If you’re looking up how to franchise a business, you’re at the right place. We have made this comprehensive guide to teach you how to prepare and properly franchise your business in the USA. Read on!
Key Takeaways
- By offering a franchise opportunity to interested investors, it is possible to scale the business in a quick and cheap way.
- The FTC rule demands that every franchisor provide all potential franchisees with a copy of the Franchise Disclosure Document.
- As an owner of the franchised business trademarks, a franchisor makes a profit from Royalty Fee that the franchisee pays according to gross sales.
- A franchisor must provide initial training and ongoing support in every business segment to their franchisees during the whole duration of the franchise agreement.
What is Franchising
Franchising is the creation and distribution of a brand and its franchise system. It involves a franchisor, who creates the brand and franchise system, and the franchisee, who pays royalties to run a business under the franchise’s name.
Let’s say you wanted to open a KFC. You would pay the franchisor a royalty that will allow you to open a KFC outlet. The franchisor in this case will also let you know their recipes, train your workers, share their marketing plan and provide ongoing support to you.
You on the other hand will provide them with local market research, find and lease a space for the franchise, pay franchise fees and run the business according to the standards of the franchisor.
What Businesses Can Be Franchised?
There are 5 types of franchises
- Job franchise
- Product or distribution franchise
- Business format franchise
- Investment franchise
- Conversion franchise
1. Job-Franchise
This is a type of low-investment franchise that requires little staffing, usually less than 5. Job franchises are usually run by one person. The franchisee has to pay a franchise fee and invest in other requirements like equipment. Job franchises usually include jobs like pool cleaning, pet grooming, party organizing, cell phone repair and production of specialty coffee.
2. Product or Distribution Franchise
These are usually supplier-deliverer business relationships. The franchisor provides the franchisee with distribution rights and usually a business management model isn’t included in the agreements. Sometimes a part of the production process is also licensed to the franchisee.
Product franchising deals with large products like cars, computers, heavy machinery, and appliances. In cases where the production process is also licensed, the product is usually something like soft drinks.
3. Business Format Franchise
This is the most popular type of franchise. In this model, the franchisee not only gets the trademark license but also a detailed business model on all aspects of the business including how to run the business. The franchisor will also train employees and provide consistent support for the franchisee. This model is most famous in fast food chains, hotel chains, fitness chains, and retail store chains.
4. Investment Franchise
These are large-scale investments that require a large amount of capital to initiate. In this model, the franchisee buys the rights to the franchise and uses their own management system, or the franchisor themselves manages the business and pays the franchisee a share in exchange for their investments. Large corporations and hotels engage in this model of franchisement.
5. Conversion Franchise
This is a franchise model where an existing franchise merges with a business and converts the union into a franchise unit of its own. This franchise inherits the trademarks of both parent companies and gives those companies a chance to grow rapidly. This model of the franchise is most popular with electrician businesses, florist businesses, plumbing businesses, and real estate brokers.
How to Franchise a Business
- Make sure your business is ready to franchise.
- Protect your business’s intellectual property.
- Prepare a financial disclosure document (FDD)
- Draft a franchise agreement
- Compile an operational manual for franchisees
- File or register your FDD
- Set a strategy to achieve your sales goals
1. Make sure your business is ready to franchise
There are 12 main criteria you have to check to make sure your business is ready to be franchised.
Credibility
To be a successful franchise, a business must show credibility to potential franchisees. Credibility can be built on multiple bases. Customer awareness of the brand, years in business, management style and strength are some factors that can make or break credibility.
Differentiation
A franchise must have unique characteristics that allow it to rise above its competitors. Uniqueness can come in many forms like features of products/services, management style, marketing style etc.
Transferability of Knowledge
A franchisor must be able to teach prospective franchisees about the management systems and style of operations in a short amount of time. Franchises with long and complicated management systems that have to be taught for longer times tend to fail. Generally, if it can’t be taught in 3 months it’s too long. You can, however, train individuals with some training to bypass this problem.
