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The Scenario
The restaurant’s dessert menu has produced an exceptional revenue stream. These products can easily be marketed as a standalone venture. The company portfolio includes the Sahara Dessert Dish property purchased in anticipation of this day. The properties are all in upscale locations that easily support the restaurant’s thematic dessert menu.
“Sally, it’s now or never,” you state. “We need to implement our franchise division.” Sally seems a little concerned about the plan interfering with entering the third gold Michelin star competition. You reassure her, “If Wolfgang Puck can open up gourmet pizza shops, we can create a dessert franchise operation.”
Sally replies, “Start working on the documents, and I’ll get started on creating the franchise operations menu and food handling processes.”
You reviewed all of the eventualities a company may face in expansion periods. Your company’s initial investment in the purchase of bankrupt properties has placed the company in a growth position. The commercial paper securing the properties is almost paid off. Converting the properties into a new enterprise will reduce the carrying cost and increase the current revenue streams by a minimum of 20%. Franchise licensing fees and property leasing rentals will initially bump revenue by approximately 35%.
To start your review, research the federal regulations required to establish a legally recognized franchise operation.
Part 436 – Disclosure Requirements and Prohibitions Concerning Franchising (Electronic Code of Federal Regulations). (Links to an external site.)
Please proceed to the Assignmentsection.
To fully understand the nature of a franchise operation, review the SBA information.
SBA Introduction to Franchising (PDF)
Download SBA Introduction to Franchising (PDF)
Issues and limits for consideration in creating a franchise agreement include:
Nature and extent of the rights granted to the franchisees
Duration of the franchise period
Exclusiveness of franchise
Authorized use of a trademark
TRANSCRIPT – Introduction to Franchising
Introduction to Franchising
1.1
Introduction
Welcome to SBA’s online training course: Introduction to Franchising
The SBA’s Office of Entrepreneurship Education provides this self-paced training exercise as An
Introduction to Franchising basics. You will find this course easy to follow and the subject
matter indexed for quick reference and easy access. It will take about 30 minutes to complete the
course. Additional time will be needed to review included resource materials and to complete the
suggested next steps at the end of the course.
As audio is used throughout the training, please adjust your speakers accordingly. A transcript
and keyboard shortcuts are available to further assist with user accessibility.
When you complete the course, you will have the option of receiving a completion confirmation
from the SBA.
1.2
Course Objectives
This course has four key objectives.
One, define franchising and the types of franchises.
Two, explain the pros and cons of owning a franchise.
Three, discuss the components of a Franchise Disclosure Document.
Four, identify resources to assist you in franchising a business.
1.3
Course Topics
There are several topic sections within the course. Each section covers a different aspect of
franchising. Some of the areas covered include:
Definition of franchising
The pros and cons of owning a franchise
Investigating your options
Is franchising right for you?
Numerous additional resources are identified to assist you. Visit the resource icon in the course
player or locate additional tools, templates, and mentors on SBA.gov once you finish the course.
Let’s get started!
1.4
What Is Franchising?
Owning your own franchise can be a great way to start a small business without taking on the
risks that are associated with starting from scratch.
A franchise is a license to use the name, trademarks, and proprietary products of an existing
company. Owning a franchise allows you to distribute the company’s products as well as to use
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TRANSCRIPT – Introduction to Franchising
their business systems. These may include national marketing, accounting, point-of-sales
information, site selection, and site acquisition.
In exchange for these rights and services, the franchisor receives an upfront fee for the rights to a
geographic area, as well as royalties based on sales.
1.5
Types of Franchises
There are two primary forms of franchising: product/trade name franchising and business format
franchising.
In product /trade name franchising, a franchisor owns the right to the name or trademark and
sells that right to a franchisee. This is most often seen in the soft drink or automotive industry,
where a product is sold or distributed through a franchisee.
Business format franchising is when the franchisor and franchisee have an ongoing relationship,
and the franchisor provides a full range of services, including site selection, training, product
supply, marketing plans, and even assistance in obtaining financing.
1.6
The Pros and Cons of Owning of a Franchise
In order to determine whether franchising is right for you, you must first evaluate the pros and
cons.
A good franchise offers site selection assistance, training, purchasing power, marketing plan,
brand recognition, and financing.
The cons of owning a franchise include the lack of control of certain business decisions, such as
marketing and product offerings; the length of contracts; and the cost of exiting the franchise.
1.7
Investigating Your Options
There are approximately 3,000 different franchise companies operating in 80 different industries.
So how do you know which company is right for you? The answer is Market Research.
Franchise opportunities can be identified through Internet research, in magazines such as
Entrepreneur, Success, and Inc., or in various trade journals such as the Franchising World, Wall
Street Journal and USA Today.
