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Setting up a franchise scheme

11 May 2006
Setting up a franchise scheme

The problem
Your successful pizzeria has a distinctive atmosphere which has proved popular. You would like to open a few more but do not have enough of your own working capital, and are worried about taking on large bank borrowings. You've heard that franchising might be the answer. What do you need to think about?

The law A franchise agreement is a kind of licensing agreement by which the franchisor allows someone else to operate a business using its name and knowhow but retains sufficient control over the franchisee to prevent it from running in a way which damages the reputation of the franchisor and other franchisees.

Franchising is less regulated in the UK than in other countries, which ought to mean that there are fewer legal pitfalls. However, franchisors still need to be wary of diverse areas of law, including the law relating to intellectual property, competition, property and contract.

If your franchising plan will involve more than one layer (for example, by appointing franchisors for specific parts of the country who then sub-franchise), you will be subject to greater regulation under the trade schemes legislation, although you may be exempt if all the franchisors and franchisees are VAT-registered.

While you may want the same prices throughout your franchise network, franchisors and their franchisees must avoid price fixing. A franchisor must not set minimum prices for its franchisees, whether in a contract or by informal practices and discussions.

Expert advice

  • Before selling any franchises, carry out a pilot operation to test how "franchisable" your enterprise is. This ought to run for at least a year.
  • The pilot project will identify problem areas and give some substance to what you may tell potential franchisees about the prospects for their franchises.
  • You will need to create a franchise manual and put all the nitty-gritty of how to run your business into it. Such manuals often run to many hundreds of pages and, although there are professional manual writers to help, you know your own business best so you are probably the best person to write it. If you do not write the manual yourself, make sure you own the copyright.
  • It is usual to charge franchisees an initial fee, which should cover start-up costs. This allows you to expand your business using the funding from the franchisee and its lenders, so they bear the greater financial risk in their operation. This is one aspect which makes franchising an attractive way to expand your business.
  • It is also usual to charge ongoing licensing fees, payable on a monthly or weekly basis, to cover marketing costs, training and assistance. These fees can be a fixed amount or, more usually, a percentage of turnover.
  • If a franchisee fails, you may become liable for rent arrears on their property if you take a lease and then grant a sublease to the franchisee.
  • If you supply your own branded products to your franchisees, you may benefit from economies of scale as your network expands.
  • Some franchisors join the British Franchising Association, which operates according to a code of ethics, designed both to protect and to give confidence to potential franchisees. It is also a source of advice.

Check list

  • Not all businesses are franchisable. You need to have a strong brand and a well developed business model which you can teach others to follow. Franchising is often used in retail businesses, although it can be adapted.
  • Remember that, as a franchisor, your business will change from being an operator to being a mentor and trainer of other people.
  • Your franchise agreement ought to ensure that:

    You retain ownership of your brand and intellectual property, and business knowhow.

    You can terminate the franchise if the franchisee acts in a way that damages your brand.

    You retain control over how the franchisee operates the business.

    There are clear provisions relating to the sale of the franchise by the franchisee, giving you the power to approve a new franchisee.

Beware! Don't make extravagant statements to franchisees about the potential of the franchise, as this could result in a claim for misrepresentation, which could render you liable for damages. You should take specific professional advice before setting up a franchising operation.

ContactsDavid Morrison
Rooks Rider
020 7689 7000
dmorrison@rooksrider.co.uk

British Franchising Association 01491 578050 www.british-franchise.org
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