Fran­chis­ing: gaining in­de­pen­dence through part­ner­ship

You are a committed young en­tre­pre­neur and have a burning desire to start your own business. However, you don’t have a concrete business idea, you lack sales ex­pe­ri­ence, or maybe the market entry barriers are just too big. There are also plenty of “big players” who have already somehow managed it. These suc­cess­ful busi­ness­es already have a func­tion­ing business concept, harbor in­flu­en­tial re­la­tion­ships, and have the necessary capital. How tempting would it be to just get involved in a business that is already suc­cess­ful without having to give up your appetite for in­de­pen­dence? Fran­chis­ing might just be the right choice for you. Here, we explain how it works.

The French term “franchise” refers to granting certain priv­i­leges to others. After several changes in meaning through­out history, this term now primarily refers to priv­i­leges of an economic nature. “Fran­chis­ing,” also called “con­ces­sion purchase”, is in this sense a form of dis­tri­b­u­tion based on a part­ner­ship between two parties: the fran­chisor who sells the rights to use their brand (i.e. brand name, logo, design, business idea, and dis­tri­b­u­tion rights to products and services), and the fran­chisee who receives these trans­ferred rights. This part­ner­ship forms a “franchise system.” Due to the division of labor and synergies, both par­tic­i­pants usually benefit from fran­chis­ing, creating a win-win situation.

Due to in­creas­ing market entry barriers (es­pe­cial­ly with regard to financing), it is becoming in­creas­ing­ly difficult for committed young en­tre­pre­neurs to set up their own companies. The need to be a self-employed all-round talent in all things related to creating a business (business, financial, and legal aspects) is already nipping many en­tre­pre­neur­ial spirits in the bud.

If this effort also makes you shy away from setting up a business, then fran­chis­ing could be an in­ter­est­ing al­ter­na­tive. By in­te­grat­ing yourself into an already-es­tab­lished business model, a large part of the or­ga­ni­za­tion is taken care of for you. This allows you to enter the market much quicker and easier than if you were self-employed outside a franchise system. Your fran­chisor’s ex­pe­ri­ence and resources reduce the risks of setting up a franchise – and can also protect you from common mistakes made by many beginners. Nev­er­the­less, you remain legally in­de­pen­dent at all times – you alone are re­spon­si­ble for your business.

A fran­chisor is usually driven by mo­ti­va­tion to further expand their business ac­tiv­i­ties and advance their company eco­nom­i­cal­ly. Fran­chis­ing offers them the op­por­tu­ni­ty to expand quickly into new markets without having to set up and manage their own branch systems. Fran­chis­ing is therefore also regarded as an efficient, low risk form of in­ter­na­tion­al­iza­tion for good reason. A stronger effort to spread the brand brings added value to the customer, while the company becomes more at­trac­tive to regional suppliers at the same time. In this way, profits can be increased in the long term.

Fran­chisors see their fran­chisees as strong allies. In contrast to employees, they are demon­stra­bly more motivated, work harder, and often have local re­la­tion­ships and knowledge. The proximity of fran­chisees to regional markets also allows the fran­chisors to react quickly and flexibly to the needs of end consumers and to con­tin­u­ous­ly adapt and further develop the business model.

Franchise systems are becoming in­creas­ing­ly popular as a counter-model to tra­di­tion­al forms of dis­tri­b­u­tion and are often also competing with larger cor­po­ra­tions. They can be found in a broad range of in­dus­tries: retail (The Body Shop), education (Sylvan Learning), and real estate (Engel & Völkers), while some opticians (Pearle Vision) and fitness studios (Or­angeth­e­o­ry Fitness) work together with in­de­pen­dent company founders.

The franchise sector is becoming more and more important globally. Most of them belong to the service sector (tutoring, sports programs, car rental, and cleaning services) followed by retail trade and crafts. Fran­chis­ing is also wide­spread in catering and food services – the most well-known fran­chisor in this sector is certainly the fast food giant McDonalds.

