Is franchising the right expansion strategy for you? We’ll help you ask the right questions–and find the answers.
Do you think your business is unique? Are your friends, family–and, more important, your customers–telling you every day that you should franchise your business? They may be right.
But are you sure you really know what franchising is all about? Is your concept really “franchiseable”? How does one go about franchising? What does it cost? And do you have the skills necessary to become a successful franchisor? In this article, we will answer these questions so that you will have a better understanding of franchising as an expansion strategy. And while it’s not the right strategy for everyone, for some companies the explosive potential that franchising affords is unparalleled in the world of business growth.
How Franchising Works
Generally speaking, franchising means opening additional outlets through the sale of franchise rights to independent investors who will use your name and operating system. A franchisee pays a franchisor an initial franchise fee in return for the rights to open and operate a business under the franchise trademark and for training in how to operate the business. In some cases, the fee may also cover additional services such as assistance with site selection. In most systems, after the startup period, franchisees also pay an ongoing periodic royalty fee–4 percent to 10 percent of sales on average–for continued support and training in advertising, marketing, sales, operational guidance, financial and human resources consulting, and other services.
Perhaps most important from your perspective, a franchisee furnishes all of the capital required to start the business and assumes all risk for success or failure.
Franchising has many attractive features, particularly when compared with more traditional methods of expansion such as opening more outlets on your own. Typically referred to as company stores, you own and operate these locations yourself. You provide the entire investment for the startup, and while you keep all the profits the company store generates, you are also responsible for all the losses. This is great if you are passionate about preserving the values you built into your original operation and believe you are the only one who can do that. But if you want to expand more quickly and get ahead of a competitive curve, it may not be the best way to expand. Opening company locations takes capital and time–sometimes a lot of both–plus you retain all the risk if a unit doesn’t do well. And how will you manage operations that may be far from your home base?
Let’s look at the issue of capital first. If you have only one or two units operating, or your concept is new or unusual, bankers may not be willing to lend you money for aggressive expansion. Lenders need collateral or a history of demonstrated success over time and in different markets to make taking a chance on you sensible. For a young or unproven business, this may be an obstacle that’s impossible to overcome.
And what about running company stores? Does your current organization have sufficient depth to handle the hiring, training and supervision of a number of employees who will be handling your money and your reputation–especially if they will be operating at a distance? Plus, opening company stores can be a slow proposition as it takes time to get each unit open and successfully operational; you can’t be everywhere at once. And all too often a business owner spends months looking for and training a new unit manager only to see that manager leave or, worse yet, get hired by the competition.
For all of these reasons, more and more entrepreneurs are finding that franchising is the best way to expand a great business quickly with minimal capital and risk. And franchising offers a number of advantages worth considering:
- You expand using someone else’s money.
- Franchisees are responsible for all hiring, leases, and unit-opening expenses, reducing your risk.
- Franchises can open quickly, often getting a new concept out ahead of the competition.
- A franchisee assumes the risk of succeeding or failing.
- Franchise owners are highly motivated operators.
So, with all of this going for it, let’s take a closer look at what franchising involves:
Is Your Business “Franchisable”?
Before making the decision to franchise, you must first determine whether franchising is a viable strategy for your particular business. Here are some questions to ask yourself:
Is there a wide market for your concept?
Does the market for your particular product or service transcend your current neighborhood or region? You may need professional advice to see the bigger picture objectively. Many entrepreneurs “just know” they have a hot, new concept and they act on their convictions. But unless you have opened several prototypes in a variety of markets to test those convictions, it is important to ask yourself candidly whether or not your concept will work in other locations under other owners.
Do you have a point of differentiation?
What makes your business special? It doesn’t have to be something no one has ever seen before, but it must have something about it that is unique and that will attract the public and investors. Maybe it’s gourmet hot dogs, or quick made-to-order sushi or fast furniture repair. Whatever it is, it has to offer something that the public sees as unique and desirable.
Can the concept be duplicated?
How difficult or easy will it be to train inexperienced franchisees to run an operation like yours? Have you streamlined processes to make them easy to teach? Or has your success been the result of years of perseverance and relationship-building that is not readily transferable to a new owner? Will your concept flourish in a wide variety of locations?
Is your concept saleable?
Will investors–potential franchisees–see the value of your offering and be willing to commit to it? Will you be able to offer a program with real advantages for the potential franchise owner?