You can also reach out to franchisors to help you during this process.
1.8
Research the Franchisor
Once you have conducted market research and decided on a business that you are interested in,
the next step is to research the franchisor. You risk losing a significant amount of money if you
do not investigate a business carefully before you buy.
By law, franchise sellers must disclose certain information about their business to potential
buyers. Make sure you get all the information you need first, before entering into this form of
business.
Consider the following questions during your research:
1. How long has the franchisor been in the industry?
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TRANSCRIPT – Introduction to Franchising
2. How many are currently operating in your area?
3. What is the financial health of the franchisor?
4. Are there any current or pending legal issues faced by the franchisor?
Take the time to talk to other franchisees to get a first-hand account of their experience with the
franchisor.
1.9
Franchise Package
During your research, you will also want to take a detailed look at the franchise package to see
what is included.
Are there are licensing or other fees?
Is a land and/or building purchase or lease required?
What equipment is needed and/or provided?
How long is the contract?
What training is provided?
What level of inventory is needed to get started?
What other costs will need to be paid to the franchisor? Royalties, advertising, insurance?
1.10 The Franchise Disclosure Document (FDD)
Once you identify a company that you are curious about, the next step is to request and read
thoroughly the Franchise Disclosure Document, or FDD. The FDD defines what the franchisor
will do for you and what is expected of you. Each franchisor is legally required to provide this
document to potential franchisees.
There are 23 important sections to the FDD.
Sections 1 through 4 contain information pertaining to the history of the franchisor
company, their business experience, litigation, and bankruptcy details (if applicable).
Sections 5 through 10 outline the fees associated with the franchise, such as initial
investment costs, royalties, advertising fees, and all financial arrangements, including
restrictions as to sources of products and services.
Sections 11 through 19 detail the franchisee’s obligations and provisions in the
agreement. These are very important, as they define what restrictions there are on
products that can be sold, transfer assignments, terminations, and dispute resolutions.
This section also includes information about advertising, computer systems, and training.
Sections 20 through 23 provide a list of existing franchisees, those that are active and
those that have left the company. They also provide financial statements of the franchisor
and copies of contracts used in connection with the franchise offering, including the
Franchise Agreement.
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TRANSCRIPT – Introduction to Franchising
1.11 Personal Assessment
Before you decide to invest in a franchise, you should first ask yourself a few important
questions relating to your personal ambitions, goals, and needs.
Consider the following questions:
What is your experience level?
What are your abilities?
What is your education level?
What are your goals?
What is your financial situation?
Do you know how much you can invest?
Remember, this is about you. Focus on the best possible company that will be able to meet all of
your needs.
1.12 Advice and Counseling
During this process you should also consider seeking advice from franchise consultants,
franchise attorneys, accountants, and other business experts.
The primary goal of the franchise consultant is to match the needs, skill sets, and business
objectives of the prospective franchisee with the right franchise and franchisor. A
franchise consultant also helps guide the research process and can offer advice on
financing options.
A franchise attorney will help you review the lease agreement and the incorporation
documents, as well as providing relevant legal advice.
The franchise accountant will help you by reviewing the franchisor’s financials.
A reliable lender will help secure the financing that best fits your business model.
And a professional site locator is valuable in selecting and securing the right site for your
franchise.
It is important to find organizations and individuals that can guide you every step of the way
during your research before you decide to purchase a franchise. Networking with other business
owners, Chambers of Commerce, and friends are some approaches to finding help.
1.13 Summary
Now that we’ve covered the basics of franchising, you should be able to:
Define franchising and the types of franchises
Explain the pros and cons of owning a franchise
Discuss the components of a Franchise Disclosure Document
Identify resources to assist you in franchising a business
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TRANSCRIPT – Introduction to Franchising
1.14 Next Steps
If you are serious about franchising a business, consider taking the following steps:
Step 1: Be a Detective. In addition to the routine investigation that should be conducted
prior to any business purchase, contact other franchisees before deciding to invest. You
can obtain a Uniform Franchise Offering Circular (UFOC), which contains vital details
about the franchise’s legal, financial, and personnel history, before you sign a contract.
Step 2: Know What You are Getting Into. Before entering into any contract as a
franchisee, you should make sure that you would have the right to use the franchise name
and trademark, receive training and management assistance from the franchisor, use the
franchisor’s expertise in marketing, advertising, facility design, layouts, displays, and
fixtures, and do business in an area protected from other competing franchisees.