There are three different types of com­mer­cial franchise systems:

• Product fran­chis­ing is when there is just one specific product or product group sold by the fran­chisee (e.g. Coca Cola)
• Service fran­chis­ing is where the part­ner­ship agreement relates to a par­tic­u­lar service (e.g. Subway)
• Wholesale fran­chis­ing is where the man­u­fac­tur­er supplies a whole­saler with material, equipment, and know-how to complete a product and pass it on to the retail trade for dis­tri­b­u­tion (e.g. Home Depot)

The franchise approach is also in­creas­ing­ly being adapted in social projects. This “social fran­chis­ing” transfers the concept, which is in fact highly com­mer­cial, into the non-profit or­ga­ni­za­tion area. This is not about expanding a business, but instead about the (in­ter­na­tion­al) dis­sem­i­na­tion of a social idea or a char­i­ta­ble project. Franchise donors in this case are, for example, foun­da­tions or non-profit as­so­ci­a­tions that have already achieved a certain degree of awareness.

The franchise systems they set up work in a similar way to their economic equiv­a­lents. First, fran­chisees are con­tract­ed, receive a manual with in­struc­tions, and are trained in their future ac­tiv­i­ties. As a rule, no fees are charged, but the fran­chisor has access to valuable data records that can help with the further de­vel­op­ment of the project.

Basically, every company founder can set up their own business as a fran­chisee. Before choosing to, however, you should first really consider whether or not this dis­tri­b­u­tion system is really appealing to you. While working with an es­tab­lished company will take some work off your hands, you still need to fulfil a number of tasks and re­quire­ments before you can of­fi­cial­ly open your franchise.

When you begin, you need to choose what kind of franchise system suits you. If you want to save yourself the hassle of searching online, you can try out this portal to assist you.

You can search for op­por­tu­ni­ties using filters like industry, low cost fran­chis­es, or new fran­chis­es. Detailed profiles of each company provides you with a de­scrip­tion of the en­ter­prise, as well as in­for­ma­tion about the year of es­tab­lish­ment, the history of the business, and the entrance fee as well as current fees and net worth required.

Ad­di­tion­al research is of course, in­valu­able, when it comes to selecting a franchise to invest in. News and press releases are a rich source of in­for­ma­tion. During your selection process, you should consider the following questions:

• How con­vinc­ing and future-oriented is the business concept?
• Are in­no­v­a­tive/risks or proven/outdates products and services on offer?
• What about the rate of growth of the company?
• What is the current market situation in the industry like?
• How strong is the com­pe­ti­tion?
• How many fran­chisees are there?
• What is the fluc­tu­a­tion rate among fran­chisees?
• How are the fran­chis­es ge­o­graph­i­cal­ly dis­trib­uted?
• Has there been any negative publicity or scandal recently?

If you are in­ter­est­ed in a franchise system, you can request in­for­ma­tion through the Franchise Direct website. You can then apply for a franchise, and if you’re lucky, be called in to interview or receive a follow-up phone call. Be sure that the in­for­ma­tion you receive is truthful, com­pre­hen­si­ble, complete, and ver­i­fi­able. You may also be offered a chance to sit in on another branch so that you get an idea of how the business is run.

The details of a franchise part­ner­ship are outlined in a franchise agreement. This agreement regulates, among other things, a specific co­op­er­a­tion period, all im­ple­men­ta­tion re­quire­ments, as well as the legally compliant transfer of usage rights and licenses.

Special attention should be paid to the fees charged by the fran­chisor in order to amortize the capital invested in you and ul­ti­mate­ly generate profits. This includes:

• The entry fee com­pen­sates (at least partly) for the costs incurred by the fran­chisor in de­vel­op­ing and im­ple­ment­ing their franchise system. It is also used to cover part of the opening and operating costs for your franchise. In the case of smaller busi­ness­es, $5,000-15,000 is a common sum, but for larger busi­ness­es in­vest­ment sums can be $100,000 or more.
• The fran­chisor collects franchise fees, also known as ongoing fees, as a fixed per­cent­age of your net revenue on a monthly or quarterly basis. This usually ranges from between 5-10%.
• In addition to the entry fee and ongoing fees, some franchise contracts also charge ad­ver­tis­ing fees to finance and implement ad­ver­tis­ing materials and marketing campaigns.

