What is Franchising?

By: Laura Canada Lewis

In simple terms, a franchise is a license agreement from the franchisor to a third-party, the franchisee. The franchisor licenses its trademarks, business know-how, and trade secrets to the franchisee for operation of a uniform business. Famous franchises include McDonald's, 7-Eleven, Re/Max, Great Clips, Twin Peaks, and Anytime Fitness. However, there are also thousands of smaller franchises across the country in many industries, including restaurant concepts, commercial and personal services, entertainment, and event planning.

What is a "franchisor"?

A "franchisor" is the franchising business entity that owns the rights to license its trademarks, trade secrets, and general business know-how. A franchisor is typically the owner of the franchise concept; it then licenses the trademarks and business know-how to third-party independent business owners. For access to proprietary information and business format, franchisors charge their franchisees franchise fees, including an initial fee, and on-going royalty fees and marketing fees.

What is a "franchisee"?

A "franchisee" is a third-party, independent business owner who obtains a license from a franchisor to operate a franchised business. This relationship is governed by a franchise agreement, which is a binding contract that lays out the terms of the franchise relationship, and the rights and obligations of the franchisor and the franchisee to each other.

What is an FDD?

A franchise disclosure document, or FDD, is a federally required disclosure document that most franchisors must provide to potential franchisees. The contents of the FDD are governed by the Franchise Rule, which is enforced by the Federal Trade Commission. In addition, each state has its own rules and regulations which may require certain additional disclosures.

Why is the FDD useful?

The FDD is a very useful document that can be used to get a glimpse of the franchise system. It contains the basic information necessary to determine whether the franchise opportunity is right for you and if doing business with the franchisor is a viable opportunity. It can help you research franchise opportunities, ask better questions, and negotiate a deal that works for you. Additionally, the FDD gives information so that you can contact existing franchisees and speak with them about their experience.

What is a Franchise Agreement?

The franchise agreement creates the contractual relationship between the franchisor and franchisee and lays out the obligations of each party. It establishes the framework for the franchised business relationship, and along with the operations manual, instructs the franchisee on how to adapt the franchisor's business model for his or her local market. While many franchisors claim that they "never make changes to their franchise agreement," a good franchise attorney can often help you negotiate some reasonable terms that are helpful when committing to a long-term business relationship.

"Business in a Box"

Many franchisors sell their franchises as "business in a box," promising to provide you with all the necessary tools, products or services, training, and information to get you running as a turn-key operation. In reality, every franchisee should remember that starting any business — including a franchise — is not easy. While the trademark license, training, and consistent operations are valuable, you still have to put in a lot of hard work, and there are no guarantees that franchising will result in a successful business.

What a Franchise is Not

A franchise is not a multi-level-marketing scheme, pyramid scheme, direct marketing, or any other type of business relationship where a series of third-parties receive a commission for the sale of goods or services. Just like with any business opportunity, there are fraudulent opportunities masquerading as franchises. If you are ever in doubt as to the validity of a franchise opportunity, contact your franchise attorney.

Franchising can be very successful — but all business ventures come with risk. Do your research, and start with a solid legal foundation.