Thinking of franchising your business?

Franchising is a well-tested business model that is used by many big brands and many growing brands as a way of expanding their business through independent organisations, while still keeping control of the brand and business system.

Franchising describes the arrangement where one person (a franchisor) grants to another (a franchisee) a licence to operate a business using the franchisor’s trading name, trademarks, know-how and business systems. Essentially, franchising enables a person with no previous experience or training in a business to operate that business.

If you are considering franchising your business, there are a number of factors for you to consider.   Here are just a few of them.

Starting out

Franchising can prove an effective method for expanding a business but franchisors have to accept an element of loss of control as the franchisees run their own businesses and franchisors are required to support and encourage them in this, to the mutual benefit of both parties.

A potential franchisor will often be operating one or more successful outlets of their business themselves before deciding to franchise – setting up a new franchise should be tested first with one or two pilot outlets, so that the franchisor can gain experience and gather data on performance before rolling out the franchise.

Some businesses are well suited to franchising; others less so. The key is a business that is ‘tried and tested’ and which is easily replicable – the operation of  pilot outlets can be of enormous value in determining whether franchising a business is viable and by providing the franchisor with key information as to how best to successfully operate the franchise network.

Choosing franchisees

With many businesses, there is often a temptation to offer franchises to their top employees given their knowledge of and involvement in the business being franchised, which is perfectly understandable. However, a good employee does not necessarily translate to a good franchisee – a top employee, while no doubt highly skilled at their job, may lack broader business skills. This can often be overcome with good initial and ongoing training for the franchisee and proper, full and close on-going support from the franchisor (see Training and ongoing support below).

Or it may be more advisable to look further afield at those with good business skills, even if they are not necessarily familiar with the franchisor’s industry. In such circumstances, a good manager can be employed to provide the necessary industry knowledge.

Either way, a franchisor should do its research and ensure that it is satisfied that the franchisee has the means, ability and dedication to run the franchise business both profitably and reputably and in line with the franchised business model.

Franchisors will need to provide potential franchisees with information regarding the franchise. However, care should be taken not to “over sell” and any information disclosed must be clear, accurate and not misleading. Many disputes arise due to the franchise business not performing to the financial levels that the franchisee felt they were led to expect from the franchisor.

Franchise Agreement and Manual

Normally, it is prudent for an individual franchisee to contract through a limited company – this means the franchisee will be a company controlled by that individual but, as it will be important to ensure that the individual is contractually bound and committed to the franchise, it is usual for the franchise agreement to also contain specific provisions that the individual commits to and guarantees the performance of the company.

A key document with any franchise is the Franchise Manual which should contain the business know-how, methodologies and operating processes of the franchise business. As it is the “Crown Jewels” of any franchise, it must be kept confidential and ideally not supplied to the franchisee until they have committed to the franchise, signed the franchise agreement and paid the franchise fee(s).

The pilot phase (see Starting out above) will be instrumental in assisting the franchisor to develop the operations manual for its franchise network. The manual is central to the running of a successful franchise and to growing the franchisor’s brand. The manual provides franchisees with detailed information on the day to day running of the franchise business and ensures consistency, both internally and externally, across the franchise network. A significant amount of time will need to be invested in putting this together and updating and amending it as improvements to the franchise business are made.

The franchise agreement will be a comprehensive and legally binding agreement to manage the franchise network and the franchisee. It will also set out the rights and obligations of both the franchisor and the franchisee.

Intellectual Property Rights and branding

The franchisor’s brand and know-how is a large part of what the franchisee is buying into. Equally, the franchisor will have spent a significant amount of time and money building its know-how and brand awareness and will want to ensure that this is protected, used only for the benefit of the franchised business and not damaged or diluted.

Before embarking on franchising, the franchisor should ensure that its intellectual property is properly protected and registered, as far as possible, and that business processes are generally kept confidential. Controls over the use of the franchisor’s branding and intellectual property will be key elements of the franchise agreement.

Compliance and ethics

Franchising is not specifically regulated in the UK but there are a number of laws that are particularly relevant. For example, franchisors should be careful to ensure, if at all possible, that their franchise arrangements fall within one of the exclusions to the Trading Schemes Act 1996 and associated Regulations.

Competition law is also very relevant and franchisors must ensure that their franchise agreements comply with UK competition laws and fall within the prescribed terms of the block exemptions if relevant. This is particularly relevant when considering matters such as exclusivity and restrictions on franchisees.

The Bribery Act 2010 must also be given careful consideration as the franchisor can be responsible if a person associated with it bribes another person for the benefit of the franchisor’s business. Franchisees may or may not be considered as “associated persons”, depending upon the circumstances, but it is prudent for the franchisor to assume compliance and, in any event, it will at the very least be bad publicity for the franchisor if one of its franchisees commits a bribery offence. The only defence to breaches by associated persons is to have “adequate procedures” in place to prevent bribery by those persons and it is therefore advisable that a franchisor has those procedures in place. It also highlights again the importance of considering who the franchisor appoints as its franchisees and keeping open monitoring to ensure compliance.

Specific laws applicable to the franchisor’s business must also be complied with and the franchisee must become familiar with them. Guidance may be provided by the franchisor as part of the training and support given to the franchisee, but not necessarily so (see Training and ongoing support below).