The majority of fran­chisors also set a minimum amount for the equity capital you need to be able to raise when setting up your franchise business. While this can vary greatly, most fran­chis­es in the USA require between $50,000-200,000. If there is no concrete amount specified, a ratio of 20:80 from equity and debt capital is rec­om­mend­ed for financing. By using your own funds, you aren’t just proving your own cred­it­wor­thi­ness, but you are also signaling to your fran­chisor that you are willing to take risks and have con­fi­dence in the business idea.

Overall, a good franchise system presents you with fewer financial hurdles than other forms of self-em­ploy­ment. If financing is still a problem, there are a number of ways you can get access to external capital:

• Since franchise systems are tried and tested concepts, you generally have a better chance of obtaining loans and other financial support than for a solo self-employed project.
• If this argument is not enough, you can also refer to the fran­chisor’s rep­u­ta­tion when making your case to the bank. As a rule, the fran­chisor can provide you with documents, data, and com­par­a­tive figures that will strength­en your ne­go­ti­at­ing position.
• Although it might require more effort (and sometimes luck), you can undergo a personal search for investors or make a call for crowd­fund­ing. 
• In addition, there are public pro­mo­tion­al programs for fran­chis­ing offered by most banks.

Within the part­ner­ship, the fran­chisor doesn’t just determine the rules, they also act as a “mentor” of sorts for the fran­chisee with their extensive business ex­pe­ri­ence. The fran­chisor fulfils this role by offering (before the contract is signed) struc­tured training and/or further education, which gives you the necessary know-how to operate your franchise. In addition, you will usually receive a com­pre­hen­sive manual de­scrib­ing in detail how to run your franchise.

Strict guide­lines for man­age­ment, personnel policy, marketing, sales, con­trol­ling, book­keep­ing, and reporting are intended to achieve a uniform ap­pear­ance for all franchise op­er­a­tions, since a ho­moge­nous corporate identity increases brand recog­ni­tion value. However, the strong stan­dard­iza­tion of business processes also implies that you have little or no freedom to design your own business or to directly influence the de­vel­op­ment of your core business. If you are striving for “real” in­de­pen­dence, this cir­cum­stance may be a difficult one for you.

Here is a summary of your most important duties:

• Con­sid­er­ing the con­trac­tu­al­ly agreed prin­ci­ples
• Adhering to the corporate identity
• Active co­op­er­a­tion with the fran­chisor
• Reporting regularly and in detail
• Implement ad­ver­tis­ing measures as pre­scribed
• Attend necessary seminars and training courses

What do you get in return for your com­pli­ance? Here is an overview of the benefits you can expect in a good franchise system:

• The guarantee of a func­tion­ing, proven business concept
• Usage rights for the entire corporate identity, as well as dis­tri­b­u­tion rights for products and licenses for services
• Help finding a location for your business
• A local monopoly, also known as ter­ri­to­r­i­al pro­tec­tion, within the franchise system
• Support in setting up and opening your office
• Access to the fran­chisor’s IT systems (e.g. the mer­chan­dise man­age­ment system)
• Support in setting up dis­tri­b­u­tion channels and re­cruit­ing personnel
• A wide range of financial as­sis­tance, like favorable pur­chas­ing con­di­tions (e.g. cost ad­van­tages for office supplies), loans, rent subsidies, graduated fees, supplier and commodity credits, as well as the provision of financing, liquidity, and prof­itabil­i­ty plans to prove el­i­gi­bil­i­ty for funding to banks
• Possible insurance options
• Help with the or­ga­ni­za­tion of an opening campaign, and the provision of ad­ver­tis­ing material and other pro­mo­tion­al ac­tiv­i­ties

