Updated August 2017
This Briefing Note is intended to provide an introduction to franchising and should not be relied upon as legal advice. Please contact us for advice on your specific circumstances.
Some of the most well-known and successful businesses are franchises, e.g. McDonald’s, Domino’s Pizza and Europcar to name a few.
In principle a franchise is a contractual arrangement whereby the owner of a business (‘the franchisor’) licenses to another party (‘the franchisee’) the use of the franchisor’s goodwill, branding and intellectual property rights. This type of arrangement is commonly used when a business is looking to expand into another territory or region.
Any business or individual can become a franchisor. When a franchisor licences its goodwill, branding and intellectual property rights it grants the franchisee the right to use its name, branding, trademarks and confidential information. Although the franchisor has overall control over the franchisee in terms of standards and brand image the franchisor is not responsible for the success or failure of the franchisee’s business.
Conversely any business or individual can become a franchisee by purchasing the right to use the franchisor’s branding etc. Provided that the franchisee can keep up with the regular payments and adhere to the terms of the franchise agreement this type of arrangement can be very beneficial to both parties.
The main advantages for the franchisor
- Franchising provides the opportunity for a company to expand and sell its products or services faster than if it had to find its own premises, train its own employees and develop its own internal marketing, sales and distribution organisation.
- The success of the franchisee’s business can directly improve the financial well-being of the franchisor.
- As a result of franchising the franchisor may have increased purchasing power which may reduce overheads and therefore increase profitability.
The main disadvantages for the franchisor
- Despite the franchisor having significant control over the franchisee it is important to remember that the franchisee will be operating under the franchisor’s brand name and therefore any scandal or damage to reputation will affect both parties. This is of particular note as the franchisee is likely to focus on maximising its own profits and not on the overall marketing strategy or brand name of the franchise.
- The franchisee will retain a portion of the profits.
- By entering into a franchising agreement the franchisor will have to disclose ‘know-how’ and trade secrets. Although the agreement is likely to contain restrictions on the franchisees use of this information, these types of provisions are often difficult to monitor and enforce.
- Although the franchisee will be in many respects running its own operation, the franchisor will still need to manage its franchisee which is substantially different to operating a business with employees.
- A franchisor may have a duty of care to its franchisees and prospective franchisees.
The main advantages for a franchisee
- A franchisee will acquire a ‘ready-made’ business model and therefore will not need to develop many business practices, policies and procedures itself as many of these are likely be standard for all franchisees e.g. staff handbook, health & safety policy and general employment contracts.
- The franchisee will benefit from the franchisors reputation and all the benefits that come with it e.g. customer loyalty, buying power and ability to recruit staff.
- As part of a franchise it is likely that a franchisor will have greater access to capital and finance arrangements as it will be deemed less a risky venture than setting up a business independently.
- A franchisor is likely to have established websites and marketing strategies which will benefit the franchisee.
The main disadvantages for a franchisee
- A franchisee’s creativity and ability to diversify will be restricted as the franchisor will have significant control over what the franchisee can and cannot do.
- Any scandal or damage to reputation will affect both parties. This damage to reputation can come from either the franchisor or other franchisees.
- It is common that a franchisee will pay an initial fee to purchase the franchise, advertising fees and management fees which are often based on revenue generated by the franchise.
- Terminating or selling the franchise agreement may prove difficult depending on its contractual terms.