Franchising is an extremely adaptable method of distributing products and services. It allows for rapid expansion, but spreads the risks and costs of expansion. A franchisor typically provides the franchisee with training and support for setting up and running a business that uses the franchisor’s business system and trademark or service mark. A franchisee typically supplies the capital for starting the business at a new location, and the day-to-day operation and management of the new unit. The franchisee usually pays the franchisor an initial fee and an ongoing royalty for the right to use the franchisor’s marks and business system, and for ongoing support.
Franchising is a very flexible way of doing business. According to the International Franchise Association, there are more than 75 different industries that use the franchising format, ranging from accounting services to weight loss clinics. Just about any type of business can be franchised – whether selling products or services, at retail or wholesale, from a storefront or from home, or anything in between. But just because franchising might be suitable for your business does not mean that your business would be right for franchising.
Is Your Business Franchisable?
1. How can we tell if our business would be right for franchising?
Keep in mind that, to be successful, a franchisor has to sell franchises, and then the franchisees have to sell the products or services. So, the business has to be right for franchising on 2 different levels. First, it must be attractive to prospective franchisees who are considering buying a franchise (and who might be considering other franchises too). And second, it must be supportable in the marketplace among consumers.
Before starting a new franchise system, you should carefully consider whether your franchise "package" will be something that other people will want to buy in to, and whether you have the time, energy and money needed to get a new franchise system started.
Here are some specific factors you should consider:
whether you have a proprietary concept that others would be willing to pay to learn;
whether your business concept can easily be taught to others;
whether any unusual skill sets are required for successful operation of the franchised business;
whether your business concept is easily adaptable to other markets;
whether the market for your products or services is increasing;
whether your business has a profit margin sufficient to allow a franchisee a reasonable return on investment (even after paying royalties);
whether there is any value in the franchise system to your franchisees after they have learned how to operate the business;
whether franchising could divert customers away from your existing business;
whether you can fund the launch of a new franchise system; and
whether your existing business will can survive if you devote substantial time and energy to starting a franchise
On this same topic, see the material below about the key components of a successful franchise.
2. Are there people who can help us decide whether to franchise?
Franchise consultants, franchise attorneys, and franchise development companies can help you reach a decision about franchising. If you want, you can spend several months and thousands of dollars on a feasibility study. But here are a few things to keep in mind:
because franchising is so flexible, the result of a feasibility study is almost always that the business can be successfully franchised;
the person performing the feasibility study almost always has a conflict of interest because they want you to hire them to do more work if you do decide to franchise; and
the result of a feasibility study is someone’s opinion -- not a guaranty.
3. How do we make the decision whether to start a franchise system?
There is no easy answer. The decision to franchise is serious. Franchising involves a substantial commitment to your business and to your franchisees, and it involves risks.
Starting a new franchise will require you to spend time and money to do it right the first time. It may take a few months or a few years for you to recover these costs -- or it is possible that may never recover the start-up costs at all. You may have to work nights and weekends to keep your existing business going while you are starting a new franchise. And, that is the easy part!
The hard part is selling your first franchise. Once you start to sell franchises, your franchisees will be depending on you to help them start and run their business. These people will be looking to you as the expert on how to run a successful business. Some franchisees will invest their life savings or retirement funds into a franchise. They will have a lot to lose if their franchise is not successful.
Like all businesses, franchising involves certain legal risks. If you do not comply with all of your obligations in the franchise agreement, you could be liable to your franchisees. There is also some risk of liability to a franchisee’s customers and employees in certain circumstances.
Here are some things you could do to help yourself make the decision whether to franchise:
Learn all you can about franchising. Study this site, and other web sites on the Internet. Read books on franchising.
Consider alternatives to franchising to see if a different business model would be better for you (see Franchise Alternatives).
Learn what successful franchisors do. Study FDDs from other franchisors. Study their operations. Talk to other franchisors (and franchisees) about their franchising experiences.
Prepare a business plan for franchising. See if it makes financial sense for you to franchise.
Key Components of a Successful Franchise System
You need a good business concept – preferably one that is unique, interesting, and with long-term potential. This is what your business is all about. It needs to be appealing to consumers and to prospective franchisees.
You also need systemized standards for operations. These include things like policies, procedures, and other types of standards that will be used at every business location. The system includes the special know how about how to set up and run the business. Usually, the system is represented by the information in the franchise operations manual.