Do you yourself have a suc­cess­ful company and are con­sid­er­ing es­tab­lish­ing a franchise system? Then you should first ask yourself the following questions:

• Do I have a clearly defined business idea?
• Is this business idea com­pet­i­tive in the current market en­vi­ron­ment?
• Can I make clear demands of any fran­chisees I might get?
• Do I have enough en­tre­pre­neur­ial ex­pe­ri­ence for this expansion project?
• Do I have secure financing for my project?
• Have I already suc­cess­ful­ly tested my business idea?

The last question, in par­tic­u­lar, should be a re­sound­ing yes. Generally it is necessary for fran­chisors to have at least one, or prefer­ably more func­tion­ing test or pilot companies. These are con­sid­ered suc­cess­ful if they have been in operation for at least one to two years and have been con­tin­u­ous­ly optimized on the basis of the ex­pe­ri­ence gained.

You will need to advertise your franchise dili­gent­ly so that potential fran­chisees can find you. You should take time to create a clear re­quire­ment profile that covers not just vo­ca­tion­al training and en­tre­pre­neur­ial ex­pe­ri­ence, but also financial re­quire­ments and soft skills. Some fran­chisors also hire special re­cruit­ment agencies to meet their need for new sup­port­ers. However, you shouldn’t get frus­trat­ed if the search doesn’t work right away – a rule of thumb says that 100 first attempts never result in a contract.

As soon as you have entered into a part­ner­ship, remember that a fran­chisor also has certain oblig­a­tions and re­spon­si­bil­i­ties towards their con­trac­tu­al partners. A re­la­tion­ship based on mutual trust and seeing eye to eye is par­tic­u­lar­ly em­pha­sized. Trans­paren­cy in decision making is important on both sides.

Im All­ge­meinen bietet das Fran­chis­ing mehr Vorteile als Nachteile für alle Beteiligten. Trotzdem gibt es ein paar Risiken, die es zu beachten gilt. Dazu gehört, dass die Win-win-Situation bei einem Franchise-System stets aus einem Kom­pro­miss entsteht: Der Franchise-Geber kann mithilfe en­gagiert­er Un­ter­stützer sein Business ausweiten, verzichtet dafür aber auf einen Teil seines Umsatzes. Der Franchise-Nehmer wiederum kann für die Ex­is­ten­z­grün­dung auf bereits vorhan­dene Expertise und Ressourcen zurück­greifen, muss sich aber an klare Regeln halten und hat so gut wie keine Möglichkeit, seinen Betrieb oder das Ker­nun­ternehmen mitzugestal­ten.

Fran­chis­ing in the USA is regulated by the US Federal Trade Com­mis­sion (FTC). Rule 436 defines a franchise as a business re­la­tion­ship with en­com­pass­es these three aspects:

• They allow the use of a name or trademark
• They provide “sig­nif­i­cant operating control/as­sis­tance”
• A fran­chisee is required to pay above $500 in the initial six months of the operation (which can cover initial/ad­ver­tis­ing/training/equipment fees, among others)

If a com­mer­cial re­la­tion­ship adheres to this FTC franchise de­f­i­n­i­tion, the fran­chisor is then required to provide any prospec­tive fran­chisee with a Franchise Dis­clo­sure Document (FDD). This is a document which contains up to 23 specific items in a pre­scribed format, as well as any contracts the fran­chisee is required to sign and a copy of the fran­chisors audited financial state­ments, if ap­plic­a­ble. The FDD must be given to the fran­chisee at least two weeks before selling them the franchise, and a completed franchise agreement must be presented to the fran­chisee at least a week before selling them the franchise. You may only claim with certainty in­for­ma­tion included in the FDD with regards to the business. Another important rule is that all fran­chisee ap­pli­cants must be treated equally, i.e. any business ne­go­ti­a­tions you are willing to engage in with one prospec­tive buyer must also be offered to others.