The British Franchise Association (BFA) is a member body for franchisors, franchisees and others involved in franchising. Franchisor membership requires commitment to the bfa’s Code of Ethics which is also a quality mark which well-informed franchisees and customers may look for. It is not obligatory to be a member but it is certainly worth considering.  RB is an accredited affiliate member of the BFA. We are experienced in advising on ethical franchising, are familiar with the BFA’s Code of Ethics and technical bulletins, and can support you in ensuring that your franchise agreement is compliant.

Restrictions

Customers are customers of the franchised business and it is essential for the franchisor to incorporate appropriate and enforceable restrictions in the franchise agreement which apply both during and for a stated period after the end of the franchise agreement. This is a key issue as a franchisee may build up a customer base and then endeavour to take those customers with them if they move to another (rival) business or start their own business.

These restrictions normally seek to prevent franchisees from setting up/operating/owning or working for competing businesses within a specified geographical radius of the franchised business, and from poaching customers and staff. However, such restrictions need to be carefully thought through and drafted, as the courts will generally only allow them to be enforced to the extent that they are necessary to protect the franchisor’s legitimate business interests. That means, their duration should not be for longer than is necessary or cover a wider geographical area than is required.

Products and suppliers

If the franchised business is goods based, it will usually be important to ensure that the franchisee only purchases the specified goods, either through the franchisor or its recommended suppliers.

If the franchised business is service based, it may be less central but still important for the consistency and quality of the franchise. It may be that the franchisor will negotiate with a major supplier and that the franchisees must stock or use only certain brands of product. Alternatively, the franchisor may wish that its own brand products are stocked.

Either way, it needs to be a franchise term that no other brand products or unauthorised products are to be sold through the franchise business. Competition law also needs to be considered (see Compliance and ethics above).

Property

Premises is another key issue. The franchisor needs to decide whether it wishes to: own the freehold/take the head-lease of the premises and grant the franchisee a lease/sub-lease (as applicable); or allow the franchisee to take a lease/sub-lease direct from the freeholder/head lessor.

If the franchisor has or intends to develop a strong brand, and the location of the premises is a key factor (for example, in a prime retail location), controlling the premises may be preferable to ensure the franchisor retains rights to the property should the franchisee leave or the franchise agreement terminated. However, the downside for the franchisor is that it will be on the hook for the rental (which is fine as long as the franchisee does not default). Allowing the franchisee control means that the franchisee is primarily responsible for the rent but the franchisor will need to ensure that it has adequate safeguards and the ability to require the assignment of the lease/sub-lease of the premises back to it in the event of any default by the franchisee or termination of the franchise agreement.

Similar points apply if the business is mobile based. Will the franchisor own the vehicles and lease them to the franchisees? Or does the franchisor require the franchisee to obtain their own vehicles but with strict requirements as to the type of vehicle and how it is to be liveried and kitted out?

It is also important to ensure that the franchise agreement enables the franchisor to have all branding/signage removed on termination or cessation of the franchise agreement for any reason.

Overseas

Franchising can be used by UK businesses wishing to expand overseas, whether or not they have franchised within the UK. The same principles for franchising generally apply but the franchisor must of course also consider the local laws, customs and regulations of the countries into which it wishes to expand.

Franchising overseas may be done by the franchisor appointing individual franchisees as it would in the UK. Or, alternatively, the franchisor may wish to appoint a “master franchisee” in the relevant territory, who is familiar with that territory, and the master franchisee is then responsible for granting individual franchises within the territory.

There are also other possibilities and different considerations which will apply to each business and the territories that the franchisor is looking to expand into.

Training and ongoing support

A significant part of what the franchisee will be expecting from the franchisor is initial training and ongoing support.

This will include focus on the franchisor’s products or services as well as the specific business methods and idealogy that the franchisor has developed and which the franchisee must follow. It may also include other more general training on matters such as IT systems, marketing and business management.

This is an area in which many franchise disputes arise and it is therefore important to be clear and upfront as to what the franchisor will provide, and then to provide it.

Franchisees moving on

If a franchisee is unable or unwilling to operate the franchise to the required standard due to ill-health, death or neglect, step-in rights may be necessary to allow the franchisor to manage the business, at least in the short term, to minimise any adverse effect to the franchise network and its reputation. The cost of this will often be imposed on the franchisee but is essential to ensure that both the franchised business and the franchise network as a whole does not suffer.

The franchisor must also accept that the franchisee may wish to exit the franchise network at some stage and it is important to allow a franchisee an opportunity to sell their franchised business and enjoy the fruits of the goodwill they have generated. But the franchisor needs to be able to approve any sale, in particular to approve (or reject) the choice of incoming franchisee; and to have the right of first refusal to buy back the franchise, usually on the same terms/price that a willing buyer is prepared to pay the outgoing franchisee. Any sale will normally be conditional on a number of considerations, including the franchisee not being in breach of the franchise agreement, having paid all sums due and owing to the franchisor, paying the franchisor’s legal and administrative costs for dealing with the sale, and so on.

The franchisor should also be prepared to terminate the franchise agreement if necessary. Franchise agreements will usually contain extensive termination rights for the franchisor to cover breaches, defaults etc. by the franchisee. These must not be exercised for non-legitimate means (for example, to get rid of a franchisee for spurious reasons) but are essential to ensure that the franchisor can deal with any franchisee who may damage the franchise network as a whole and/or bring the franchise (or franchisor) into disrepute, or who is performing inadequately (after the franchisor has taken steps to assist the franchisor to improve performance).

How we can help

We can assist you with drafting and advising on franchise agreements. For further information on all our franchising services, please contact us.

Disclaimer: This article is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from taking any action as a result of the contents of this article.