You should protect the system to the extent possible. This involves steps like:
keeping your proprietary information confidential;
using confidentiality agreements and non-competition agreements with anyone who has access to your confidential information;
claiming copyright protection for key documents, training videos, recordings, etc.; and
filing for a patent in appropriate circumstances (using an experienced patent lawyer).
The system need to be transferable. Most franchise systems do not require new franchisees to have any experience in any particular industry, but somefranchise systems do require specialized knowledge or pre-existing licenses (such as real-estate franchises and medical-service franchises). You must be able to teach your franchisees how to successfully set up and run the business using your system. The transfer of this detailed information takes place through the initial training program, through the franchise operations manual, and through the ongoing support the franchisor provides. If there are parts of the system that require special skills that are not easily transferable (such as business experience, musical ability or artistic talent), it may still be possible to franchise your concept, but the pool of potential franchisees will be limited to those people who already have these special skills.
Your franchise operations manual needs to be comprehensive. Your franchise agreement will require your franchisees to follow the mandatory system standards in the manual. So, it is important that the manual includes everything that the franchisees must do. It can also include non-mandatory suggestions for other things. Manuals change over time as system standards are added, dropped, or changed. Your franchise agreement should allow you to modify the manual anytime you want to. It is crucial that your franchise agreement and franchise operations manual mesh together very well.
Your training program will be a short course on how to set up and run the business. Some training programs last a few days, while others last a few months. The complexity of the business, and your franchisees’ previous experience will affect how long your training program will last. Most franchise training programs involve some "classroom" time, and some on-the-job training. Classroom time typically consists of meeting key franchisor personnel, reviewing key parts of the franchise operations manual, going over the franchisor’s forms, learning to use computer software or point-of-sale equipment, and learning other things needed for day-to-day operation of the business. Some training programs involve "self-study" time where the franchisees watch power-point presentations or training videos, or fill out worksheets about the business. On-the-job training is usually offered at the franchisor’s location, at the location of an existing franchisee or company-owned unit, or at the new franchisee’s location right before opening.
Your concept needs distinguishing features to give it a clear identity in the marketplace. This identity includes things like:
trade dress and image (the way the locations look);
trademarks (identify the business and/or the products offered); and/or
service marks (identify the business and/or the services offered).
You should take the necessary steps to protect the franchise identity by registering with the U.S. Patent and Trademark Office all important trademarks and service marks. This federal registration will give you important legal rights. Part of this process will be to investigate who else might already be using the same or similar names and logos. A trademark lawyer should be involved in this process for maximum protection of the marks.
You should have experience in setting up and running the same business that your franchisees will. Actual operating experience is important for several reasons:
It demonstrates the viability of your concept.
It helps you refine your concept and system.
It gives you more credibility with franchisees and prospective franchisees.
If units are managed by someone else, it helps you refine your franchise operations manual and training program.
If units are managed by someone else, it helps you set up the management and support staff and infrastructure you will need for franchising.
All of these factors will help you sell franchises. While experience is strongly recommended, it is not required. It is possible to start a new franchise without experience. But inexperienced franchisors usually have an extremely difficult time selling franchises.
Operating a franchise is a business, and the primary purpose of businesses is to make money for the owners. Each franchisee will expect to make a reasonable return on initial investment by the end of the initial term. You must make sure that the concept is capable of generating profits sufficient to make money for your franchisees (even after paying you royalties and other fees).
7. Staffing & Support
Your franchisees will need some initial support and additional on-going support. You must have capable staff to provide this support, in appropriate categories such as site selection, lease negotiating, staff recruiting, staff training, marketing, customer service, etc. You will also need to inspect your franchised units periodically to make sure that the franchisees are following your system standards.
The support you should offer depends on the type of franchise involved. It might include the following:
Customer service training
Identification of suppliers
Negotiation of favorable prices for required products or services
Sale of certain products or services to your franchisees
Staff recruiting and training
Marketing materials and promotions
General business advice
You will need money to start a new franchise. The amount you will need depends on your system, how much of the start-up work has already been done, and how much of the additional start-up work you will do yourself. If your efforts are successful, you could recover your start-up capital quickly. It is not unusual for a new franchise system to recover its out-of-pocket start-up costs after the sale of 2 or 3 franchises.
You will probably want to form a new legal entity to be the franchisor; however, this is not a requirement. By setting up a new entity, you will help protect other assets (such as company-owned units) from liability that may arise under the franchise system, and you will reduce the cost of getting audited financial statements. The most popular entity choice for franchisors are limited liability companies and corporations.
