Every industry has their own language and the industry of buying and selling franchise businesses is no different. Understanding the basic terminology can help get you started on the right foot. Transworld Business Advisors is here to help you every step of the way so let's start with a few commonly used terms. Franchising is a form of business by which the owner of a product or service expands or obtains distribution through affiliated dealers (also known as franchises).
A franchisor owns the rights and trademarks of a company and then allows a third party (the franchisee) to use these rights and trademarks to conduct business at a franchise location. In return for a fee, the franchisor (owner) grants the rights to operate a branch of the business under the names, brands, and associated aspects of the business. The franchisor ultimately owns the brand and proprietary knowledge of the specific business entity.
A franchisee is the person or party that is purchasing the right to use a business's trademarks, associated brands, and other proprietary knowledge in order to open a branch. The franchisee invests in their location and use of the brand and any intellectual capital inherent in the brand as long as they adhere to the business rules and payment structure the franchisor requires to be brand compliant.
Franchisor vs. Franchisee
Franchising is a continuing relationship in which a franchisor provides a licensed privilege to a franchisee to do business using their brand. One of the benefits of being a franchisee is that the franchisor offers assistance with information that is needed for running the business such as organizing, training, vendor relations, marketing, and management. In exchange for this assistance and instant brand equity, the franchisee typically pays a franchising fee and a portion of the branch's profits or gross sales to the franchisor. The franchisee and franchisor enter into a legal contract detailing the terms of the mutually agreed upon legally binding arrangement, known as the franchising agreement.
The franchise fee (also called the "initial franchise fee") is the payment made by a franchisee to the franchisor for joining the franchise system. This is the initial payment that the franchise makes to the franchisor when they become a franchise. The franchise fee is typically a one-time upfront flat fee, paid upon signing the franchise agreement for the right to use the brand name of the franchise. This payment acts as compensation to the franchisor for the initial training and support for new franchisees. The amount a franchisor sets as their franchise fee varies from industry to industry and even within franchisors in the same industry.
A royalty fee is a payment made from the franchisee to the franchisor to compensate for the use of the franchise brand. The use of royalties is common in franchise situations where an original owner chooses to sell his product to a third party in exchange for royalties from the future revenues it may generate. Royalties are often expressed as a percentage of the franchisee's revenues. Many factors affect the royalty rate including exclusivity of rights, risks involved, market demand, technologies involved, and the level of innovation the product or service provides the franchisee.
Many franchisors grant their franchisee an exclusive area or territory, where no other franchises belonging to the same underlying business can set up shop. These territories are commonly known as protected territories, or areas of protection. As the name suggests, the purpose of a protected territory is typically to prevent internal competition and to protect franchisee sales from being cannibalized by other locations utilizing the same brand in close proximity. Protected areas or territories may be defined by a radius in miles, postal codes, or cities. Territories are protected for a specified amount of time and agreed to in the franchise agreement.
Because no two franchisor's operations or agreements are the same it is vital that prospective franchisees obtain the assistance of knowledgeable and experienced franchise professionals. Transworld Business Advisors can help you identify any problem areas in the contracts, or franchise agreement, that can lead to confusion and future disputes over the franchise agreement. If you are considering buying a franchise, Transworld offers the professional services that successfully bring buyers and sellers together.
Contact us today at 248-590-1377 or Lstephens@tworld.com to discuss how we can help you reach your franchise-related goals.