If your answer to these questions is yes, read on.
What is a Franchise?
The legal definition of a franchise comes from the Federal Trade Commission through Rule 436, amended in July 2007. It defines a franchise as a business relationship with three primary components:
The use of a common name or trademark
The presence of significant operating assistance or control of a prescribed method of operation, including such things as procedures, practices, and techniques
A required payment by the franchisee
It is important to remember here that regardless of what someone may wish to call a business relationship–whether it’s distributorship, joint venture, or business opportunity–the FTC will tell you that if it walks like a duck and quacks like a duck, it is a duck and therefore is subject to regulation as a franchise. Failure to observe federal and state franchise regulations can subject you to severe fines and even felony convictions. And infractions must be reported in your disclosure documents for 10 years, something that can seriously hamper your future franchise sales activities.
When one well-known franchisor was in its infancy, one of the principals was meeting with what he thought would be a dealer in California, and he had taken a check to cover the dealership fee. But his partner was back at the office reading up on franchise law and put in a frantic call to his eager colleague telling him to return the check and come home. A visit to a qualified franchise development consultant shortly afterward helped them develop a proper franchise program, which they then registered with the appropriate state authorities. They now have a network of 200 franchise locations plus 20 company stores, but if they realized their mistake back when they started, they could have been barred from franchising for life.
More than one entrepreneur has fallen into the trap of becoming an accidental franchisor and rued the day. So if your plans include expansion in any way through third-party investors, you are strongly advised to engage the services of an attorney experienced in franchise law.
Getting Started as a Franchisor
Developing a franchise program does require an investment of time and funds, but the cost of the services of professional advisors to get you going the right way is often less than the cost of opening one additional company store. Let’s take a look at the elements of a good franchise program:
The protoype: One of the primary ingredients for a successful franchise program is a proven prototype. While it’s not a legal requirement, it is the best possible illustration that you have something of value to offer. The legal by-ways are littered with the sad stories of hotshots who thought they could sell franchises based only on an idea. One company I know of was formed by a trio of professionals: a lawyer, an experienced advertising executive, and an operations person. They believed they could create the perfect franchise concept despite the fact that none of the three had worked in the particular field they had in mind: the alteration of clothing in a shopping mall storefront. It just seemed like a good idea. They spent hundreds of thousands of dollars starting up and operating a prototype, creating glossy franchise marketing pieces, and memorializing store procedures in an operations manual. There was just one problem: The store was not profitable. This team was sunk before they even got started.
The lesson? There’s nothing like a successful prototype to show your prospects something real, that they can experience and appreciate first hand. A successful prototype is a real-life example of the possibilities of your business. An active, exciting operation allows prospects to paint themselves into your picture. But beyond a demonstration of the viability of your concept, an original location can also become a live training center for future new franchisees and a testing laboratory for new products, services, or techniques.
Documented systems: A direct offshoot of a functioning prototype is the documentation of how the business operates–in other words, the written procedures that memorialize your methods and that will become your textbook for training new franchisees.
These procedures become your operations manual, a valuable document that should cover everything from startup activities to marketing, office procedures, and personnel management–everything that makes your business what it is. Illustrations, tables, and lists help make this kind of information lively and accessible. Depending on the depth and talents of your home office staff, you may be able to create much of the manual yourself, but you may need assistance from professional technical writers who know how to create procedures that are easy to read and follow and that will avoid getting you into legal hot water. At the very least, be sure to have this document reviewed by a competent franchise consultant as well as an experienced franchise attorney.
A protected trademark: One of the most valuable assets of a franchise program is a protected trademark. A trademark represents the brand–the whole identity and mystique of the concept. Failure to protect a trademark is a typical mistake made by new franchisors, so the first task is to develop a name that can be protected–that is, one that isn’t in use by anyone else so it can be approved by the U.S. Patent and Trademark Office. Securing a registered trademark is an easy but tedious process that can often take a year or more to complete. But while many companies will begin franchising before their trademark is fully registered, you will certainly want to have at least begun the process. Your rights to your trademark vest on the date you file the trademark application, and without this protection you will be throwing away marketing dollars–and throwing a monkey wrench into any plans to franchise.
You’ll want to find yourself an experienced trademark or intellectual property attorney to do the recommended search and application process for you. It’s not a very expensive project–perhaps a couple of thousand dollars–but it is worth every penny. And until you are awarded the coveted R symbol, you can use the TM symbol to let the world know that you are protecting your mark.
