franchising

Franchising is a sophisticated form of licensing in terms of which the franchisor licenses its intellectual property including its trade marks, trade dress, copyright, know-how, trade secrets, business concept, methodologies and if relevant designs and patents to the franchisee.

The South African Franchising Association has published a practical definition of a franchise which reads as follows:

A franchise is a grant by the franchisor to the franchisee, entitling the latter to the use of a complete business package containing all the elements necessary to establish a previously untrained person in the franchised business, to enable him or her to run it on an ongoing basis, according to guidelines supplied, efficiently and profitably.

what you should know

At one time or another in our lives we all want to own our own business. For many of us, taking that giant leap towards total independence is very frightening. However, buying a franchise is a very lucrative option where you, as the franchisee, are provided with the established name of the company, i.e. its well known trade mark and backing in the form of advertising, uniforms, the location, the equipment, etc.

These usually have a large price tag attached which, with a lot of hard work, you will recoup your initial capital outlay.

Many South Africans are jumping on the bandwagon of buying franchises without being fully aware of the potential dangers of doing so.

Before even contemplating buying a franchise, consider the following:

• Does the company have a well-established trade mark that the general public clearly identifies with? For instance, will you be selilng Coke or Coak? It sounds the same, may even taste the same, but legally it is not. You must be very careful of this for not only will the public not believe in your product, it is an infringement of the trade mark law, i.e. it is not legally correct and you could land yourself in hot waters;
  
  
• Do the franchisors, the people who are selling the franchise to you, have a proven track record? Ask them to show you their accounts books and have a professional bookkeeper look at them to verify that they are correct and not trying to rob you of your money;
  
  
• Make sure that you will receive the service and backing that they promise. Contact others who have bought the same franchise as you intend to and ask them questions pertaining to how well business is going, are they making the profit as was promised, are they receiving the backing and service they were told they would get, etc;
  
  
• The most important point to bear in mind when considering buying a franchise is to carefully review the franchise agreement. Look out for the small type. It is advisable that you consult an attorney who deals with franchise contracts. Ask him to explain all the details of the contract to you so that you will know if there are any pitfalls or not, and if the partnership between you and the franchisor, the person selling the business to you, is beneficial to both you and him. Make sure royalties you will have to pay to the franchisor are realistic. Never ever sign on the dotted line until you have obtained legal advice. Undertaking the meeting with the attorney will cost you some money, but by not seeking legal advice it could cost you everything you have. Don't be afraid to question the contract and to ask for changes to be made. Remember that whilst you are trading on the name of the franchise, the franchisor is selling his name to you in good faith. You have to work together as a team and your working arrangement must be a win-win situation for you both. Therefore, from the very start, make sure that you are both in agreement with the contract, that no confusion exists, that you both know who will be deriving what profits, etc; and
  
  
• It is too late to seek legal advice after the animosity sets in when you feel you are being robbed of your earnings.

franchisor and francisee

Marriage between franchisor and franchisee

A franchise can, in many ways, be thought of as a marriage - both from a relationship and a legal point of view. Franchising is about relationships that work between a franchisor (the person selling the franchise) and a franchisee (the person buying the franchise). A franchise revolves around the give-and-take aspects that formulate successful partnerships.

Both the franchisor and the franchisee are responsible for giving, even though each party probably believes, at certain times, it gives more than the other! In essence, the relationship must be beneficial to both parties. It can, for instance, be said that the franchisor gives in the form of providing a successful business opportunity with clearly stated procedures, knowledge of the product and target markets as well as in-depth experience of the business. The franchisor also provides marketing, advertising, and established image and importantly, a sounding board for problems.

Because about eight out of 10 small businesses do not last as long as three years, the fact that the good franchisor is always on hand to discuss problems is a vital part in making the relationship work. In this way, the franchisees risk is decreased. The franchisee thus benefits from the hard earned expertise and the reputation of an established business practice.

Not only does the franchisee give in monetary terms, e.g. up-front fee on the business, royalties to the franchisor, and payment for special ingredients (burger rolls, sauces, salads, etc.), but also gives greater penetration into the market place thus increasing the business and creating greater exposure for the franchise as a whole. This includes improvement in the reputation of the trade mark which is central to any franchise agreement. However, as with all relationships, there is always a downside and the following pitfalls should be considered before embarking on this costly partnership.

The capabilities of the franchisee to successfully handle the running of the franchise may be an unknown quantity especially if the franchising operation is new or small. Thus the reputation of both the franchisor and trade mark of the franchise may be questionable thereby increasing the business risk of the franchisee and decreasing the value of the franchise.

The franchisee carries the initial risk of the franchise not working because of a poor location or because the franchisor did not fully research the need for the franchise. The total investment could be too high and, as a result, the profit margins could be too small to warrant the initial cost and subsequent payments. Also, the franchisee does not own the trade mark and works for the reputation of the franchisor and not entirely for his own, or his business' reputation.

The franchisee is ultimately more at risk than the franchisor. For this reason, the franchisee must check on the credit-worthiness of the franchisor. How long has the franchisor been in business? Does he own a successful franchise himself? Does he have a proven track record? Is support given to other franchisees? And, importantly, have other franchisees failed? If so, why?

