Franchising

Franchising

Think of well-known franchises such as Subway, McDonald's, and Burger King. Add some companies less readily associated with franchising, such as Europcar, Benetton, and Best Western hotels, and it will probably come as no surprise that UK franchising turnover in 2011 was £13.4 billion, up by 8% over the previous year, well ahead of UKGDP growth of 7%. Over 594,000 jobs were attributable to franchising and approximately 929 active business format franchising systems were in existence with a total of over 40,100 franchised units. "In contrast to a UK-wide rise in unemployment of 180,000 in 2011, a total of 73,000 jobs were created in the franchise industry"

What is a franchise?

A franchise must have the following elements:

  • The franchisor allows the franchisee to use a name which is associated with the franchisor.
  • The franchisor exercises continuing control over the franchisee.
  • The franchisor provides assistance to the franchisee.
  • The franchisee periodically has to make payments to the franchisor.

Setting up a franchise system

A business sets up a franchise operation in, essentially, two circumstances. First, it may have a successful existing business which it wishes to expand and will choose business format franchising to do this. Second, either a newly formed business or an existing business with little or no experience of a proposed area of business activity may decide to enter this business area. The former method is likely to prove more successful than the latter.

As with all new businesses the first step for a prospective franchisor is to prepare a business plan. The form of the business plan for a franchised business will be similar to other businesses, but should contain sections on:

Reasons for franchising

Confirmation that the proposed products or services are susceptible to franchising.

A breakdown of the proposed management structure and an explanation as to its appropriateness to franchising.

Intellectual property rights

Intellectual property rights in a franchising context can have particular significance because a franchisor will have built up a substantial amount of know-how and brand awareness, which it will seek to protect. Patent protection is unlikely to be of significant concern to a franchisor since most franchises will not involve the use or licensing of a patented process. Copyright, which gives protection to original literary and artistic works and which can extend to advertising slogans and trademarks, and registered and unregistered designs, can be significant.

Undoubtedly, trademarks, because of the importance of brand names and image, are of the greatest significance in a franchising context. The criteria for being able to register have been relaxed so that a mark which is capable of distinguishing one trader's products or services from those of another will be registrable. The Trade Marks Act has significantly widened the concept of infringement so that the use of an identical or similar mark on goods or services similar to those of another's mark can give rise to an action for infringement.

CRC Energy Efficiency Scheme

On 1 April 2010, the CRC Energy Efficiency Scheme (CRC) came into force. The CRC is a new UK-wide mandatory emissions trading scheme, created by the CRC Energy Efficiency Scheme Order 2010 (Order), which was introduced under the Climate Change Act 2008.

The purpose of the CRC is to make organisations more energy efficient and reduce their CO2 emissions. Under the CRC, organisations that meet the relevant qualification criteria have to report on CO2 emissions associated with their energy use and buy enough allowances to cover the amount they have emitted.

Franchise agreements

The CRC will apply to commercial agreements between two separate undertakings (that is, a company, partnership, LLP or unincorporated association) which fall within the definition of "franchise agreement" in the Order.

Under the Order, a franchise agreement is where one undertaking (the franchisor) enters into an agreement with another undertaking (the franchisee), not in the same corporate group, under which:

  • the franchisee carries on a business activity selling or distributing goods or providing services;
  • the franchisee carries out the franchise business using a name provided for by the franchisor;
  • the franchisee carries out the franchise business in premises which are used exclusively for that franchise business; and
  • the premises have an internal or external appearance agreed by the franchisor and the appearance is similar to that of other premises in respect of which the franchisor has entered into a franchise agreement.

All of these requirements must be present for a supply agreement to be defined as a franchise agreement under the CRC.

Franchising: advantages and disadvantages: franchisee

Advantages

Research suggests that as many as 50% of franchisees would not otherwise become self-employed were it not for the franchise format.

Franchisees do not have to have general business or management skills, or specialised knowledge in the proposed business activity.

By taking advantage of the franchisor's name and reputation the lead time in making a business successful may be reduced. This reduces the franchisee's working capital requirements.

Finance may be more readily available to franchisees than those setting up in business on their own account. All the clearing banks have their own franchise departments. Gearing of 1:1 between a business's own financial resources and bank borrowings may be relaxed in a franchising context so that banks may be prepared to accept a gearing of 1:2 or even 1:3 for well established franchises.

The risks of business failure are substantially reduced.

The franchisee is able to make use of the franchisor's purchasing power and there may be other benefits relating to the size of the franchisor's operation.

National advertising is undertaken by the franchisor for the benefit of the franchisee.

Assistance and training is given throughout the term of the franchise.

Disadvantages

A franchisee is subject to substantial control from the franchisor. (No restrictions would, in theory at least, be placed on the franchisee were he to set up in business independently.)

A franchisee will have to pay royalties and/or a mark-up on the goods or services which he receives from the franchisor or his nominated supplier.

There may be restrictions on the franchisee's ability to sell the franchised business or to pass it on to a relative.

The franchisee's operation will be directly affected by the actions or insolvency of the franchisor.

To discuss franchising further, contact us at commercial@berrysmith.com or on 029 2034 5511.

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