Adaptability
A business’s ability to adapt to the location it serves is very important. Some locations have legal restrictions. If it’s a food franchise, for example, different geographical locations have different spice palettes and taste preferences. Adapting and fine-tuning to these differences will make success more likely.
Refined prototype operations
A refined prototype can prove that the system is effective and can train new employees. It can also be a testing ground where new products and marketing tactics are tested.
Documented Systems
All businesses have systems. But these systems need to be properly documented in a user-friendly manual for franchisees to access. Some things that must be documented are business policies, systems, management styles and business practices.
Affordability
A franchise has a target group of idea franchisees. The franchise must be affordable to this group of people. Prices depend on the type of franchise and industry.
Return on Investment (ROI)
The profit turned in by the franchise must be enough to pay the royalties to the franchisor and at least an ROI of 15% for owner-investors and 20% for area developers.
Market Trends
An analysis of market trends can help prospective franchisees see whether or not to invest. Staying aware of if the market is expanding or depleting and how the competitors are doing is necessary for the longevity and credibility of the franchise.
Capital
Franchising, while a cheap option for expansion, is not cost-free. An estimated $250,000 is needed to open just one franchise unit if you’re looking for aggressive expansion. Cheaper options are available, of course. Capital is needed to take care of legal documentation, marketing and adding of personnel.
Commitment to Relationships
A sign of a good franchise is looking to maintain long-term business relationships. Long-term relationships and profits are directly proportional. It can also increase the credibility in prospective franchisees.
Management Strength
An adequate number of properly trained and experienced employees can make or break a franchise. A franchisor or franchisee taking on the job of multiple people including marketing, management and training is bound to fail. Especially since they probably aren’t experienced in all of those fields.
2. Protect your Business’s Intellectual Property
There are 4 types of intellectual property protection. Copyright, trademark, utility patents, and trade secrets.
- Copyrighting is done for tangible representations of a creator’s ideas. This can be applied to art, music, manuscripts, photography, and more.
- Trademarking can be done to logos, brand names, catchphrases, and artwork that’s used to identify a business.
- Utility patents can be received for new inventions.
- Trade secrets are intellectual properties that a business keeps secret from the rest of the market because they can be in a position of significant disadvantage if said intellectual property is publicized.
Additionally, practices like documenting your discoveries, creating strong NDAs and creating strong access credentials (like passwords) will help protect intellectual property. If your intellectual property is being misused or violated you can opt to send a warning notice or pursue legal action.
3. Prepare a Franchise Disclosure Document (FDD)
An FDD discloses important financial information for prospective franchisees to make decisions about your franchise. It contains comprehensive information on both the franchisor and franchisee. It contains 23 sections.
- Information of the franchisor, any affiliations, and predecessors
- Litigation (covers pending and prior action taken against the franchise)
- Initial fee
- Other fees
- Estimated initial investment
- Financing
- Franchisor’s assistance, training and advertisements etc.
- Franchisee’s obligations
- Franchisor’s business experience
- Bankruptcy involving franchise and its affiliates
- Any restriction on the sourcing of products or services
- Trademarks
- Copyright and patents
- Public figures affiliated with the franchise
- Financial performance estimate
- Renewal, termination and dispute resolution
- Outlets and franchisee operation
- Contracts
- Receipts
- The obligation of the franchisee to participate in the actual business or not
- Territory
- Restrictions on what the franchise can sell
- Financial statements
4. Draft a Franchise Agreement
The franchise agreement, once signed by both the franchisor and franchisee, allows the franchisee to use the franchise’s brand name and trademarks, etc., and allows the franchisor to receive royalties in return. It’s usually drafted by the franchisor and is non-negotiable.
Here are some key points included in a franchise agreement.
1. Overview of the relationship between franchisor and franchisee.
This includes brand guidelines and responsibilities of the 2 parties.
2. Duration of agreement.
Usually, franchise agreements last for 5-10 years.
