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Apr22019
INDUSTRY

Common Franchising Terms You Need to Know Before You Buy a Franchise

Deciding to buy a franchise location can be both exciting and daunting. There are a lot of factors to consider and decisions to make. For new entrepreneurs considering franchising, even some of the terminology itself may be unfamiliar and confusing. Many industries seem to have their own language, and franchising is no exception.

In the franchising world, the lingo can be overwhelming at times, especially for prospective franchisees conducting early research to compare opportunities across multiple brands. Understanding the commonly used terms below will give you a better grasp of the ins and outs of franchising and help you make an educated and confident decision when choosing the right business for you.

Common Franchise Terms

Franchisor

The parent company that grants individuals the right to operate a business using their trademark, products and processes.

Franchisee

The individual granted the right to operate a business using the franchisor’s name and method of operation.

Feasibility Study

An analysis used to determine the potential success of establishing a franchise location in a specific market or location.

Franchise Agreement

The legal, written contract between the franchisor and franchisee that outlines the responsibilities of each party during the franchise relationship.

Franchise Disclosure Document (FDD)

A legal document that franchisors are required by the Federal Trade Commission to provide prospective franchisees. You’ll want to review this carefully as it provides details about the franchisor, contractual obligations, fees, start-up costs, a listing of current and former franchisees and other required information about the franchise system.

Term of Agreement 

The length of time the franchise agreement is valid, typically anywhere from 5 to 20 years. At the end of the term, the franchisor can offer a renewal, often for a percentage of the then-current franchise fee.

Intellectual Property Terms

Trademark

The marks, brand name and logo representing the franchisor that are licensed for use by the franchisee.

Service Mark

Protected by law like a trademark, service marks distinguish the services a company provides from the services of another.

Copyright 

The right to use and license others to use a piece of work created by the franchisor, such as system manuals or other published materials.

Franchise Types

Business Format Franchise (BFF)

This type of franchise includes licensing for the complete operating methods/system of doing business in addition to the product, service and trademark. It refers to the system of delivery, rather than a specific product or service itself as in a Product Distribution Franchise.

Product Distribution Franchise

This type of franchise includes licensing to sell or distribute a specific product or service only using the franchisor’s trademark, trade name and logo. It does not include the franchisor’s method of conducting business as in a Business Format Franchise.

Franchising Contracts

Single-Unit (Direct Unit) Franchise

The simplest and most common type of franchise agreement. When you buy a franchise using this model, you are licensed to own and operate a single franchise location.

Multi-Unit Franchise

A franchise agreement where a franchisee purchases the rights to open and operate more than one unit, generally in a defined market over a specified period of time.

Company-Owned Location

A location owned and operated by the franchisor, rather than a franchisee.

Master Franchisee

In this arrangement, the franchisee assumes some of the responsibilities of the franchisor within a specified territory. They have the right to sell franchises to other individuals (sub-franchisees) and receive the fees and royalties themselves while also taking on training and support activities.

Area Franchise

A relationship where the franchisee agrees to open a certain number of locations within a defined territory during a specified period of time. These franchisees usually pay an area fee and may open and operate the locations themselves or recruit other franchisees to open them.

Multi-Concept Franchisee

A franchisee that owns and operates franchises from two or more different franchisors. Some brands strictly prohibit this practice while others encourage it.

Fees Associated with Opening a Franchise Business

Start-up Cost/Initial Investment

Also known as an Item 7 disclosure, this is the total amount required to open the franchise. It includes the franchise fee, along with other start-up expenses such as the cost of real estate, leasehold improvements, inventory, equipment, supplies, deposits, other fees and costs, business licenses and working capital.

Franchise Fee

The initial, one-time fee paid by the franchisee to the franchisor for the rights to operate under their name and use their systems. The fee arrangement varies among franchises. Some are a standard flat fee and others vary based on territory size, experience or other factors. In addition, many franchisors offer discounts for Veterans, minorities and current franchisees.

Royalty Fee

In addition to the franchise fee, most franchisors also require franchisees to pay a fee at given intervals of time (weekly, monthly or annually). These regular payments are typically a percentage of gross sales, but they could also be fixed or based on another fee structure.

Advertising Fee

A monthly contribution to a collective pool of funds the franchisor uses to market the brand. The fee is typically calculated as a percentage of gross sales.

Financing Options When Opening a Franchise Business

In-house Financing 

Many franchisors offer financing options to new franchisees to help get their business off the ground. Financing can be used to help cover the initial franchise fee, startup costs, equipment and inventory, as well as day-to-day expenses like payroll.

Third-Party Financing

Financing provided by an organization outside of the franchisor like a bank or specialty financing source. Many franchisors have relationships with banks or are registered with the Small Business Administration. This helps to expedite the loan process for their franchisees.

What to Do Before You Buy a Franchise

Before you buy a franchise, do your homework on the industry and opt for the brand that best aligns with your goals and expectations. Look for an experienced brand with the knowledge and support systems necessary to help franchisees succeed. You should also reach out to current franchisees to learn first-hand about day-to-day operations and what it takes to be successful. Take the time to thoroughly review all aspects of the business to ensure a long and prosperous franchise relationship.