Franchising presents a very real opportunity for growth and survival in the current challenging economic environment.

It can be a highly effective business model but it needs care and understanding to function properly and avoid a disaster. David Munn, a franchise law partner with Gaze Burt Lawyers, recently gave the Business to Business team a quick lesson in becoming a franchisor. 

The term franchise is often loosely applied to a plethora of different situations ranging from car dealerships to sports shops to mortgage brokering. Some see franchising as the ultimate business network and the best hope for independent business in a competitive environment.  Others see it as not to be trusted.  Still others see it as an opportunity to rapidly expand their business using someone else’s capital. This can be a distinctly attractive proposition when credit is tight and capital precious. 

While there is no specific definition in law, franchising is based on a relationship between two participants:  a franchisor (the person who creates the business opportunity) and a franchisee (the party who buys that opportunity). It is a format for doing business that gives a contractual right to use a person’s intellectual property, trademark, brand and developed system for running a particular business. Within this framework the specifics can be very strict or very loose with an entire spectrum of different levels of control.

“As the business is substantially dependent on the franchisor’s trademark and system, you have to look carefully at how the franchisor should expect the franchisee to run the system in the franchisee’s own business,” David told Business to Business. The degree of flexibility a franchisee has within a system will be regulated by the Franchisor. 

“It is one thing for a franchisor to have run a successful business – it’s another to run a business of franchising.  Each franchisee is the independent owner of their own business, not branch managers. They are risking their own business and capital and that usually influences their motivations and priorities. It should also be remembered that if things go sour it can affect a lot of people, so extra care and responsibility is needed by franchisors.”

A franchise model should be adopted for the right reasons. It is a marketing concept designed for business to effectively penetrate and compete in the market. The franchise model should not be used simply to stroke someone’s ego by rapidly selling off franchises at a rate which exceeds the franchisor’s ability to responsibly support those franchises. It needs to expand for good reason. Is there opportunity for market growth with the particular goods and services involved or is the market saturated and possibly even in decline?  It could be even worse if one is buying a new franchise opportunity when the existing franchise network itself has reached saturation point. A good understanding of exactly where the market is going is crucial. Equally important is where the franchisor is going in that market and why.

“You  need to have a good tried and tested business which is financially sound. If you have financial weaknesses do not look at franchising. You should also strive to establish quality relationships with franchisees. You can’t control franchises as you can employees.” 

A credible, dependable and trustworthy franchise system should be proven and David recommends looking at structures carefully and even piloting a franchise. 

“Get one or two initial franchisees well honed in a franchise development and you have a tremendously powerful marketing tool for selling future franchises.”

Undertaking the business of franchising is very distinct from running the business upon which it is based. Success in one direction does not necessarily mean success in the other. Some businesses make the transition well but many don’t.

The right structure for the franchise should be carefully considered and clearly demonstrate an acceptable profit potential for everyone involved.  Some franchise operations run into difficulty simply because not enough prior thoughtful consideration has been given to the financial structure involved as new cost centres that will arise as a result of franchising. The franchise business needs to generate an adequate return to both franchisor and franchisee in the short and long term.

The characteristics of a quality franchise should be established from the outset. This includes comprehensively documenting and updating systems and procedures. A robust franchise agreement should also be prepared. There is good reason for this including to protect the integrity of the brand and the system for the benefit of everyone. It should be tailor made to the particular business but it should also be fair to both parties. When all is said and done it is a working relationship of mutual trust that is being created and the agreement and business practices should fairly reflect the mutual interests of the parties. 

The important intellectual property upon which the system is based should be well protected and enforced by the franchisor, otherwise everyone is at risk. Sound communication and information gathering systems should be put in place and used to their full potential. Good dispute resolution policies and procedures will help ensure that relationships can endure. Conflict will inevitably come in such a close working relationship. That needs to be both anticipated and managed carefully so that the relationship can survive any conflict. It is desirable to have mediation clauses in place to help manage conflict when it arises.  Being a good ‘people person’ also helps the franchisor in these situations – or at least be prepared to pay for  someone who is .  “The vital brand reputation also needs to be preserved through any conflict.  The brand value can be delicate and easily damaged by the conduct of a few or even just one franchisee. When that happens, everyone’s business value can be affected.

It is important that the franchisor is credible.  That means they should understand and demonstrate the importance of the franchise relationship. They should walk their talk. One also needs to be wary of misrepresentations particularly at the stage of negotiation relating to the sale of a franchise opportunity.  A good indicator of a prudent franchisor is if they talk cautiously with realistic expectations and challenge a prospective franchisee to do their own business research and develop their own business plan.

It has been said many times that franchising is like a marriage.  Building trust, transparency and integrity in the relationship is vital.  These are qualities developed over time through attitudes, conduct and character. The franchisor needs to be seriously committed to an ongoing attitude of win/win for each party (the franchisee should commit to this as well) and aspire to best franchise practice. If they don’t know what that means then they could start by being educated by and associated with the Franchise Association of New Zealand and choosing advisors who have recognised expertise in franchising. One expects franchisees to be teachable but in David’s view, it is even more important for a franchisor to be willing to learn as well. He considers franchisors generally hold too many people’s lives and businesses in their hands to do otherwise. 

The franchisor’s success and return on their investment should generally be entwined with that of the franchisee’s business and revenue expectation. There should be a demonstrated recognition of the importance of the shared economic interest that each party has in the relationship. Good franchising is not about a franchisor making money up front by simply carving up New Zealand and selling off territories.  Aligned with the mutual financial interest of the parties there should be an effective and responsive support structure available to franchisees so that reasonable help is available.At the same time that should not detract from the franchisee’s primary responsibility to perform to reasonable expectations in their own independent business.

The franchisor should know where they are going with the franchise, have a plan to get there and be keen for all the franchisees to get there as well. The franchisor should also tap into the knowledge, experience and local market awareness of its franchisees and then through its own wisdom and experience, be continually leading and adding value to the system for the benefit of all. A quality franchisor facilitates that process well.