Franchising

'Franchising' describes some very different business arrangements. It is important to understand exactly what you're being offered.

Business format franchise

Business format franchise is the most common form of franchising. The owner of a business (the franchisor) grants a licence to another person or business (the franchisee) to use their business idea - often in a specific geographical area.

The franchisee sells the franchisor's product or services, trades under the franchisor's trade mark or trade name, and benefits from the franchisor's help and support. In return, the franchisee usually pays an initial fee to the franchisor and then a percentage of the sales revenue.

The franchisee owns the outlet they run. But the franchisor keeps control over how products are marketed and sold and how their business idea is used. Well-known businesses that offer franchises of this kind include Prontaprint, Dyno-Rod and McDonald's.

Other types of arrangement

Different types of sales relationships are also sometimes referred to as franchises. For example:

• Distributorship and dealership- you sell the product but don't usually trade under the franchise name. You have more freedom over how you run the business.
• Agency- you sell goods or services on behalf of the supplier.
• Licensee- you have a licence giving you the right to make and sell the licensor's product. There are usually no extra restrictions on how you run your business.

Multi-level marketing

Some businesses offer franchises that are really multi-level marketing schemes. This is where self-employed distributors sell goods on a manufacturer's behalf. You get commission on any sales you make, and also on sales made by other distributors you recruit.

Be aware that some multi-level marketing schemes may be dishonest or illegal.

There are advantages and disadvantages of buying a franchise:

Advantages

• You can check how successful other franchises are before committing yourself. The business is based upon a proven idea.
• Using a recognised brand name and trade marks.
• The franchisor gives you support - usually including training, help setting up the business and ongoing advice.
• You usually have exclusive rights in your territory. The franchisor won't sell any other franchises in the same territory.
• Financing the business may be easier. Banks are sometimes more likely to lend money to buy a franchise with a good reputation.
• You can benefit from communicating and sharing ideas with, and receiving support from, other franchisees in the network.
• Relationships with suppliers have already been established.

Disadvantages

• Costs may be higher than you expect. You pay continuing management service fees and you may have to agree to buy products from the franchisor.
• The franchise agreement usually includes restrictions on how you can run the business. You might not be able to make changes to suit your local market.
• The franchisor might go out of business.
• Other franchisees could give the brand a bad reputation, so the recruitment process needs to be thorough.
• You may find it difficult to sell your franchise - you can only sell it to someone approved by the franchisor.
• All profits (a percentage of sales) are usually shared with the franchisor.

You need to consider carefully whether you have got the right skills and attitude to run a successful franchise.

This page will help you decide whether franchising is right for you and which type of franchise plays best to your strengths.

Assess yourself

• You must be prepared to sell and you will need entrepreneurial flair. A franchise gives you a business blueprint but it won't automatically give you customers.
• You'll need to work hard, probably for long hours. Do you have the necessary dedication?
• Running your own business can be stressful. Think how you react to pressure.
• You may be starting up in business because you want to be your own boss. Would you be happy with the restrictions imposed by a franchise arrangement?
• You may want to limit your risk. You might be more comfortable with a franchise than starting a new business from scratch.

The right franchise for you

• Do you like office work? Or would you prefer a business that involves physical labour or using a particular skill?
• Are you happy working on your own? Or would you be good at recruiting, training and managing employees?
• Do you like dealing with members of the public? Or would you prefer a franchise where you sell to business customers?
• Are you weak in particular business skills such as finance? Can you find a franchise that offers the support you need in those areas?

To assess if a franchise represents a sound business opportunity, you'll need to consider:

• what the business is and how it operates
• the location of the franchise
• the success of the franchise concept - the number of franchises in the UK, the length of time in business and how financially successful they are
• the amount and strength of competition from other businesses in the same market sector - at local and national level
• any market research that has analysed the public perception of the franchisor's brand
• levels of initial and ongoing costs
• how much training and support you'll get in setting up and running the business
• conditions and restrictions in the franchise agreement, including how long it will run and whether you'll have the option to renew

The franchisor will probably give you an information pack but you should ask questions and look for evidence of their claims.

Before deciding on a franchise it's helpful to visit other franchisees and talk to them. Ask the franchisor for a full list of past and present franchisees, not just the two most successful ones. It is important to visit new and established franchises - of differing levels of success - in as many different locations as possible. This should give you a good idea of the challenges you will face should you decide buy a specific franchise.

Take advantage of other sources of information and advice. Many banks have franchising specialists.

How a business plan can help

A business plan will help you assess the prospects for the business and identify potential weaknesses. It is also essential for raising finance. You should be able to get assistance with your plan from the franchisor. Banks with specialist franchise units can check how realistic your projections are.

When calculating the likely cost of a franchise, you need to take both initial and ongoing fees into account.

Initial costs

The franchisor (the business that sells you the franchise) usually charges an up-front fee. If the franchisor relies mainly on taking a percentage of your sales revenue, rather than on a high initial fee, it is usually a good indication that they have confidence in the value of their product or service.

Your largest initial costs are usually your investment in:

• premises
• equipment
• initial stock

You will need to establish a business entity. Although a franchisee holds a contractual agreement with the franchisor, each franchisee is an independent business. It is this business entity that will enter into the franchise agreement.

Your chosen business structure could be a limited company, partnership or sole trader or your franchisor might have specific requirements. Each business structure will involve different costs

Continuing costs

You usually pay a percentage of the sales revenue to the franchisor by way of a management service fee. Alternatively, you may pay a fixed management fee of some kind.

Under the terms of the franchise agreement, you may have to buy stock from the franchisor. Check what they charge. They may mark up the prices. Or they may be able to offer them to you at a discount because of their buying power.

You also have to pay the usual business costs - for example, rent for premises, utility bills or the costs of any employees you take on. Check if the things that you pay for through the franchisor have a realistic cost.

Check too if the agreement includes additional charges. For example, you may be required to pay for training, or to contribute to the cost of national advertising campaigns.

Think about the following when buying a franchise:

• assess yourself to see if any kind of franchise would suit you
• find out what franchises are available and draw up a shortlist
• assess franchise opportunities carefully, ask questions and talk to other franchisees
• research the business' performance and management figures to assess their financial prospects
• ask your bank if it will consider a loan for the franchise you're considering
• do your own market research into the business and the competitors in your area
• draw up a business plan
• check the franchise agreement and get professional advice

It is advisable that you don't:

• take up the first opportunity before investigating alternatives
• allow yourself to be hurried into making a decision
• commit yourself before you're completely sure
• assume a business will work in your area
• rely on the forecasts provided by the business selling the franchise

The franchise agreement is crucial. Don't sign any agreement, or pay any fees or deposit, until you have taken legal advice from an experienced franchise solicitor accredited by the British Franchise Association. Get a specimen contract for them to review.

Areas covered by a typical agreement:

• the length of the franchise, the terms and renewal options
• the area your franchise covers and whether you have exclusive rights to sell within it
• the initial fee and percentage of sales revenue you will pay
• the amount of help and support you will receive
• any restriction on how you run the business
• selling the franchise

Read our guide Growing a franchise