Step 3: Seek Professional Help. The tax rules surrounding franchises are often complex,
and an attorney, preferably a specialist in franchise law, should assist you in evaluating
the franchise package and tax considerations. An accountant may be needed to determine
the full costs of purchasing and operating the business, as well as to assess the potential
profit to the franchisee.
1.15 Resources
SBA has a broad network of skilled counselors and business development specialists. Below is a
short description of our resource partners:
Small Business Development Centers (SBDCs) are associated with institutions of higher
education – universities, colleges, and community colleges. More than 900 SBDCs offer
no-cost, extensive, one-on-one, long-term professional business advising, low-cost
training, and other specialized services such as procurement, manufacturing, and
technology assistance, which are critical to small business growth.
SCORE offers free, confidential small business advice from successful entrepreneurs.
SCORE is a nationwide program and boasts more than 12,000 volunteers to give you
guidance to grow your business.
Women’s Business Centers (WBCs) provide free management and technical assistance to
help women and men start and grow small businesses. There are over 100 WBCs located
throughout the U.S. and Puerto Rico.
SBA’s 84 District and Branch offices connect entrepreneurs to resources, products, and
services that can help them start, manage, and grow their business. These offices are
located in all 50 states, Puerto Rico, the U.S. Virgin Islands, and Guam.
The SBA Learning Center is an online portal that hosts a variety of self-paced online
training courses, quick videos, web chats, and more to help small business owners
explore and learn about the many aspects of business ownership. Content is filtered by
topic, so no matter what the stage of your business, or the kind of insight you need, you
can quickly get answers.
Find your local resource using our handy ZIP-code tool by visiting www dot SBA dot gov slash
local assistance.
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TRANSCRIPT – Introduction to Franchising
1.16 Have a Question?
Call SBA at 1-800 U ASK SBA (1-800 827-5722)
E-mail SBA at answerdesk@sba.gov
Locate a SCORE counselor, SBA District Office near you, or an SBDC office near you at
www.sba.gov/local-assistance
To provide feedback, comments, or suggestions for other SBA online content, please
email: learning@sba.gov
1.17 Certificate
Congratulations on completing this course. We hope it was helpful and provided a good working
knowledge of franchising. Click the certificate to receive a course completion confirmation from
the U.S. Small Business Administration.
Page 6 of 6
CHECKLIST
BASIC FRANCHISE AGREEMENT TERMS
One of the most popular way to start your own company is through a franchise; a business organization in
which a well-known firm with a successful product or service – the franchisor – enters into a contractual
relationship with another business – the franchisee – that operates under the franchisor’s name in exchange
for a fee. Franchise agreements vary from franchise to franchise so it would be impossible to identify every
term and issue that should be considered in all situations. The checklist should be used in conjunction with
the franchise agreement – the document that will set out all the terms and conditions that will govern your
ownership of the franchise – which will be drafted by the franchisor. In any event, you shouldn’t sign it until
you’ve discussed your options with your attorney.
Issues relating to the franchise cost terms
❑ What is the initial franchise fee? Is any part or the entire initial fee refundable?
❑ Does it include an ‘’opening” inventory of products and supplies?
❑ What are the payment terms: amount, time of payment, lump sum or installment, financing
arrangements, etc.?
❑ Does the franchisor offer any financing, or offer help in finding financing?
❑ Are there any deferred balances? If so, who finances and at what interest rate?
❑ Does the contract clearly distinguish between “total cost” and “initial fee,” “initial cash required,”
or “initial costs,” etc.?
❑ Are there periodic royalties? If so, how much are they and how are they determined?
❑ How and when are sales and royalties reported, and how are royalties paid?
❑ If royalty payments are in whole or part payment for services by the franchisor, what services will
be provided?
❑ Are accounting/bookkeeping services included or available?
❑ How are advertising and promotion costs divided?
❑ Is a specified amount of working capital required of the franchisee to cover operating costs until
profits can be made?
❑ Must premises be purchased or rented, and are there further conditions on either of these (from
franchisor, selected site, etc.)?
❑ How and by whom will the building be financed, if purchased?
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❑ Does the franchisee have to make a down payment for construction and/or equipment?
Issues relating to the franchise location terms
❑ Does the franchise apply to a specific geographical area? If so, are the boundaries clearly
defined?
❑ Who has the right to select the site?
❑ Will other franchisees be permitted to compete in the same area, now or later?
❑ Is the territory an exclusive one, and is it permanent or subject to reduction or modification under
certain conditions?
❑ Does the franchisee have a first refusal option as to any additional franchises in the original
territory if it is not exclusive?
❑ Does the franchisee have a contractual right to the franchisor’s latest products or innovations? If
so, at what cost?
