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Does a Franchise Make Sense?

Introduction

A franchise is the right to conduct a business in a way that mirrors an already successful business and using the public image cultivated by that business. Recent years have seen the rapid development of the use of franchise structures in all types of businesses, from curbside hotdog vending to large scale manufacturing. This type of structure allows for the rapid growth of a single business and its quick establishment through a wide geographic area.

This article has two different perspectives, that of a potential franchisee or buyer of a franchise, and that of the franchisor or creator and seller of the franchise.

Buying a Franchise

Inherent in assessing any franchise opportunity is matching that opportunity to your own personality. If the business will require an extremely outgoing personality to make it succeed and you are shy and reclusive, the chances of changing your personality type and succeeding are not high. Do not try to fit your round plug into a square hole.

When a person approaches a franchise opportunity, it is important to do your homework respecting all aspects of the proposed business.

It is important to make sure that the franchisor is a legitimate person or entity and they have taken steps to protect the overall franchise concept. If you know where to look, various search methods are available to determine information about the person or other entity acting as a franchisor.

Typically the purchase of a franchise involves the buying of certain assets. These may include products used to conduct the business, products to be sold in the business, rights to certain specialized trademarks or designs, systems used in the business, and access to certain product suppliers. The franchisor obtains revenue from the sale of the franchise to a franchisee. This may take the form of an upfront payment for the right to be a franchisee. It could also take the form of a continuing royalty payment based on a percentage of the sales of the franchise. A franchisee could also be required to pay based upon a combination of both of these methods.

You should obtain the projected financial statements for a typical franchise outlet to determine the level of sales and profits that can be reasonably expected from the operation of the business. You should review these carefully with an accountant to ensure that the projections are realistic and attainable. You should balance the expected return against your personal needs for living expenses and any requirements that you might have to pay for any bank financing used in obtaining the franchise.

You should relate the projected financial statements to the available market opportunities. This may require significant hands-on research into the types of people that the products of the business may appeal to, the location areas where the most traffic passes by and other more abstract types of information. This may be difficult for some people to accomplish because there is no set structure for obtaining or interpreting this information, but it may result in some important insights into potential success or failure of the franchise. You would be surprised what different types of information are available from various sources such as City Hall, the Library, or Statistics Canada, and many of these institutions have very helpful reference personnel on staff.

The franchisor should provide you with their track record for franchise success. You should look at the history of their franchises and ask many questions regarding things such as: how long their franchises have existed for; how many franchises start up each year and in each of the last five years; how many franchises fail each year and in each of the last five years; what is the average lifetime of their franchises; and any other questions that you can think of that will give you an accurate picture of the success of their franchises.

The franchisor should have taken steps to obtain trademark protection for the name and/or logo that is used in the business. This can be confirmed through a search of government records. If they have not taken steps to obtain this protection, then it is possible for someone to use those trademarks in direct competition to the franchise.

In addition to simply providing you with access to trademark usage, the franchisor should be providing you with a significant level of operating support.

This usually centres around operations manuals that meticulously set out methods of conducting the business and these should be carefully reviewed to ensure that the conditions of operating the business are realistic.

The franchisor should provide hands-on training to you and your senior employees on an initial and ongoing basis, but you should be aware in advance whether you will be paying the costs of such training. They should also provide all of your employees with initial on-site startup training.

The most important aspect of your relationship with the franchisor is for you to have protection from a competitive and identical franchisee. This means that your relationship should provide that within a certain territory, you are the sole franchise operator.

Creating a Franchise

The rest of this article looks at franchising from the perspective of the franchisor, or seller, of a franchise.

The business of franchising, as with all businesses, is a very competitive one. The seller of a franchise must have carefully prepared all aspects of the business to be franchised before it is offered for sale in order to maintain a competitive position and to make the opportunity attractive to potential franchisees. The sale of a franchised business involves asking someone to pay money for the right to carry on a business. In order for this to make sense, the right to carry on that business must be appealing to someone willing to invest money in the opportunity. Most people willing to invest in this type of opportunity are either sophisticated themselves, or they have access to sound professional advice from their lawyer, accountant, banker, realtor or family members. If you have prepared an ill-conceived idea for sale to the public, you are not likely to convince these types of people to buy your ideas. It is essential to the long-run success of any franchised business that you have prepared, tested, reviewed and revised a sound business plan.

