Those unfortunate souls who lost their jobs during the most recent downturn in the economy are living proof that the term ‘employment for life’ has become a myth. Of course, the economy moves in cycles and the current downturn will pass by who knows when the next upturn will peter out, to be followed by another downturn and another… There is yet another thing to consider. Even during periods when the economy is strong, mergers, acquisitions and other corporate strategies will be followed by rationalisation drives and jobs will be lost.

Should you consider starting your own business but hesitate at the perceived risks, ask yourself the question. Given the uncertainties of the world economy, what could be riskier than depending on others to keep you employed? Of course, there are risks attached to starting your own business. The free enterprise system can be a harsh task master, but this does not mean that you have to fail. You just have to be extra careful.

Going the Franchise Route

UK Franchise Industry

After assessing your strengths and weaknesses realistically, you need to take some calculated risks. Going the franchise route fits perfectly into this scenario. The slogan ‘Being in business for yourself but not by yourself’ sums up what it is all about. Investing in a franchise allows you to enter entrepreneurship with a safety net. And no, it doesn’t mean that you have to flip burgers for the rest of your life, unless of course you choose to. Opportunities in franchising are no longer limited to quick service restaurants. The list of sectors that have had franchised business established are virtually endless, and can be divided as many times as you’d like to split various sectors. Broadly speaking, the following sectors are represented within the UK franchise industry.

  • Retain
  • Food and beverage
  • Automotive
  • Hotels
  • Business-to-business
  • Cleaning
  • Health and beauty
  • Property maintenance
  • Leisure and travel
  • Printing and signage
  • Lettings and estate agency
  • Distribution

The biggest and most significant hurdle that would-be entrepreneurs encounter is capital or, to be more precise, lack of thereof. Because most franchises are highly formalised, investment levels are relatively high. This is not necessarily a bad thing because customers are more likely to trust a business that is properly resourced. This tends to result in the payback period being shorter than if you run a makeshift operation. There is also a marked willingness among commercial banks to offer franchisees of reputable franchisors preferential access to loans.

What a Franchise Looks Like

Business format franchises can come in all shapes and sizes, and the brands listed above show that these businesses can either be large, consumer-facing retail chains or smaller business operated from home. There are, however, a few similarities across most franchise networks that help define the business as a business format franchise:

  • The use of franchisor’s brand by a franchisee: Whether the brand controlled rigidly, as is the case with the major food and beverage franchises, or the brand is secondary to the community trading name, like in the case with Trussell Trust where franchisees operate as ‘Swindon Foodbank’ with a sub-brand of ‘seeded by the Trussell Trust’. There will be some element of branding provided from the franchisor to the franchisee. Usually, a franchise will control its brand, and ensure that a franchisee’s signage, printed literature and web presence is consistent with the franchise’s brand guidelines.
  • The use of a franchisor’s operating system by a franchisee: A franchise agreement includes passing the systems and processes of the business to the franchisee. Every business format franchise should be systematised to a point where the operations can be defined within an operating manual, which can be passed to anyone to allow them to run the business. The phrase that is often used for this is a ‘turnkey business’. An incoming franchisee should expect to receive an operations manual as part of the package.
  • Payments from the franchisee to the franchisor: In exchange for the brand and systems, there is normally a payment from the franchisee to the franchisor. This will usually be both an initial franchisee fee, together with an ingoing management service fee (MSF). The MSF is often calculated as a percentage of sales; however, in some businesses it is a flat monthly fee. There are often other fees payable, such as a contribution to a central marketing levy, or purchases of centrally supplied goods.
  • Legal agreement between the franchisee and franchisor: Underpinning the above is a legal agreement between the franchisee and franchisor. This usually takes a standard form and is often non-negotiable. A legal agreement will set out the obligations of both the franchisee and franchisor, the payments due to the franchisor and the franchisee, and will set the scene for the ongoing relationship.

10 Important Considerations for a Franchise Business Model

There are 10 important business considerations for a Franchise business model that must be well-thought-out before taking the plunge.

