What you need to know when creating a franchise for your own business

First of all, in order to understand what this article is about, you need to familiarize yourself with the terminology used in legal relations related to franchising.

Franchising is a system of business organization and development in which one company (the franchisor) transfers to another independent company or individual entrepreneur (the franchisee) the right to conduct business using the franchisor's name and business system and selling goods (services) similar to those of the franchisor in an identical manner.

A franchise is a package of benefits whereby the franchise buyer obtains from the franchise seller the right to use the seller's trademark and business system. But what is particularly important is that the buyer receives comprehensive assistance from the seller, enabling them to replicate the seller's business exactly.

A franchisor (licensor) is the owner of a trademark who sells a franchise. It is a company or individual entrepreneur that transfers the right to conduct business using its name (brand) and business system.

A franchisee (licensee) is a company or individual entrepreneur who purchases the right to operate in the market under the franchisor's name, using its business system, and also acquires the opportunity for training and assistance in setting up a business (depending on the field of activity, other benefits necessary for copying the franchisor's business are transferred, for example, merchandising support for a retail store).

A lump sum payment is the amount of the initial payment received by the franchisor from the franchisee in accordance with the franchise agreement.

Investments are the amounts spent by franchisees to start a business, on equipment and fitting out production premises, purchasing consumables, stock, etc.

Royalties are monthly payments made by franchisees to franchisors under franchise agreements. When the royalty column simply indicates a percentage, it often refers to a percentage of turnover rather than franchisee profits. A zero royalty indicates either that the royalty is already included in the cost of goods or supplies provided by the franchisor, or that the franchisor has no intention of supporting the franchisee in its operations.

Marketing (advertising) deductions — deductions in favor of the franchisor, which it uses for promotional and advertising campaigns of the franchise network at the national level or throughout the territory where the entire system operates.

Now that we have clarified the basic terms, we can move on to the topic of franchising your own business. A franchise is an excellent tool for expanding your business with “other people's resources and efforts,” i.e., those who purchase your business franchise will invest their efforts and funds into expanding your brand.

But how can you determine whether your company needs to expand?

You need to evaluate the following indicators:

1. Increase in customer flow and, accordingly, profits.

Each business has its own indicators. Growth and stability are important here, not just generating income as such.

Otherwise, you are likely to encounter the following problems:

- Lack of inventory. Products will sell out too quickly, creating a shortage that will provoke the formation of favorable conditions for competing firms with similar products to enter the market.

- Lack of service personnel. There may be difficulties with receiving and processing orders, as well as finding available specialists who are ready to provide services in a timely manner. Due to staff overload, errors will occur more frequently.

- Interruptions in supply and delivery. As the flow of orders increases, so does the flow of cargo, which the existing infrastructure may not be able to handle. In turn, delays can seriously damage the company's reputation.

2. Profit should not be generated solely through the efforts of the business owner.

Therefore, you must have a staff of employees whom you can trust without hesitation to handle day-to-day operations.

It is important to be “above the business” rather than “in the business.” Learn to trust your team!

3. The potential owner of the network wants more.

The attitude of “be content with little” is useless. If you are determined to conquer the world, DON'T STOP!

4. A unique product or technology that you will replicate.

This is primarily necessary to maintain the constant interest of potential buyers in your offer.

Uniqueness and innovation are important conditions for cloning a business, especially for a successful franchise.

To understand whether your franchise is unique or not, try to find 10 profitable differences in the way you do business. At the same time, the differences must be tested for competitiveness. If you can easily identify them, congratulations—no competitor can match you. If not, you need to work hard on making your business unique.

Common mistakes businesses make before scaling up:

- Lack of a profitable and sustainable business model;

- Lack of clarity in the necessary action plan;

- Lack of uniqueness and innovation in the business;

- Lack of competent legal support;

- Lack of a quality control system.

It is worth noting the advantages, sources of income, and risks when making a decision about scaling a business. Understanding these indicators can provide a clearer picture of the feasibility of scaling, what aspects of the business need to be improved before scaling, and, in general, help make a decision.

Advantages for the franchisor:

- Increased sales and additional income from this;

- Expansion of the sales network and the possibility of sales in remote areas;

- Increased control over the market;

- The ability to bring new products/services/works to market more quickly;

- Advantages in their promotion and distribution;

- Faster market promotion without direct investment or infrastructure costs;

- Acquisition of new ideas for improving the system;

- Protection of legitimate commercial interests through product quality control;

- Systematic knowledge of the market, allowing for forward planning;

- Additional income from royalty payments.

Franchising – replicating a business with minimal costs.