Although there are many common elements to a complete franchised business plan, the actual business mechanics of each franchise are different. Each franchised business plan should be developed by the seller of the franchise to fit their particular product and based upon the level of monitoring and control they desire over the user of their franchised product.

For the purposes of the discussion in this article, we have divided the elements of a franchised business into three broad categories: the history of a profitable model of the franchise; the protection of the business concept from unauthorized infringement by competitors; and the packaging of the methods which will detail how to conduct the business.

The most effective tool for selling a franchise is to be able to point to a specific example and show that this business is profitable. No one is going to buy a concept from a franchisor unless they have established that the concept is something that generates a profitable business. In the early stages of developing a business idea, the emphasis should be on developing the product and the concept by establishing a profitable business centre. Only when you have shown that the concept of marketing your products in a profitable and attractive manner is something that the buying public wants should you then make the transition to franchising.

Once a business can be shown to be profitable, then the seller has a real life example upon which to base a series of financial projections to show the potential of the franchise opportunity. Nothing sells an opportunity better than a track record of success. A seller of a franchise must be careful however to clarify that these are not representations or guarantees and that the results may vary according to location and operator.

One of the most important elements of a franchise package is some protection for the business concept from unauthorized competition through registration of copyrights, trademarks or patents. If proper registrations are obtained, then the buyer of a franchise can be assured that the development of its business can be protected from infringement by unauthorized competitors. While the proper registration of these can be time consuming and costly, the protection given and the sophistication that it projects to potential franchisees outweighs the costs in the long-run.

Most people buying into a franchise will not have had the prior experience of operating a business of this type. It is important for the seller to develop a series of manuals that deal with the uniform and comprehensive conduct of the business, containing sections dealing with such things as: site selection, interior decoration, hiring of employees, conduct of the business, accounting, marketing, manufacturing, advertising and sales.

Considerable time should be devoted to the creation of these manuals because they create the largest impression about the business and they must be designed to give someone who has never carried on this business a head start in the competitive world. Consideration should be given by the seller to setting up a series of relationships which the buyer could be obligated to, or be given the option to, enter into. This would cover aspects of the business such as: creating a prearranged financing and banking relationship with a bank; establishing a custom created accounting software and hardware for use in the business; and establishing suppliers for products used in the day to day sales of the business.

An important element of protection of the business idea and the concepts of how the business should be run is the creation of the franchise agreement itself. This is a powerful and essential tool in the relationship between the seller and the buyer of the franchise. In addition to establishing the fundamentals of how payments are to be made and the length of the relationship, it is the basis for regulating the method of carrying on the franchise business and the things that can be done to assure that the business is carried on in a uniform and professional manner. This is a complex document which should be given a lot of thought in order to anticipate all aspects of the future relationship between the parties.

Summary

We have tried to give you some initial areas to investigate in assessing a franchise opportunity, as well as some of the elements that go into assessing the appropriateness of a business for franchising.

From the perspective of buying a franchise opportunity, there are many areas that we have considered in this article. These are left for more in depth reviews and include the careful review of the technical structure of the proposed relationship and the language of the contract that creates it. There is no such thing as a standard franchise relationship and there is always an opportunity to make some changes before the relationship is committed to. You must obtain professional advice from your accounting and legal representatives in order to maximize your understanding of the opportunity and your chances for success.

From the perspective of creating a franchised business, there are too many elements to the creation of a franchised business to be dealt with at length in this article. While we have not presented all the elements that make up a franchised business and the possible variations, we hope that we have left you with the impression that the creation of a franchise is something to thoroughly research and the time spent meticulously preparing all of the materials that make up your franchise package will be rewarded in the long-run.

The opinions set out in this article reflect generally on this area of law. The impact of the law on any given situation depends upon each individual’s circumstances and the opinions contained in this article should not be relied on for assessing anyone’s legal position. Advice should be obtained directly from our business law lawyers regarding your particular situation.