What Is a Franchise?
A franchise is a type of license that grants a franchisee access to a franchisor’s proprietary business knowledge, processes, and trademarks, thus allowing the franchisee to sell a product or service under the franchisor’s business name. In exchange for acquiring a franchise, the franchisee usually pays the franchisor an initial start-up fee and annual licensing fees.
Key Insights
1. A franchise is a business whereby the owner licenses its operations—along with its products, branding, and knowledge—in exchange for a franchise fee.
2. The franchisor is the business that grants licenses to franchisees.
3. The Franchise Rule requires franchisors to disclose key operating information to prospective franchisees.1
4. Ongoing royalties paid to franchisors vary by industry and can range between 4.6% and 12.5%.2
Unveilling Franchises
When a business seeks to expand its market share or geographic footprint affordably, it may opt to franchise its product and brand name. In a franchise arrangement, the franchisor, which is the original business, grants the franchisee the right to use its name and business concept. The franchisee, in turn, purchases this right to market the franchisor’s goods or services under an established business model and trademark.
Franchises represent a popular avenue for entrepreneurs, particularly in competitive industries like fast food. One significant benefit of investing in a franchise is gaining access to a well-established brand name, thereby eliminating the need to allocate resources towards building brand recognition among consumers.
The franchise business model has deep roots in the United States, tracing back to the mid-19th century when companies like the McCormick Harvesting Machine Company and the I.M. Singer Company pioneered organizational, marketing, and distribution systems that laid the foundation for modern franchising. These innovative structures facilitated the sale of their products to a growing domestic market.
Potential franchise investors are urged to carefully review the Franchise Disclosure Document provided by franchisors, which contains vital information such as franchise fees, expenses, performance expectations, and other operational details.
The earliest examples of food and hospitality franchises emerged in the 1920s and 1930s, with brands like A&W Root Beer and Howard Johnson Restaurants leading the way. These franchises have since become integral components of the American fast-food industry, contributing significantly to the economy. In 2022, there were 790,492 franchise establishments in the United States, a number expected to rise to 805,436 by 2023. Among these franchises are well-known brands such as McDonald’s, Taco Bell” data-wpil-keyword-link=”linked”>Taco Bell, Dairy Queen, Denny’s, Jimmy John’s, and Dunkin. Additionally, franchises like Hampton by Hilton, Days Inn, 7-Eleven, and Anytime Fitness remain popular choices for investors.
Fundamentals and Regulations of Franchises
Franchise agreements are intricate and customized for each franchisor. Typically, such agreements outline three main payment categories. Initially, the franchisee must procure the controlled rights, including the trademark, from the franchisor, often through an upfront fee. Secondly, the franchisor commonly charges for training, equipment, or advisory services provided. Lastly, ongoing royalties or a percentage of the operation’s sales go to the franchisor.
These contracts are temporary, resembling a lease or rental arrangement for a business. They do not confer business ownership upon the franchisee. Depending on the terms, franchise agreements typically span between five and 30 years, with severe penalties for premature termination or violation by the franchisee.
Franchising in the United States is subject to state-level regulation, with the Federal Trade Commission (FTC) introducing a federal regulation known as the Franchise Rule in 1979. This rule mandates that franchisors disclose comprehensive information to potential buyers, covering aspects such as fees, litigation history, approved suppliers, financial performance expectations, and other critical details. Originally named the Uniform Franchise Offering Circular, this disclosure document was renamed the Franchise Disclosure Document in 2007.
Comparison between Franchise and Startup
If you’re not keen on building a business based on someone else’s blueprint, launching your own venture is an option. Yet, initiating your own company entails significant risks, although it promises both financial gains and personal fulfillment. When you embark on entrepreneurship, you’re navigating uncharted waters. Questions like, “Will my product resonate with customers?” or “Can I sustain profitability?” linger.
The harsh reality is that new businesses face steep odds. Roughly two-thirds barely make it past the two-year mark, and only half survive five years. If your business aims to defy these statistics, the responsibility lies solely with you.
Bringing your vision to life demands relentless dedication and effort, often without guidance or formal training. Venturing solo, especially without prior experience, poses formidable challenges. If this prospect seems daunting, opting for the franchise route might be more prudent.
Many are drawn to franchises by the success stories of other franchisees. These models provide cautious entrepreneurs with a proven framework for business success. Conversely, launching your own startup offers the promise of personal and financial autonomy for those with innovative ideas and a solid grasp of business operations. The decision between the two hinges on your unique circumstances and aspirations.
The Bottom Line
Franchising offers individuals a compelling entry point into the realm of entrepreneurship, leveraging the groundwork laid by established, successful, and renowned businesses. With a plethora of franchise options available, aspiring entrepreneurs have ample choices.
By paying a fee and covering start-up costs, you can set out on the path to becoming your own boss and potentially embarking on a lucrative career. However, it’s essential to recognize that success is not assured, and running a profitable franchise demands considerable effort and dedication.