10. Legal Documents & Legal Compliance
To be able to sell franchises legally, you must have a franchise disclosure document (FDD) to deliver to your franchisee prospects, and you will need to register the franchise in certain states. The FDD must comply with certain rules for the content and format of the required information, and it must include copies of the form franchise agreement and other contracts you will use with your franchisees.
You will also need to learn about the federal and state laws that regulate franchising before you begin talking to franchisee prospects. Some of these laws restrict what you can and cannot say to franchise prospects.
11. Financial Statements
The FDD must also include financial statements prepared by an independent accountant according to U.S. generally-accepted accounting principles. For new franchisor entities, there is a phase-in period for the requirement for audited financial statements. The initial financial statements for a new franchisor entity will typically be an opening balannce sheet. After the franchisor's first fiscal year end, the FDD would then need to include a full set of unaudited financial financial statements (balance sheet, income statement, cash flow statement, and statement of owners equity). After the franchisor's second fiscal year, the full set of financial statements will need to be audited by an independent certified public accountant.
In California, Maryland, Minnesota, New York and Virginia, the use of unaudited financial statements in a franchisor's FDD is not authorized under applicable state franchise laws. So, we recommend that franchisors who may desire to offer franchises in any of those states within the first 3 years of existence should have audited financial statements from the outset.
12. Business Plan
To help you formulate your plans for your new franchise system, we recommend that you develop a business plan. This is not a legal requirement, but it makes sense to prepare a comprehensive business plan.
13. Marketing Plan
Similarly, we recommend that you develop a specific plan for how to market and sell franchises. There are many different marketing techniques and tools available for selling franchises. You should formulate your plan based on your budget, and the target audience of prospective franchisees. Franchise advertising is regulated in some states, so be sure to consult an experienced franchise lawyer early in this process.
How Much Does it Cost to Start a New Franchise System?
Some experts suggest that you will need from US$50,000 to US$250,000 to get started. But, we have worked with lots of start-up franchisors with much less than US$50,000.
1. Why do we need so much money to get started?
There are 2 reasons.
a. Financial Ability. If you plan to sell franchises in a state where you have to file your FDD for review by the state franchise regulators, you must be able to show that you have the financial ability to perform your obligations under the franchise agreement. The franchise regulators will examine your financial statements that are included in the FDD. If these statements do not show sufficient liquid capital, the franchise regulators may impose a "financial condition" by refusing to register the franchise unless you:
infuse additional capital into the company; or
file a surety bond; or
file a guaranty of your performance by another company which has audited financial statements showing sufficient liquid capital; or
agree to impound all fees collected from each franchisee in that state into a special account until after the franchise regulators approve your withdrawal of the funds; or
agree to not collect any fees from each franchisee in that state until after the franchise unit is open for business.
The state franchise regulators have never announced any guidelines for determining whether a franchisor has sufficient capital. A general rule of thumb is that a franchisor will be considered to be adequately capitalized if it has current liquid assets (in excess of any current liabilities) of at least 2 times the total of the initial franchise fee and other amounts the franchisor will collect from a new franchisee before the franchised business opens. However, a new franchisor with a limited operating history may be subject to the imposition of financial conditions regardless of its financial strength.
b. Start-Up Costs. Like most businesses, there are certain costs involved in starting a new franchise. You can control these costs to some extent by: deciding which types of start-up service you can do without; by choosing to do some of the start-up work yourself; and by carefully selecting your franchise lawyer and accountant. At one extreme, you can hire a franchise development company to do practically everything for you. At the other extreme, you can do almost all of the start-up work yourself.Here are some places where you could spend your start-up capital:
overhead (such as separate office for franchise operations, management staff, franchise sales staff, travel, etc.)
state registration fees (ranging from US$0 to US$750 per registration state)
2. What are Typical Start-Up Expenses for a New Franchise System?
TYPICAL OUT-OF-POCKET EXPENSES TO START A NEW FRANCHISE SYSTEM
Filing fees and legal fees for forming a new entity (LLC or corporation) to be the franchisor
$200 to $500
State filing office and local business lawyer
TM or SM Registration
Filing fees and legal fees for federal registration of principal trademark or service mark to be used in the franchise system
$1,800 to $2,000
U.S. Patent and Trademark Office and trademark lawyer
Costs to prepare a franchise operations manual
$0 to $20,000
New franchisors are required to disclose an opening balance sheet prepared by independent accountant
$500 to $3,000
CPA or accountant
Franchise Legal Fees
Legal fees for preparing required franchise documentation and related counseling
$19,500 to $22,000
Filing fees and legal fees for preparing and filing state registrations
$0 to $20,575
Franchise lawyer and state franchise regulators
$22,000 to $66,075
a. We strongly recommend establishing a new entity to serve as the franchisor of the new franchise system for several important reasons.
