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Franchising...is it for you?

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If you’re looking to set up your own business, it may be worth considering becoming a franchisee.  In the current economic climate, this may be a path worth exploring, explains Geoffrey Sturgess, a commercial lawyer.

“Business Format Franchising now accounts for approximately £13.5bn of the turnover of UK plc,” begins Geoffrey. “There are around 900 systems operating in theUKand 40,000 franchised units. Those units employ approximately 600,000 people, and 90% are profitable.  These organisations can differ enormously: from McDonalds restaurants requiring initial investments in the hundreds of thousands, to small back bedroom operations that can be set up for under £5,000.”

What these businesses share is the concept of franchising—a company, often with a well-known brand, licensing others to operate under that brand using the, hopefully tried and tested, marketing and business systems of the franchisor and with the benefit of set up and ongoing consultancy from the franchisor.

This, of course, does not come free for the franchisee. Typically he pays a significant sum on entry and then an ongoing management services fee; perhaps 10% of turnover. Potential franchisees should take that into account (and that it is a tax on sales, not profit), as well as the amortisation of the initial franchise fee over the term when creating a business plan for the franchised business.

“The immediate benefits are two fold,” continues Geoffrey.  “Firstly, new franchise businesses are substantially less likely to fail than other small start-ups and, secondly, in recognition of that, the major banks will generally lend a larger proportion of the start up capital than they would otherwise.”

Taking a franchise is not, however, without risk. New franchisor businesses are not immune to failure, and if this happens it will leave the franchisees high and dry. Also, and almost without exception, franchisors require their franchisees to enter into highly onerous franchise agreements. These agreements include clauses such as being tied in for the term, no possibility to resign if the business is making a loss, the franchisor has enormous discretion to change the system halfway through, and although the franchisee is given the “option” to renew at term end (usually five years) that is almost discretionary for the franchisor who can impose a different agreement upon renewal. There is also generally only one guaranteed renewal, so the term ‘maximum’ can be ten years.

Provided that he complies with the procedures manual of the franchisor, the franchisee is his own businessman but, increasingly, franchise agreements include performance clauses allowing substantial management from the centre, and even termination if the financial performance is not as the franchisor would want.

“The agreements are unbalanced,” warns Geoffrey.  “There are extensive and detailed obligations on the part of the franchisee and these are not reflected by the few, vague obligations of the franchisor. In a nutshell franchisees do not win legal arguments with franchisors. For legal purposes franchisees are not ‘consumers’. They have no protection against their own contractual stupidity.”

So, on the down side the franchisee has invested his capital and tied himself in to a long relationship with the franchisor who may try to manage them as if he were an employed branch manager, but without the option of resignation.

On the up side he may have the advantage of a well known brand name, assistance from experts at head office and the ability to build a capital asset (his franchised business) to sell when he wants to retire or do something different. Some franchisees end up with multiple outlets of the same franchise.

“Choosing the franchisor is probably more important than choosing the area of business or trying to negotiate a better agreement, which is rarely achieved”, advises Geoffrey.  “A good, well established, franchisor gives much greater chances of success and is much less likely to abuse the extensive powers given to it by the franchise agreement.”

Good franchisors tend to belong to the British Franchise Association which acts as the guardian of good franchising practice in the UK. Membership is open to franchisors who agree to comply with its code of ethics and can demonstrate that they have a sensible, franchiseable concept and current franchisees. Franchisees of member franchisors can also join.  Those thinking of becoming franchisees should consult its website at www.thebfa.org.

Geoffrey concludes, “Although the franchisee agreement will be stated to be non-negotiable, would-be franchisees should always get it reviewed by a BFA affiliated law firm. They will offer a standard price to provide a standard report along the lines of ‘this is horrible but normal’. If requested they should also be prepared to discuss the whole concept in greater detail and assist with a risk analysis.”

For more information on becoming a franchisor or franchisee, contact Geoffrey or the Warner Goodman Commercial Team on 02380 717717, or visit their website www.warnergoodman.co.uk.

ENDS

This is for information purposes only and is no substitute for, and should not be interpreted as, legal advice.  All content was correct at the time of publishing and we cannot be held responsible for any changes that may invalidate this article.