  • Capital is provided by the franchisee since they fund the set-up of the business.
  • Faster growth is possible since there is less cost involved, the company can set up units very quickly.
  • Fewer staff need to be employed by the head office, since many staff will be managed by the franchisees.
  • If provides a wider range and more secure units for products and services.
  • The franchisor is not concerned with the detail of the day-to-day operations of each unit
  • The business benefits from local knowledge and contacts.
  • There is greater protection against the forces of recession.
  • A mature franchise network enables national customers to be services.
  • There is greater return on capital invested by franchisor.
  • The business unit is operated by highly motivated owners, as the franchisees reap the benefits of their own hard work.

Financial Arrangements

The fees that are typically charged in a franchise can be divided into initial fee (or upfront fee) and an ongoing fee, usually described as a management service fee. Most franchised networks also collect a fee that is used to collectively fund the cost of product marketing. In addition, it is the franchisee’s responsibility to fund the setting up of the business and provide the necessary working capital.

1. The Initial Fee

The initial fee is a fixed amount that is almost akin to a joining fee. It is usually payable at the time when the franchise agreement is signed and pays for the assistance with site selection, the establishment of the business, initial training for the franchisee and staff and, in suitable circumstances, access to preferential sources of supply. The actual amount varies greatly, not so must from one network to the other but from one industry sector to another. The reason for this is that the time and effort it takes the franchisor to set up one franchisee in business is affected by the complexity of operating the business.

2. The Management Fee

The management service fee pays for the cost of ongoing support and allows the franchisor to make a profit. In most instances, it is calculated as a percentage of the franchisee’s sales and is payable in arrears, usually within a week or so after the end of the reporting month.

Some franchisors levy a fixed monthly fee but most bona fide franchise practitioners frown upon this practice. It removed the joint risk-taking aspects which should be at the heart of every franchise arrangement. A short-sighted franchisor could recruit large numbers of franchisees then sit back and collect fee income from them without providing any worthwhile assistance in return. In the long run, such an approach would not be sustainable, and the network would surely fail but this self-styled franchisor would still walk away with a sizable sum of money.

Management services can range from 1 per cent to 8 per cent or more. In industry sectors where sales are high but margins relatively low, for example in certain retail operations, 1 percent may be all the franchisee can afford. Volume ensures that the arrangement remains attractive for the franchisor. Higher percentages are common in industry sectors where gross margins are high but sales levels relatively low, for example in plumbing repairs.

3. Marketing Fee

The marketing fee is sometimes referred to as a contribution to the advertising fund. In most instances, it is calculated in the same way as the management services fee, but legitimate exceptions exist. To increase its ability to find major campaigns and plan them well in advance, a network may decide to levy a fixed monthly fee. As long as this money is spent on product advertising and all franchisees in the network benefit equally, this practice is acceptable.

4. Other Fees

Some networks charge other fees, usually in exchange for providing services that go beyond the normal obligations for the franchisor and therefore not covered by the management services fee. An example if an administration service to franchisees. This may offer franchisees genuine benefits, especially if most of the franchised businesses are relatively small and the employment is an administrative assistance would not be justified. Case must be taken to ensure that such practices do not erode the franchisee’s profitability.

Advantages and Disadvantages of Investing in a Franchise

There are some very clear advantages and potential disadvantages of investing in a business franchise:

Advantages of a Franchise:

  • A proven business model and brand
Franchise Business Model

By joining a franchise, you are obtaining the business model and the business plan that has been proven to be successful in the past. In the case of established franchise networks, you might also be purchasing a well-known brand, either locally or nationally. To put this into context, a franchisee of McDonalds could open in almost any town across the UK and have brand recognition locally from day one, unlike an independent fast-food start-up.

A knowledgeable support team

The franchisor will have an obligation to support you in your business, and as a franchisor becomes more mature they tend to employ regional franchise managers to provide hands-on advice and support. Since the franchisor has vested interest in your success, particularly if they receive a percentage-based MSF, they will be motivated to help you develop your business to generate more sales and ultimately make more profit.

Reduced risk

As mentioned earlier, the business model is proven, and the main benefit of this is that, in theory the risk to you as an investor should be lower than investing in a start-up business. This is simply because there is a proven blueprint, which will give you the benefit of the franchisor’s experience in business.

Control over your earning potential

Unlike shareholdings in listed companies and rental properties, you will have a direct input into the performance of your business, whether at an operations level or at a managerial/strategic level.