Sources of income for the franchisor:

- Initial fees from new franchisees;

- Royalties;

- Markups on goods, consumables, ingredients, semi-finished products, etc.;

- Discounts from wholesale suppliers;

- Leasing of buildings and equipment to franchisees;

- Interest on loans provided to franchise network members;

- Fees for management and consulting services;

- Possible payment for training and internships for franchise network personnel;

- The franchisor's own retail outlets (businesses);

- Sale of the franchisor's own retail outlets to its franchisees;

- Income from the operational management of franchise facilities.

Risks for the franchisor:

- Risk of reputation loss associated with the franchisee's failure to comply with instructions, standards, and other necessary conditions;

- Risk of territory loss associated with various forms of opposition from the franchisee;

- Concealment of important information by the franchisee and/or presentation of false information giving a false impression of the market;

- Risk of loss of competitive advantage associated with the franchisee's disclosure of confidential information to competitors;

- Use of the brand and corporate identity after termination of the agreement to the extent that it is confused with the franchisor;

- Refusal to pay royalties.

Advantages for franchisees:

- Use of a brand that has earned consumer loyalty and reputation;

- Choice of economic sector;

- Entry into a proven system and use of its advantages;

- Savings on resources for research, training, business development, marketing, advertising, supplier search, etc.;

- Support from an experienced partner;

- Access to innovations and new technologies;

- Increased competitive advantages;

- Satisfaction from participating in a “collective” business.

Risks for franchisees:

- Insufficient and false information about the franchise;

- False promises by the franchisor, its inability to manage the growth of the network, loss of interest in development;

- Poor market research by the franchisor and the product not meeting market interests;

- Inefficient development of the territory (a large number of enterprises in the territory and unreasonable proximity of franchisees' enterprises to each other, etc.);

- Excessive restriction of franchisee activities;

- Strict contract terms and lack of flexibility, preventing timely consideration of innovations;

- Early termination of the contract by the franchisor in the absence of serious violations on the part of the franchisee;

- Refusal to extend the contract and/or significant changes to the terms of the contract upon renewal;

- Liquidation, reorganization, and change of ownership and strategy.

Where to start? With making a decision!

We offer you a step-by-step algorithm for creating a franchise:

- Benchmarking existing franchises;

- Developing a franchise concept;

- Development of a franchise financial model;

- Development of franchise agreements;

- Preparation of franchise presentation materials;

- Search/selection/audit of an information system;

- Development of a Business Book.

It is important that the franchise be developed on a win-win basis so that each party benefits from this scaling.

1) Competitive benchmarking of existing franchise programs.

Benchmarking is the search, study, and comparative analysis of existing competitive or similar business models that use franchising. Benchmarking is the basis for the subsequent development of your own franchise model or the selection of existing offers on the market.

2) Franchise concept.

A brief description of the key processes, theses, criteria, and competencies that form the essence of the franchising project. The franchise concept involves defining the requirements for the franchise as a whole and for each format in particular (if any).

3) Franchise financial model.

Contains calculations of the necessary investment volume for franchisees, forecasts of income and expenses, and details of the indicators on which these forecasts are based. The financial model traditionally calculates the break-even point and the payback period of the project.

4) Legal documentation for the franchise program.

Legal documentation involves the meticulous work of lawyers to develop and legally formalize the previous steps. It includes:

- Parties to the transaction;

- Legal structure of the transaction. Legitimacy of legal relationships between the parties;

- Main franchise documents: License agreement, Commercial concession agreement;

- Supporting and additional documents;

- A package of documents formalizing various relationships between the franchisor and franchisee.

Also, if necessary, the package of documents is supplemented with agreements regulating the processes of procurement, material liability, work with personnel, etc.

5) Business Book (Operating Manual).

The Business Book is a reference book on managing a franchise, which includes:

- formalization and description of the stages of franchise operation;

- daily activities: standards, situations, and questions.

The process of establishing a franchise is not easy, which is why franchisors make many mistakes when they do it themselves.

Let's list the most common mistakes that are made:

- Rushing and wanting to save money at all stages;

- Lack of scoring for franchisee selection;

- False promises by the franchisor during negotiations;

- Low level of franchise development;

- Desire to earn more from franchisees;

- Network growth crisis - inability to manage network growth;

- Loss of interest in developing the franchise network and the business as a whole;

- Degree of control over the franchise network.

To minimize the risk of making the above mistakes, we recommend:

- Continuously improving innovation;

- Automating business processes as much as possible;

- Optimizing and reducing the costs of purchasing and launching a franchise;

- Being prepared for the multi-format nature of franchising;

- Expanding into smaller cities to increase the number of outlets;

- Being more selective in choosing franchisees;

- Enhancing the company's reputation and brand capitalization.

If you are planning to create your own franchise or purchase an existing one, the specialists at LEX Law Firm are ready to provide you with comprehensive support. We will help you:

- legally formalize the franchise;

- develop a license agreement, business book, and other documentation;

- conduct a legal review when purchasing a franchise;

- protect the interests of both parties within the framework of the franchise relationship.