Marketing materials: While your legal documents are being developed and submitted to states for required review and registration and your operating methods are being developed into training materials, you will also need to develop the marketing tools that will help you sell your franchise opportunity. You will want to engage a franchise development consultant who has experience designing the powerful sales tools necessary to put your business in the best possible light. These tools will most likely include a franchise brochure, perhaps a DVD that introduces your concept and company to potential investors, and training on franchise sales techniques, including the proper way to disclose prospects and how to avoid pitfalls like making illegal financial performance representations.
Of equal importance, you will need to develop a marketing plan to optimize your franchise advertising budget and ensure that you will generate an adequate number of franchise leads to meet your franchise sales goals. Again, there is no substitute for experience here. With literally hundreds of web sites and publications targeting franchise prospects, you will need to spend your money wisely. You will need to carefully track the results of each medium to see what works and what doesn’t so you can adjust your plan as necessary. You will be well advised to seek the counsel of development professionals who can help you make the right decisions–particularly at first, when you need to make crucial decisions before you have much experience.
The Franchise Disclosure Document: Franchising starts with the development of a Franchise Disclosure Document, or FDD, that must be prepared according to strict guidelines. It will outline your offering, your business history and the resumes of your principal officers, and it will report your financial preparation for franchising. The FDD needs to be submitted and approved by the various states that regulate franchising before you ever even speak to anyone about your program. The intent of this requirement is to protect potential investors from shady operators by requiring franchisors to disclose their credentials. Included in the FDD is a copy of the actual franchise agreement, along with any other contracts that you will execute with your franchisees.
It is important to note that many of the topics covered in your legal documents will be business decisions, not legal ones. For example, what will your franchise fee be? How much royalty will you need to support your franchise company? What advertising will you require? Will you establish and contribute to a national consumer marketing effort? What will the franchise term be: five years? 10 years? Longer? Will you have renewal provisions? How much training will you offer? How big will an individual territory be, and how will it be defined? Will you offer area development rights? These documents contain all of the key decisions that you will live with for years.
Because of the importance and lasting effects of these decisions, you will want to work with an attorney who specializes in franchise law. It is recommended that new franchisors prepare a detailed business plan–often with the assistance of a professional franchise consultant–that will document these business decisions before legal documents are drafted. Your plan should include a realistic financial analysis that will test a variety of options for fees, royalties, territory size, organizational structure and growth options before these details are finalized.
When you are ready to get your legal documents drafted, you will again want to work with an experienced franchise attorney. While this may sound like a difficult or expensive task, a well-prepared FDD is the foundation of a solid franchise program. And using an experienced attorney is often less expensive that paying an inexperienced attorney to learn on the job.
Selling Your System
Once you have the basics in place, it’s time to take your concept to the franchise marketplace. A compelling franchise offering will be able to inspire and excite your target audience.
At a minimum, you will want to be sure that you are trained in all aspects of franchise sales–including the legal regulations governing these sales–before you start selling franchises. And while owner/founders surely have the passion and history to be effective franchise salespersons, the actual selling activities may be better delegated to someone with a full understanding of what can–and cannot–be mentioned in the sales process. Selling a franchise is not unlike selling a financial security, and the rules are strict and unforgiving. Don’t risk being charged with violations that have to be disclosed to all future prospects.
There are alternatives to selling franchises yourself. Some franchise companies use the services of outsourced franchise sales professionals. Others hire franchise sales talent and put them on staff. Either way, the savvy franchisor considers the implications of their sales and staffing decisions before they finalize them.
When you decide to franchise, you will soon realize that you have added a second career to your current one. You are now not only a restaurateur, or a remodeler, or a retailer; you are now also a franchise executive, and you have a whole new job description. As you develop a franchise network, you take on the responsibility for the care and feeding of your franchisees. They are entitled to your guidance, training, encouragement and a raft of services including things like ongoing advertising support, access to approved suppliers with purchasing discounts, and a variety of back room services.
Franchising isn’t for the faint of heart, but for confident, knowledgeable business owners who passionately believe in their concepts and who want to show others how to duplicate their success, it is a strategy that has been effectively employed for many decades. Virtually every franchise system started with just one store or shop. Through dedication, perseverance, and professional guidance, many have grown to 10, 100, and 1,000 units–and more. Will you decide to follow their example?