The above reg­u­la­tions are simply those covered by the FTC regarding fran­chis­ing. In addition to federal oversight, a number of in­di­vid­ual states also have their own leg­is­la­tion in place to regulate fran­chis­ing. More in­for­ma­tion on which states have their own fran­chis­ing reg­u­la­tions can be found here. As always, it is best practice to have a legal pro­fes­sion­al look over your documents to ensure you are adhering to both federal and state oblig­a­tions when issuing or pur­chas­ing a franchise.

Ein beson­deres Risiko birgt außerdem die enge Verbindung der beiden Parteien: Fällt ein einzelner Betrieb negativ auf, kann dies das Image der gesamten Marke beein­trächti­gen; an­der­sherum leidet das Geschäft des Franchise-Nehmers, wenn es zu Problemen bei den Kollegen oder in der Zentrale kommt. Eine un­be­friedi­gende Kaufer­fahrung kann die Meinung eines Kunden gegenüber dem gesamten Un­ternehmen verändern. Zudem ver­bre­it­et sich negative Publicity durch die sozialen Medien und das Internet so schnell wie nie zuvor. Dabei ist nicht gerade hilfreich, dass das Fran­chis­ing in Teilen der Gesellschaft eh einen eher frag­würdi­gen Ruf als „Ausbeuter-Konzept“ oder „Schein­selb­st­ständigkeit“ genießt – zurück­zuführen auf die wenigen schwarzen Schafen in der Branche.

In general, fran­chis­ing offers more ad­van­tages than dis­ad­van­tages for all parties involved. Nev­er­the­less, there are a few risks that need to be con­sid­ered. These include the fact that the win-win situation with a franchise system always arises from a com­pro­mise: with the help of committed sup­port­ers, a fran­chisor can expand their business, but forgo their turnover. The fran­chisee, on the other hand, can draw on existing expertise and resources to set up their business, but also needs to adhere to clear rules and have virtually no op­por­tu­ni­ty to help shape their business or the core company.

Another par­tic­u­lar risk is the close re­la­tion­ship between the two parties: if an in­di­vid­ual business is perceived neg­a­tive­ly, this can affect the image of the entire brand. The fran­chisee’s business suffers if there are problems with col­leagues or at head­quar­ters. An un­sat­is­fac­to­ry buying ex­pe­ri­ence can change a customer’s per­cep­tion of the company as a whole. In addition, negative publicity from social media and the internet is spreading faster than ever before. It’s not par­tic­u­lar­ly helpful that fran­chis­ing enjoys a rather ques­tion­able rep­u­ta­tion in parts of society anyway as an “exploiter concept” or “bogus self-em­ploy­ment” – at­trib­uted to the few black sheep in the industry.

In the following overview, we have once again sum­ma­rized for you the ad­van­tages and dis­ad­van­tages of fran­chis­ing for both fran­chisees and donors:

In recent years, it has become in­creas­ing­ly difficult for committed young en­tre­pre­neurs to overcome the numerous barriers to market entry on the way to setting up a business. Fran­chis­ing can help you to fulfil your dream of economic in­de­pen­dence after all. However, not everyone is made for the role of a fran­chisee: if you not only want to be legally in­de­pen­dent, but also have creative and en­tre­pre­neur­ial freedom in your business design, you will probably be dis­ap­point­ed by the sales model, because you must play according to the rules of the fran­chisor. In this case, the in­di­vid­ual of founding of a company might be the better choice.

If you are still in­ter­est­ed in the concept of a franchise, you should carefully examine your partner company and the con­trac­tu­al basis. Is it a proven business model? Are there already many fran­chisees? Is the re­la­tion­ship between fees and services right? If you can answer these questions with a clear “Yes” after suf­fi­cient prepa­ra­tion and research, chances are good that you will profit fi­nan­cial­ly from fran­chis­ing.

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