The biggest pitfall would be a contract which results in both parties being locked into an agreement that is not advantageous to both parties. The marriage between the franchisor and franchisee must be a win-win situation. It is therefore imperative that both parties have their attorneys overlook the contracts to ensure that the contracts are beneficial to both. The small print must be carefully examined and the eventual outcome of the agreement fully understood by both parties.

why aquire a franchise instead of starting one's own business?

A franchise enables one to acquire a tried and tested business, with an established reputation and a known market. The franchisor will always remain interested in the franchisee's business operation because he has vested interests. This means that you will also get the support and know-how from someone who has done it all before. Fellow franchisees can also offer one another a lot of assistance and support, which gives one many advantages over going it alone. Financially, one is given a very good idea of what the capital outlay will be, as well as what one's monthly expenditure will amount to. A private business can often have hidden expenses which are not always anticipated.

advantages of a franchisee

The advantages of a successful franchise operation may be substantial. The franchisee may acquire an entire business system including designs, decor, stocks, recipes, management and other procedures and materials. The precise package will vary from one franchise operation to another, the more developed operations usually preferring franchisees with no previous experience so that they may be trained from scratch.

The franchisee is incorporated into a large business system with all the benefits of the reputation, development and other business advantages the franchisor enjoys. The franchisee outlet is, however, also an independent business unit and can therefore take advantage of the benefits of a small business such as better customer service and a quicker response to customers, greater flexibility and better responses to change, ability to maximise local opportunities and increased morale.

The franchisor on the other hand reaps the benefits of the energy and commitment of the individual franchisees, which assist in the building of the goodwill and reputation of the brand and entire franchise operation. This enhanced goodwill and reputation increases the likelihood of success of the franchise operation making it more attractive to prospective franchisees. A number of franchisee outlets can develop and enhance the reputation of a franchise operation far more quickly than the franchisor could achieve on its own. In addition the franchisor regularly receives feedback and input from all its franchisees, which can be utilised to the benefit of all of the other franchisees and the entire franchise operation. According the Mr. Jack Barber, the executive director of the Franchise Association of Southern Africa a win-win situation can be achieved in the franchisor/franchisee relationship provided the following exists:

• Total acceptance of a common vision, mission and values by the franchisor, the franchisee and their respective staff;
• Mutual trust and respect;
• Clearly defined rights and obligations;
• Good communication at all levels;
• Dedication to long-term success;
• Support in both good and bad times;
• Maintenance of clearly defined operating procedures and standards;
• Contribution to growth through feedback, research and development and ongoing promotion; and
• Timeous and correct payment of fees and royalties by the franchisee.

types of franchises

There are two main types of franchising:

• Product and trade mark or trade name in terms of which the franchisee uses the franchisor's trade name or trade mark and sells the franchisor's products. This type of franchising is prevalent amongst motor vehicle dealers, soft drink bottlers and fuel service stations; and
  
  
• Business format franchising in terms of which the franchisee uses the franchisor's entire business concept, which obviously includes the name and trade marks, goodwill, know-how, trade secrets, trade dress and the like.

paying royalties

I wish to buy a fast-food franchise. The franchise contract states that I have to pay royalties to the franchisor (the seller of the franchise) for the next five years. What exactly are royalties and do I have to pay them?

The franchisor should be providing a more or less complete infrastructure from a business point of view for the operation of the fast food franchise you wish to purchase. We suggest that you carefully study the disclosure document relating to the franchise if there is one. If there is not you should possibly ask the franchisor to have one prepared.

The infrastructure will include important intellectual property such as one or more trade marks, copyright in various documentation such as an operations manual and store design and getup. These are essential elements of the franchise and the resulting business as such and because they do not belong to you but to the franchisor, it is generally understood that you would, as franchisee, have to pay for their use. Such payment is normally called a royalty and is often expressed as a percentage of turnover.

Insofar as having to pay the royalty is concerned, this is a contractual matter and depends on the provisions of the franchise contract. In some instances it is possible to pay a larger upfront fee instead of ongoing royalty, but we doubt that you would be able to negotiate not having to pay the royalty at all.

In lieu of the rights the franchisee receives in terms of the franchise agreement, it is obliged to make various payments to the franchisor, which include:

• A franchise fee or upfront lump sum which usually includes an element of goodwill and the cost of establishing or setting up the franchisee outlet; and
  
  
• A royalty which is often a percentage of turnover, but may also be a fixed monthly sum, usually payable monthly. The franchisee will, of course, incur additional costs such as for example working capital to assist the business until such time as it becomes profitable, an administration fee should the franchisor render such services and a contribution towards the advertising and promotion of the franchise as a whole.

what to offer buyers

I have run a successful chain of children's clothing stores for the last ten years. However, I wish to jump on the bandwagon and sell franchises of my businesses. What steps should I take to secure my position and offer buyers a guarantee of success?

In franchising business it is essential to provide the franchisee with a substantially complete basic business infrastructure. On this basis, the first thing that you should do is to ensure that your current clothing chain can provide such an infrastructure and, if not, create it as quickly as possible. Such infrastructure would include such things as trade marks, operations manuals, store get-up, etc.

On the basis of the infrastructure you should attend to the preparation of an operations manual, a disclosure document which sets out the basis of the business including its financial history and a standard franchise agreement. This latter document in particular will help you focus on and establish what it is that you are prepared to, and can, give a potential franchisee and what it is that you expect in return. These documents should be prepared out of the guidance of an attorney who has experience in the franchising field.