b. A registered trademark or service mark is not required to start a new franchise system. However, we strongly recommend developing a mark capable of registration and starting the federal registration process before offering or selling any franchises.
c. A franchise operations manual is technically not required to start a new franchise system. However, there are many important reasons to have a manual, in general, and a professionally-prepared franchise manual, in particular.
d. The fixed-fee packages for start-up franchisors offered by Vinson Franchise Law Firm are described in detail at Start-Up Franchisors. The range of costs shown is for the two most popular start-up packages. The range of costs is not meant to depict the entire spectrum of costs for these services available from other providers. Many franchise lawyers charge much more than this range, and some lawyers may charge less. Because of low overhead, prior big-firm experience, and a practice devoted solely to franchise law, we believe that our package prices are generally at or below average (for an experienced, bona fide franchise lawyer) – while the quality of our services is extremely high.
e. There are about 30 states that do not require any form of registration before franchises can be offered or sold in those states. In about 20 states, some type of filing is required first. The actual number of states requiring registration depends on the federal registration status of the franchise’s principal trademark or service mark. Most start-up franchisors choose to do state filings on an as-needed basis at first. The high range is for complete registration in every state.
f. This table does not include any amounts for any additional overhead a new franchisor may choose to incur, such as an additional telephone line, new business cards, expanded web site, additional administrative assistance, or additional insurance. It also does not include any amounts for marketing the new franchise opportunity.
3. Can we franchise on a very limited budget?
Yes, this is possible, but it has substantial risks. Here are the bare minimum steps to start a franchise:
Prepare an FDD and a form franchise agreement. Use templates found in some franchise books, or use a competitor’s documents as a guide.
Get financial statements from an independent accountant.
Register your franchise if you plan to offer franchises in a registration state.
Here are 2 more steps. They are not required. But, they will provide you with certain legal protection, and are easily worth the cost.
Form a new entity to be franchisor. Check with your state’s corporations department or secretary of state on how to do this yourself, or search online for low-cost service companies that will help you.
Register your marks yourself with the U.S. Patent and Trademark Office.
Another way to start a franchise on a limited budget is to work with those who are willing to take risks with you now in exchange for a share of possible rewards in the future. Some franchise lawyers (including us, sometimes), some franchise consultants, and some franchise development companies may be willing to take a share of future franchise fees and royalties instead of all or part of their normal fees.
1. What are some of the issues we will need to consider in planning our franchise concept?
What minimum qualifications will you require for new franchisees?
How will you find qualified prospects?
How much will the initial franchise fee be?
Will you offer financing?
How much will the royalties be?
Will there be any other fees? If so, how much?
What kinds of controls will you have to make sure franchisees pay all they owe you?
How long will the franchise term last?
Can the franchise agreement be renewed for additional terms?
Will you require franchisees to purchase certain goods or services?
Will you require franchisees to buy them from designated suppliers?
What kinds of ongoing value will you provide to franchisees to keep them in the system after you have trained them on how to run the business?
2. What are some of the steps we can be taking now as we consider franchising?
Here are some concrete steps you can do now that will give you a head start when you are ready to franchise, and that will probably help your business even if you decide not to franchise:
Make sure your core business is stable and successful (and can serve as a prototype and training facility for franchisees, if appropriate).
Start the process of obtaining federal registration of your principle trademarks or service marks as soon as possible (this process can take 12 to 24 months to be completed).
Begin preparing your franchise operations manual.
Set aside sufficient capital to meet your anticipated start-up costs.
Research your competition.
Plan the management, technology and supply infrastructure needed to support your franchisees.
Select an experienced franchise lawyer.
3. How can we research competing franchises?
There are two primary sources for free, online copies of FDDs:
Licensed in California, Nevada and Texas. Not certified as to any specialty by any state bars.
This web site provides general information only. Laws differ from state to state, and they change over time. Nothing included in this web site should be construed as creating an attorney-client relationship, or as the provision of legal advice.
Links to other web sites are provided for your convenience and information. They are not intended to be endorsements. Third-party trademarks and service marks used in this web site belong to their respective owners.
All contents copyright 2002-2017 Robert E. Vinson, Jr. All rights reserved. The information contained in this web site may not be reproduced, downloaded, disseminated, published or transferred in any form or by any means, other than downloading for personal use, except with prior written consent of Robert E. Vinson, Jr.