The Basics of American Franchising

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Perhaps you have seen an advertisement at a restaurant suggesting that you can open your own franchise and make a lot of money. Or, have you seen an advertisement on TV or the Internet talking about franchising opportunities? Or has someone approached you about buying into a multilevel marketing franchise? Whatever the situation, an understanding of what franchising is and its legal ramifications can be important for a successful business.

In its simplest terms, franchising is the practice of using another firm's successful business model. The franchise model is an alternative to a company building multiple locations all owned by a single person or entity. This single owner, or 'chain store' model, requires significant investment by the owner, both for start up and throughout its operation. While it provides much more control, the expense can be crippling, particularly to companies that wish to expand widely and quickly.

Enter the franchise model.

In franchising, the franchisor licenses the use of its business model to other companies that are allowed to open their own operations using the franchisor's name, trade marks, distribution network, and products/services. The franchisee pays a royalty to the franchisor for use of the business model, marks, and name, and is normally granted access to the franchisor's distribution network from which it buys its products. As a result, the franchisor usually takes on more of a supply role, allowing the franchisees to operate the day-to-day public interactions with customers. Franchising also has the benefits for franchisors of allowing for rapid expansion and raising capital without having to give up control of the company.

The United States has a long history of franchising, dating back to the 1930's when it first gained popularity among fast-food restaurants, food inns and, motels. As of 2005, there were 909,253 established franchised businesses, generating $880.9 billion of output and accounting for 8.1 percent of all private, non-farm jobs. This amounts to 11 million jobs, and 4.4 percent of all private sector output. Examples of well known franchise-based brands include Subway and McDonald's (restaurants), 7-Eleven (convenience stores), Hampton Inns & Suites (hotels), Great Clips (hair salons), H&R Block (tax preparers), and many more.

Each party to a franchise has several interests to protect. The franchisor is involved in securing protection for the trademark, controlling the business concept, and securing know-how. The franchisee is obligated to carry out the services for which the trademark has been made prominent or famous. There is a great deal of standardization required, and this is usually enforced through strict, carefully worded contracts known as franchising agreements. For example, the franchisee normally has to display the franchisor's signs, logos, and trademark prominently, must adhere to dress policies, must meet certain minimum customer service standards, etc. Failing to do so can result in a breach of the franchising agreement and termination of the right to use the franchisor's model, name, and logos (effectively putting the franchisee out of business).

If you are considering starting a franchise business, you should consult with a local attorney experienced in corporate law. This attorney can review and advise you regarding your franchising agreement, recommend ways to remain in compliance and avoid problems with supply networks or the franchisor, and give advice and guidance on best practices for taxes and other regulatory matters. An attorney can also help smooth over any disputes that may arise between franchisor and franchisee to ensure that your business can grown and succeed.


Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.

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