What Constitutes a Franchise?: Everything You Need to Know
What constitutes a franchise is a question many entrepreneurs may ask when looking to start a business.3 min read
What constitutes a franchise is a question many entrepreneurs may ask when looking to start a business. There are numerous types of franchises today with an estimated 120 different industries that utilize franchise structures. While the largest portion of franchises is in the food industry, there have also been other franchise opportunities in the field of home health care and other medical service markets.
What is a Franchise?
In legal terms, a franchise involves a business owner granting a license to another business owner. The licensed business becomes a franchise and falls under the terms and regulation of the license agreement. With the license, the franchisor will be allowing the new business to use its:
- Trade name
- Operating system
- Rights for logo use
Not only will the franchisee be allowed to use the intellectual property and material of franchisor but they will also receive basic business support from them to be able to run the business up to the standards of the brand. In exchange for all this, the franchisee will most likely pay a one-time fee for the licensing as well as an ongoing royalty.
The franchisee will have control of the decisions in their business and the responsibility to run and finance business operations. The franchisor will continue to provide training and support in exchange for the continuing royalty fee. Some of the ongoing support that a franchisor may provide includes:
- Operational training and support
- Location scouting and design
- Financial guidance
- Marketing and advertising support
While the franchisor will provide this ongoing support, they will not be involved in the day-to-day operations of the location. The franchisee will be responsible for:
- Hiring staff
- Determining compensation
- Setting the employment practices and standards
- Dealing with employee discipline
Growing a Business Through Franchising
Franchising is a good and methodical way of growing your business by being able to distribute both products and services to a wide range of outlets and geographic location. It requires both the franchisor and franchisee to work together to help the business successfully expand.
The franchisors role in the expansion is to add and support additional franchises to grow the brand, and the franchisee agrees to operate the business day-to-day to support and promote the brand and its standards.
Franchising: The Legal Definition
Legally every franchise is a license but not every license is considered a franchise. To be considered a valid franchise in the United States, three requirements must be met.
- The business must have a substantial association with the trademark of the franchise.
- The franchisee must pay a continuing and/or initial fee enter and stay in business.
- The franchisor provides assistance and control over the franchise.
The definition of a franchise is not only legally termed under federal law but also subject to various state laws as well. Some state laws require additional stipulations to be met such as having a marketing plan or maintaining a community of interest with the franchisee.
Franchises are also subject to Federal Trade Commission Rule. Some of the rules required by the FTC including meeting certain pre-sale disclosure requirement
The FTC also has its own definition of a franchise including requirements such as:
- A franchisee is required to obtain the right to operate the business in association with the franchisor's trademark and distribute goods and services defined by the company's trademark.
- The franchisor must maintain a certain degree of authority over the franchise's method of operation.
- There must be a contracted payment arrangement between the franchisor and franchisee.
In addition to these requirements, the name the business arrangement is given is also subject to requirements. Some of the definitional requirements under the FTC Rule include:
- The name of the arrangement must follow the protocol for establishing an FTC approved franchise agreement.
- The minimum payment allowed for a franchise to be considered is $500, even if the business does not own a trademark or provide significant assistance to the buyer.
Rules Governing Franchise Sales
For a franchise to be legally binding, it must follow a set of federal and state rules and regulations including:
- The franchisor must provide a disclosure document, referred to as an FDD which discloses the 23 prescribed pieces of information the franchisee must be made aware of. This must be provided within 14 days.
- Franchisors cannot misrepresent or mislead a franchisee on money matters or financial performance.
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