If you have been running a successful business for a period of time, you may be considering expansion. One of the options available is to start a franchise. When it first came into existence, franchising was broadly frowned upon but, in recent years, it has enjoyed rapid growth.
Whilst it is possible to replicate the success of some business models, there are fundamental issues that need to be considered before embarking on this type of expansion. A business can be replicated on an exclusive territorial or geographic basis. This can provide the franchisor with substantial benefits, such as the opportunity to grow rapidly, better access to finance and the ability to benefit from the motivation and energy of the franchisees (who are generally more driven to succeed than employees, given that they have had to buy into the business).
How a Franchise Works
A franchise allows other businesses, operated by franchisees, to use the franchisor’s name, brand and other intellectual property. The franchisor retains a degree of control on a continuing basis over the franchisee’s business and normally helps them to establish the business and provides support and assistance. This may include training, IT support and other guidance. In return for the use of the franchisor’s intellectual property and the ongoing assistance provided, the franchisee pays the franchisor a fee, often based on a percentage of turnover.
Franchises vary enormously – from wheelie bin cleaning franchises to multi-million pound hotel and leisure complexes. To help you determine whether your business might be a suitable candidate for franchising, here are some issues to consider:
Finance
In order for your franchise to succeed, it is vital that you can demonstrate that your business model is a successful one and that franchisees are likely to be able to make a profit if they follow your system. The vast majority of franchisees will borrow money to buy into your franchise, so it is important to have a good relationship with a bank that is willing to lend to your intended franchisees. New franchisors in particular must ensure that they address this issue, as a franchise can fail immediately if banks are unwilling to lend to franchisees.
To give yourself and your future franchisees the best possible chance of being able to secure finance, you must be able to satisfy a prospective lender that your business plan is based on a thorough understanding of the relevant issues.
There are a number of other issues that must be thought through when constructing your franchise development plan. For example:
- · Will the franchised business succeed elsewhere? You must be able to demonstrate that there is demand in other areas for the products and services that the franchise offers. If your business is regional or relies heavily on specific local suppliers, you will have to take this into consideration;
- · Are you equipped to deal with the significant increase in workload that creating a franchised business will entail?
- · How do you decide whether someone is likely to make a good franchisee and how stringent are your selection procedures?
- · What IT systems are in place to track and assist franchisees?
- · What are the profit margins for franchisees? (A typical split is 70 per cent franchisee, 30 per cent franchisor);
- · What is the ongoing training requirement?
- · How much are the initial franchise fees and what do they cover?
- · Do you have the patience to deal with your franchisees? You want them to succeed, but do you have time to ensure that they do?
Feasibility
Once you have decided that your business is capable of being franchised, the next step is to conduct a feasibility study. There are numerous franchise consultants operating in the marketplace but it is wise to approach this type of service with caution. If you do choose to employ the services of a consultant, ensure they have sufficient experience in franchising to be able to assist you properly.
A Pilot Franchise
It is often worth operating a pilot franchise for at least a year. Not only does this give you time to develop materials for the franchise, such as the operating manual and training programme, but it will also enable you to address any issues that arise while keeping the franchise operational on a manageable level. This does not necessarily mean recruiting a pilot franchisee, although a lot of franchisors do. Running a successful franchise is not like running a team of employees: you need to develop a new skill set for helping your franchisees to succeed.
The Risks
Although there are significant benefits to expansion, it is also important to consider the potential risks. One bad franchisee can cause significant damage to your brand and reputation. Establishing a franchise costs money and you will have to spend some of your profit on running the franchise, so your original company’s profits may go down in the short run. In terms of running the franchise, you will have to provide details of company secrets, know-how and methods of business that you certainly do not want your competitors to see. If a franchisee breaches this confidence, it can be difficult to detect and/or penalise.
Subsidiary Company
In order to protect your original business, it is worth separating it from your franchise business. Often, franchisors create a subsidiary company that is the franchisor (a subsidiary is a company that is at least 50 per cent owned by the parent company). That way, if the franchise fails, the main company can continue to operate without liability, unless it is the guarantor of the franchise business.
The Franchise Agreement
The most important document in any franchise business is the franchise agreement. This is a bespoke contract that sets out all the rights and obligations relating to the agreement between the franchisor and franchisee. The franchise agreement can make the difference between the success or otherwise of your new franchise and should never be signed without taking expert legal advice.
If you are contemplating a franchising venture, contact us for advice.