Disadvantages of a Franchise

Potential reliance on the franchisee

Most business format franchises require a level of input from the franchisee, and hence cannot be deemed true ‘turnkey’ investments. There is therefore the potential risk of you being unable to work, which will affect the return that you will receive from your business. Traditional investments such as shareholdings in listed companies and rental properties will continue to generate a return without your direct input.

Entry costs

A franchise has an entry cost, which is made up of both the franchise fee and the initial working capital, which might appear to be higher than the minimum required investment to start your business, or indeed the minimum required investment to entry to the stock market .

Restrictions to trade and territories

Which trading as a franchise you will be under various obligations that will be set out within the franchise agreement. They will include operations requirements (for example, you may be required to operate at certain times, or restricted to supplying certain products); and also restrictions, particularly if you are given an exclusive territory. These restrictions are generally for the good of the whole network, either from the reputational respective or from a commercial perspective; however, as an independent business owner you would be able to operate without these concerns.

Attributes of a Potential Franchise Owner

Now that we know broadly what a franchise is, and some of the reasons why you should invest in a franchise, we can look at what personality traits can skills are desirable, or indeed essential, in a franchisee.

These attributes are common to all business owners:

  • Self-motivated: you have to be driven and proactive
  • Ambition: you need vision
  • Determination: a full and determined effort is essential
  • Commercial acumen: a good understanding of the basics of business
  • Leadership skills: if the business employs staff you need to be capable of giving clear direction
  • Communication skills: having the ability to positively engage and influence
  • Mental fortitude: able to maintain focus through difficult trading periods as well as the good ones.

Note: When appointing potential franchise owners, a franchisor will look for all the above, plus a number for additional vital attributes. Specifically, candidates will usually be required to demonstrate that they are able to conform.

Franchise Agreements and other Legalities

In a bona fide franchise arrangement, the agreement between the franchisor and franchisee is recorded in a franchise agreement. This is a substantial document that should set out the rights and obligations of both parties. Unlike may other commercial agreements, franchise agreements need to take the interest of both parties into account. This notwithstanding, the franchise agreement will be weighted in favour of the franchisor. This is necessary because the franchisor must have the power to enforce uniformity in the widest sense of the word throughout the network.

Franchise agreements are usually not negotiable. There are at least two valid reasons for this:

  • The success of the network depends on a trust relationship plus enthusiastic cooperation between the franchisor and all franchisees. If one franchisee were to discover that another franchisee was granted more favourable terms, this trust would be destroyed.
  • Mature networks can have hundred of franchisees. If each one of them were given a customised franchise agreement, administration of the network would be an absolute nightmare.

The franchise agreement is a long-term agreement, usually extending over five to seven years; some franchise agreements run for up to 20 years. The franchise agreement will contain a renewal clause in favour of the franchisee. When the original franchise agreement comes to an end, the franchisee will have the right to extent it by a similar period, but this may be subject to certain conditions as set out in the franchise agreement.

The franchise agreement should address what will happen if the franchisee should wish to sell the business. Although the franchisee owns the business, the franchisor will wish to control who becomes a member of the network. It is customary, therefore, that the franchisor reserves the right to veto the sale of the franchise to a person that does not meet the basic admission criteria in force at the time. The sale may also be subject to the incoming franchisee being willing to sign a franchise agreement and undergo training. Should the franchisee die, and no suitable heir is willing to take over, the franchisor will usually operate the business on behalf of the estate until a new franchisee can be found.

Final Words

While franchising has been around in various forms for a long time, it is still a relatively new area to many people. Franchises can be developed in various sectors, and one franchise might be the polar opposite of another. Its not limited to a certain type of business. Franchises can also be established by relatively new businesses, as well as by long established business and normally consists of the licence of a brand, system and a ‘way of doing business’, together with a fee for the rights to those. The franchisor can franchisee are bound together by a legal agreement. For a business if you can find a franchise you are passionate about, and are willing to conform to its operational guidelines and have adequate funding, going the franchising route is the safest wat to take charge of your life and become your own boss. However, not all franchises are created equal and none come with a guarantee. The onus is on you to undertake an in-depth investigation.

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