Suppose you own a successful restaurant. Business has been steadily improving and your best customers keep telling you that you should open another store. Maybe they even offer to invest in the venture because they love your food so much. You would like to expand but are not sure how to do it. You have heard about other operators that have franchised their concepts and made millions. You wonder “why not me?”
However, you are not sure whether your business is right for franchising or what is involved in such an undertaking. This article discusses the general concept of franchising to give business owners a framework for evaluating whether franchising is right for them and offers some alternatives to franchising that provide for business expansion without the cost or commitment required by franchising.
Should I Franchise My Business?
There is no doubt that franchising offers business owners a vehicle to quickly expand their businesses and increase market share without a major capital investment. Multiple stores give franchisors more buying power and increases efficiencies in advertising and operations. Sometimes, franchisors also profit from selling goods, services or supplies to the franchisees that are used in the business. Franchisees generally build and operate their stores with their own money and then pay the business owner a royalty on the franchisee’s sales. Franchisees sign up because they like the concept and get a “turn-key” system complete with training and support.
Franchising is not for everyone, however, and you should carefully evaluate your options before proceeding.
The threshold questions are “Is someone interested in replicating my business?” and “If so, will they be able to do it?” Businesses with limited brand awareness may have trouble attracting desirable franchisees.
In addition, businesses that are highly dependent on the skills of the business owner or certain employees are not good candidates for franchising.
Successful franchise operations have distinct procedures and processes for all important phases of the business operation that can be readily “exported” or easily learned by someone else with experience in the field. A detailed operations manual, for example, is a minimum requirement.
Another important consideration is the profitability of the business. Ideally, franchisees would like to net ten to twenty percent of their gross revenue, after paying a royalty to the franchisor. If a business does not have an established track record of profitability, it is not likely to attract potential investors and selling the brand based on its “potential” is ill advised.
How to Franchise
If franchising or otherwise expanding your business is of interest, you should be familiar with both the state and federal laws that govern franchising. Basically, these laws provide that any business relationship that has each of the following characteristics shall be deemed a franchise:
- A right is granted to the franchisee to engage in the business of offering, selling or distributing goods or services;
- The right to engage in the business is granted under a marketing plan or system prescribed in substantial part by the franchisor;
- The operation of the franchisee’s business is substantially associated with the franchisor’s trademark, service mark, trade name, logo or other unique characteristics; and
- The franchisee is required to pay, directly or indirectly, a franchisee fee or other charge.
If franchising is not for you but you want to expand, there are alternatives to franchising that maybe better suited for your situation. Some of these alternatives are as follows:
- Joint Venture: You can form a separate corporation or other entity with outside investors for the purpose of opening and operating additional units. Provided you do not charge the new entity a royalty or other fee for use of the trademarks of the business, and only receive payments based on your ownership interest, the arrangement is not a franchise and registration is not required. The investors can also manage the operations of the new entity.
- Limited Partnerships: You can form a limited partnership in which you act as the general partner and the investors act as passive limited partners. This arrangement can be structured in a way that avoids triggering franchise laws. Unlike a joint venture company, however, under this arrangement the investors cannot play an active role in the operations of the business.
- License: You can grant a license to use your name and trademarks but agree not to assert control over the licensee’s business plan or operations. If you are willing to allow your investors to devise their own business plan and system, this structure presents a viable alternative to franchising.
- Other Alternatives: There are other alternatives to franchising that are outside the scope of this article. Prospective franchisors should exercise caution in using any alternative, however, because the consequences of entering into a “sham” transaction, that is later determined to be a franchise, are significant.
If you are ready to grow your business there are many ways to do it. If your growth strategy involves leveraging the skills and resources of third parties you should consider franchising, and at a minimum, be aware of the laws that govern franchising so that you do not inadvertently violate those laws. Most successful business owners that want to expand their businesses are able to do so. The issue is finding the right structure for the particular situation.