This is a reprint of an article that originally appeared on the Lerman & Szlak web site.
Franchising represents a well-known business method where the franchisor, who had developed a successful business, shares its know-how, brand identity, as well as distribution and marketing strategies with the franchisees. In other words, franchising allows newcomers to utilize a brand’s name, know-how, marketing strategy, and business presence.
Contrary to a popular belief, a franchisee is not “purchasing” a franchise, but rather investing their assets in order to legally utilize a brand’s name, know-how and well-established marketing and distribution plans. The franchisor determines the terms and conditions of their relationships with the franchisees, as well as the interconnectedness, if any, of all the franchisees involved.
As a franchisee, a company chooses to invest in another brand that has made its presence known on the market, in order to capitalize on their experience and success. As a franchisor, a brand offers their continuous support and operating system to other companies in order to reinforce their business presence and conquer the market. As a team, companies involved in the franchising process must define their cooperation clearly, in accordance with legal ramifications.
Today, we delve into the four core legal challenges encountered in franchising.
(1) Designing a Clear Standard Franchise Agreement
A strong franchise company generally utilizes one standard, uniform contract to define relationships with all their franchisees, which attends to all the franchise source concerns.
This way, the franchisor creates a strong, reliable system and achieves consistency across franchisees.
A franchise agreement should clearly indicate the regulations regarding the operations of all the franchisees, including activity restrictions and specific rules. By clearly stating the “dos” and “don’ts” of the agreement, the franchisor can prevent franchisees from taking any rogue actions which could potentially jeopardize the entire system.
Mandatory contractual provisions protect not only the franchisor, its trade methods and well-kept business secrets but the associated franchisees and their businesses, as well. Contracts are generally complemented with franchisee manuals with clear and detailed operational methods, which provide clear standards for franchisees and allow franchisors to identify any deviations rapidly.
(2) Adapting the Agreement to Prevent Conflict
To be able to create a fully functioning channel of resources, the franchisor has to develop more than just a contractual relationship. Franchising is a licensing agreement which allows the franchisor to distribute products and services through the franchisees in the system. In order to manage the network of franchisees, the brand must establish adequate systems of support and monitoring in their activities.
One of the questions surrounding the organization of a network of resources is, which aspects of their business will the franchisor be directly involved in? Also, how will the communication in this chain be managed? The franchisor is responsible for monitoring all the activities surrounding the franchise, advising and directing the franchisees, as well as implementing penalties, but contracts are always more effective when they are designed around the principle of preventing conflict.
To adequately channel the resources entails prohibiting potentially injurious actions, including not choosing the proposed providers and therefore compromising the quality of the product or service; continuing to use the brand even after the contract had been terminated, selling products or providing services that have not been authorized by the licensor, etc.
When the contract takes into account the practical allocation of resources of both parties, it helps minimize and prevent risks. Thereby, the contract helps to avoid conflict situations which can harm the franchisor-franchisee relationship.
It is important to state that, depending on the laws of a country, there may be different legal requirements when it comes to franchising. In addition to these regulations, the licensor (franchisor) applies their own methods in order to ensure that the franchisees are adhering to the proposed business guidelines. Potential situations must be addressed and defined timely in order to avoid non-compliance with activity restrictions.
(3) Implementing the Franchise and Managing Pricing Issues
Providing a franchise is a complex matter which stretches far beyond the regulations and legal matters. When providing a franchise, the franchisor offers much more than just products and services. In fact, a franchise represents an entire system consisting of a wide variety of elements, including methods, strategies, training, brand standards, quality control, and operating manuals.
When it comes to the financial aspect, there are generally two fees determined in a franchise agreement: a one-time initial fee and a continuing fee — commonly referred to as royalty. The initial fee is the cost of entering the franchising process, while royalty is a fee charged for the use of the brand’s name and the entire operating system. Prior to setting the pricing and requesting investments, a brand’s performance, capability, and worth must be evaluated.
In order to implement a successful franchising strategy, the franchisor should make sure that the franchisees are prepared for this enormous step in their business expansion. The preparation process generally entails requiring a business plan from the franchisee which should outline their business path and somewhat determine their “eligibility”.
Franchisors normally decide pricing strategies, and they need to be wise to design pricing strategies that are profitable for both franchisor and franchisee. Otherwise, the franchise will not succeed.
(4) Managing the Relationships with Suppliers and Other Third Parties
Supply chains consist of approved suppliers that have been recognized and thoroughly investigated by the franchisor. Choosing approved supply chains enables the franchisor to closely monitor the quality of the products or services, and set high standards for their franchisees, as well. It is safe to say that forming a strong network of suppliers represents one of the biggest challenges in franchising, considering the fact that the quality determines the consumers’ experience.
In order to set high standards for their franchisees, a brand must have high standards when choosing the suppliers. Some of the conditions the franchisor must take into consideration include the existence of warranty policy, adequate delivery schedule, reasonable payment terms and pricing for franchisees, suppliers’ relationship with the franchisees and the existence of a training program, as well as their willingness to assist the franchisees when it comes to merchandising.
Franchisors, as well as franchisees, engage in an ongoing relationship with suppliers, which makes the choice of the supply chain crucial for the brand’s consistency and prosperity. Besides the selection, it is also the communication and cooperation between the suppliers and the brand that requires a great deal of attention, to protect the franchise and the franchisees.