❑ Will the franchisee have the right to use his own property and/or buildings? If not, will the
franchisor sell or lease his property to the franchisee?
❑ Who is responsible for obtaining zoning variances, if required?
Issues relating to the buildings, equipment and supplies terms
❑ Are plans and specifications of the building determined by the franchisor? If so, does this control
extend to selection of contractor and supervision of construction?
❑ Are there any restrictions on remodeling or redecorating?
❑ Must equipment or supplies be purchased from the franchisor or approved supplier, or is the
franchisee free to make his own purchases?
❑ When the franchisee must buy from the franchisor, are sales considered on consignment? Or will
they be financed and, if so, under what terms?
❑ Does the agreement provide for continuing supply and payment of inventory (by whom, under
what terms, etc.)?
❑ Does the franchise agreement bind the franchisee to a minimum purchase quota?
❑ What controls are spelled out concerning facility appearance, equipment, fixture and furnishings,
and maintenance or replacement of the same? Is there any limitation on expenditures involved in
any of these?
❑ Does the franchisor have a group insurance plan? If not, what coverage will be required, at what
limits and costs? Does the franchisor require that it be named as an insured party in the
franchisee liability coverage?
Issues relating to the operating practices terms
❑ Must the franchisee participate personally in conducting the business? If so, to what extent and
under what specific conditions?
❑ What degree of control does the franchisor have over franchise operations, particularly in
maintaining franchise identity and product quality?
❑ What continuing management aid, training and assistance will be provided by the franchisor, and
are these covered by the service or royalty fee?
❑ Will advertising be local or national and what will be the cost-sharing arrangement, if any, in either
case?
❑ If local advertising is left to the franchisee, does the franchisor exercise any control over such
campaigns or share any costs?
❑ Does the franchisor provide various promotional materials point-of-purchase, mail programs, etc.
and at what cost?
❑ What are bookkeeping, accounting and reporting requirements, and who pays for what?
❑ Are sales or service quotas established? If so, what are the penalties for not meeting them?
❑ Are operating hours and days set forth in the franchise contract?
❑ Are there any limits as to what is or can be sold?
❑ Does the franchisor arrange for mass purchasing and is it mandatory for the franchisee to be a
participant buyer?
❑ Who establishes hiring procedures initially and through the franchise term?
Issues relating to termination and renewal terms
❑ Does the franchisor have absolute privilege of terminating the franchise agreement if certain
conditions have not been met, either during the term or at the end?
❑ Does the franchise agreement spell out the terms under which the franchisor may repurchase the
business?
❑ Does the franchisor have an option or duty to buy any or all of the franchisee’s equipment,
furnishings, inventory, or other assets in the event the franchise is terminated for good cause, by
either party?
❑ If the preceding situation occurs, how are purchase terms determined?
❑ Is there provision for independent appraisal? Is any weight given to good will or franchisee equity
in the business?
❑ Does the original agreement include a clause that the repurchase price paid by the franchisor
should not exceed the original franchise fee? If so, this eliminates any compensation for good will
or equity.
❑ Under what conditions (illness, etc.) can the franchisee terminate the franchise? In such cases,
do termination obligations differ?
❑ Is the franchisee restricted from engaging in a similar business after termination? If so, for how
many years?
❑ If there is a lease, does it coincide with the franchise term?
❑ Does the contract provide sufficient time for amortization of capital payments?
❑ Has the franchisor, as required, provided for return of trademarks, trade names, and other
identification symbols and for the removal of all signs bearing the franchisor’s name and
trademarks?
Other points to consider
❑ Can the franchisee sell the franchised business and assign the franchise agreement to the
buyer?
❑ Is the franchise assignable to heirs, or may it be sold by the franchisee’s estate on death or
disability?
❑ Does the lease permit assignment to any permitted assignee of the franchisee?
❑ How long has the franchisor conducted business in its industry, and how long has it granted
franchises?
❑ How many franchises and company-owned outlets are claimed, and can they be verified?
❑ If there is a trade name of a well-known person involved in the franchise, is he active, does he
have any financial interest; does he receive compensation for work or solely for use of his name,
etc.?
❑ Are all trademarks, trade names, or other marks fully identifiable and distinct, and are they clear
of any possible interference or cancellation owing to any pending litigation?
❑ What is the duration of any patent or copyright material to the franchise? If time is limited, does
the franchisor intend to renew, and is this spelled out in the franchise agreement?
❑ Has the franchisor met all law requirements (registration, escrow or bonding requirements, etc.), if
applicable?
❑ Are there laws governing franchisor/franchisee relationships, including contract provisions,
financing arrangements and terminations? If so, does the contract meet all requirements?
