What is a Franchise?
A franchise involves an agreement in which one party (the franchisor) grants another party (the franchisee), in exchange for money, the right to use its trademarks, trade names, certain systems, and processes to produce and market a product or service according to specific specifications (the franchise).
Franchising a business is entirely different from running the business. If your initial business is not successful and profitable, do not expect your fortunes to improve by turning it into a franchise. On the contrary, the pressures of franchising will endanger not only the franchisees but also the very business you started (you as the franchisor). A franchise attorney can assist you.
Four Considerations
Four considerations will help you determine Whether You Can Franchise Your Business You must be convinced that the business you are interested in converting into a franchise is profitable and that its model can be successfully cloned—replicated in as many places and scenarios as possible. This requires a superior product or service with sufficient demand to generate interest from potential buyers. In other words, the business must operate under a system that allows it to generate consistent sales and a reasonable profit after covering expenses.
How do your sales compare to the competition? I mean businesses selling similar products or services. If your prototype is profitable in the long term, it’s unreasonable to sell the concept to another party and expect future royalties. Selling an unproven or unprofitable business invites legal issues. Anyone who buys a franchise expects it to be “turnkey”—ready to operate, with all systems in place so that if the owner follows the processes, they will generate a reasonable profit.
Unique Sales Proposition
To be profitable and generate sufficient demand, you need to offer a superior product that stands out from the rest. Your offer must bring something additional to what already exists in the market. That is, reasons for others to stop buying from competitors and start buying from you.
Viability of Additional Units
How easy is it to recreate your prototype (where you intend to market the franchise)? Each unit should be easy to replicate in terms of investment cost, the time needed to start the business, and offering the necessary training to operate it. If it works in some places and not in others, then the franchise model may not be suitable for your needs.
A prudent step is to open several locations before franchising the operation. If all goes well, your financial position will improve; you will prove that the concept is replicable and increase your managerial competence with the complexity of managing multiple locations.
Change of Perspective
As a franchisor, your role will change. You will stop focusing on your own business to spend time selling, training, guiding, and supporting others in creating their own businesses. You will also mediate conflicts with people who are not doing as well as you or insist on doing things their way. You can no longer act unilaterally or with the same speed as before; you must consider the rest of the franchisees for future decisions.
Time and Money
Regardless of the business you intend to franchise, you need capital and time to grow and expand; and I’m not referring to the current business—which still needs attention—but to the franchise. Some of the areas requiring time and money to move forward include:
- Legal advice for protecting copyrights, trademarks, logos, trade names of the franchise.
- Consulting to assist you in preparing a detailed and proven operations manual to be provided to the franchisee. This manual is critical for maintaining brand, service, and product consistency among the various franchised operations. Moreover, you will have to update it regularly as the operation evolves.
- Legal advice for the preparation of a franchise agreement, filing the corresponding applications and permits; and assistance in preparing the business and personal disclosures that the law requires you to provide to prospects.
- Accounting and financial advice to help you develop economic scenarios for setting fees and royalty percentages. Assistance in preparing the company for the process of submitting audited annual financial reports and handling the financial and tax matters of the parent operation. Remember, when we talk about the franchise, there are multiple parties involved. There is the main organization and the owners of the individual franchises.
- Strategic plan that includes a marketing plan. Many people are not attracted to the idea of investing time in developing an action plan. If you are not willing to create a plan with goals—at least 3 years, you are in the wrong business. Developing a business requires a serious and well-thought-out plan; not those pro-forma that some banks are satisfied with for granting micro-loans.
- An essential component of this strategic plan is the budget. Besides additional payroll, other costs must be considered. Meeting legal requirements should not be expensive, but if you plan to expand to other jurisdictions, the legal bill could be in the tens of thousands. You will also need funds for marketing. This includes the preparation of printed material (graphic artists, writers, brochures, literature, logos, designs, signs), strategic alliances with business brokers and franchises, marketing campaigns, websites, advertising slots, hiring rooms for presentations, etc.
- Payroll. Developing a franchise will take time away from your current business; which still requires attention as it is your business card. This may imply hiring additional staff; but there’s more. Besides one or more people to coordinate work with contractors (graphic artists, lawyers, architects, accountants, consultants, etc.), you will need someone—professional and trained—to assist or take care of the marketing and sale of franchises. Just because the business is profitable doesn’t mean prospects will come running to buy a franchise from you. This work is essential for the success of the project. You will also need staff to train each new franchise owner and provide ongoing support (and supervision). You cannot do everything yourself.
- Real Estate. If the franchise requires a physical location, you will need to hire an architect to develop a prototype of the establishment and a real estate professional to help you identify the most promising commercial areas and approve them.
Legal Aspects
Franchise Regulations in Puerto Rico Although many states have had laws regulating franchises for years, Puerto Rico—a highly legislated jurisdiction—strangely does not have a law on the subject. There is Law 75, which regulates distribution contracts, but not much more. The Federal Trade Commission or FTC, has enacted a regulation called the FTC Franchise Rule, requiring the disclosure of certain information about the franchisor and the franchise. This disclosure is known as the Franchise Disclosure Document or FDD. It requires the franchisor to disclose specific and detailed information on 23 topics related to matters such as: the identity and financial status of the franchisor (including financial statements) and parent entities, predecessors, and affiliates; the experience of the officers running the franchise; pending litigation; bankruptcies; initial fees to be paid, royalties, and other recurring payments; the estimated total investment to be made by the franchisee; the franchisor’s obligations regarding assistance and information on advertising, training, computer systems; the franchisee’s rights over the territory; the duties and obligations concerning trademarks, copyrights, and patents related to the franchise, information on renewals, etc.
Legal Structure of the Franchise
For many, developing a franchise is a rewarding experience. If you are willing to invest time and money in an existing and proven good business, the opportunity is there. Like everything, it requires effort and dedication.
If you want more information from a broader perspective check our article: Navigating-The Complex Landscape of Franchising: An Advisors Perspective