3. Franchise fee.
This includes an overview of the initial fee and endurance fee the franchisee has to pay the franchisor. Additional fees are also mentioned.
4. Business operations.
This includes the exact responsibilities of the 2 parties and how operational management is done in the franchise.
5. Site selection.
This is usually the responsibility of the franchisee. They are responsible for picking the optimal site and listing all of its characteristics for the franchisor to approve.
6. Support and training
Most franchisors offer to train franchisee employees. This section is a comprehensive overview of how training is done, how long training will last etc.
7. Intellectual property utilization
The franchise agreement explains which franchise trademarks the franchisee can use and how.
8. Minimum insurance coverage
9. Record maintenance
The franchise specifies what records the franchisee should maintain, the OS used by the franchisee and the franchisee’s rights to use this data.
10. Agreement renewal
Contains terms and conditions regarding contract renewal in the future. Renewal is optional.
11. Termination of the agreement
The franchisor has the right to terminate the agreement if the franchisee has committed a serious violation or if royalties are not paid on time.
12. Franchise resale
Commonly, the franchisee has the right to sell the franchise unit. However, they need the franchisor’s approval first.
5. Compile an Operational Manual for Franchise
This is a document that includes instructions for your employees on how to handle day-to-day activities. These activities include how to greet your customers, how to request payments, how to manage tasks at work etc. It’s a roadmap to how the business functions from the most basic instruction to upper management levels. It can also be described as an employee handbook.
An operational manual includes the business’s contact details, hours of operation, organizational chart, job descriptions, password lists, emergency procedures, and disaster recovery plans.
Having an operational manual will reduce your liability, increase scalability, save time in training new hires, and helps in cost-cutting.
6. Register your FFD
There is no requirement for a business to register its FDD at a federal level. Most states don’t require registration of your FFD either. It’s important to identify the states your franchise operates in. Click here to find out which states require registration and where you register your FDD in each of those states. Registration can take from 20 days to 3 months.
7. Set Strategies to Achieve Goals
Goals can be achieved using the SMART goals method.
S– specific
M– measurable
A– achievable
R– realistic
T-time limited.
Goals can vary in their nature. Not all goals are profit-driven, goals can also be customer satisfaction and increased competitiveness. Changes in marketing, how your products and services are presented, customer service quality and quality of workers will all have a say in a franchise achieving its goals.
How Much Cost to Franchise Your Business?
An estimated $18,500 to $84,500 is needed to franchise your business. The costs include,
- FDD legal fee development- $15,000to $45,000
- Operation manual development- up to $30,000
- Financial statement preparation- $2,500 to $5000
- Registration fees- $1,000 to $4,500
- Website costs- $2,500 to $15,000
- Marketing costs- up to $20,000
Please keep in mind that there can be additional costs as well.
Advantages and Disadvantages of Franchising a Business
There are many pros and cons to franchising a business. Here are some,
Pros
- Franchising gives a business the potential to rapidly expand
- Franchisees can be trained to handle responsibilities, which allows the franchisor more freedom to attend to other work.
- Franchisors can have a steady cash inflow from royalties.
- Maintaining the quality and consistency of a business is made easier by franchising.
- Franchisees are self-motivated because their capital is going to be invested in the franchise unit.
- Franchisees can report data on the local market to the franchisor, which will help when it comes to marketing and fine-tuning the franchise unit to the specific location.
Cons
- The franchisor will only make royalties. Full profit won’t be earned by the franchisor.
- The difference in management styles between franchisor and franchisee.
- The high upfront investment is needed.
- Potential for conflict between the franchisor and franchisee.
- Lack of financial privacy.
How to Make Sure your Franchise Succeeds
- Make sure you have enough money to invest in your franchise.
- Recruit enthusiastic workers and treat them generously.
- Focus on customer service.
- Get involved in your local community.
- Stay in touch with other franchisors and franchisees.
- Pay attention to the market in detail.
- Follow the operation manual thoroughly.
- Network, network, network!
- Follow a marketing plan.
Good luck!