.  Are the systems in place? Are operating procedures documented?  Could someone learn to operate the business in three months or less?

• And it needs to provide an adequate return.  Not just profitability. If a business cannot generate a 15% – 20% return on investment after deducting a royalty (typically between 4% and 8%), it is going to have difficulty keeping franchisees happy.

If your business meets these criteria, then it may be a good candidate for franchising.

Contributor: Bill Nelson, Franchise Development Group, bnelson@franchisedevelopmentgroup.com