Subway, Snap-on Tools, MaidPro, ACTIONCoach. They’re all very different types of businesses with one significant thing in common—they began as small businesses and increased their revenue exponentially by franchising. If you’ve considered how to grow your business by leaps and bounds without starting and running dozens or hundreds of locations yourself, you may have wondered how to franchise a business. In this article, you’ll learn more about what franchising means, how to determine if franchising makes sense for your business, and what’s involved in franchising a business.
What Does it Mean to Franchise a Business?
Before I go any further, let’s take a moment to discuss what franchising is exactly.
Franchising is a business model by which business owners (franchisors) systematize their business operations so that they can sell units of their brand to other individuals (franchisees). Typically, franchisees own and operate their units within a pre-determined territory. A franchisor creates a legal infrastructure and uniform processes for running its franchise units, granting franchisees the legal right to start and operate one or more franchise units using the franchisor’s systems, trademarks, and methods of operation. Franchisors provide franchisees with some degree of ongoing support, resources, and training to help ensure success.
Franchisors and franchisees sign a “franchise agreement,” which details all aspects of their contractual arrangement. Franchisees pay the franchisor a one-time franchise fee when executing the franchise agreement, and there are recurring royalty fees for continued use of the brand assets and support.
Franchising is regulated by the Federal Trade Commission’s Franchise Rule, and some states have their own state-specific laws for franchising a business.
Are You Ready for Franchising?
Not every entrepreneur or business is ideal for the world of franchising. To follow are some considerations to help determine if franchising is a good fit.
1. Does it have a replicable success formula?
If a business will be franchised, it should have well-established processes and systems that have enabled it to operate successfully. And those processes and systems must be repeatable and effective at the franchise unit level so that franchisees have a good chance of experiencing success, as well. If a business concept works well only because it’s at a specific location or because the owner or a key employee brings unique skills to the table, it may be a red flag that the business model isn’t ideal for franchising.
Most successful franchise concepts are relatively simple to operate, can thrive in varied markets, and have a business model that’s easy to teach to franchisees.
2. Can it be appealing to potential franchisees?
Franchising opportunities exist in nearly every industry, and many factors may attract or drive away potential franchisees. The niche, brand reputation, logistical considerations, staffing needs, and other things will affect how attractive a franchise is to prospective business owners.
3. Will your franchisees be able to get a reasonable return on their investment?
All things considered, after the initial franchise fee, royalties, and the other costs associated with starting and running a franchise location, franchisees will want to make an adequate return on their investments of money and time. This is something to consider carefully before franchising a brand because not all types of businesses can yield the same level of profits.
4. Are you willing to invest time and money into ensuring that your franchisees succeed?
Most successful franchised businesses have a franchisor that has well-defined processes, provides access to efficient and effective business software systems, and develops excellent training programs for franchisees and the employees of those franchisees. They also provide marketing support in the way of things like co-op advertising, ad templates, website development, email marketing, customer loyalty programs, and other needs. It’s not enough to “sell” a franchise to a franchisee; franchisors must provide support elements that will help ensure the ongoing growth and health of the brand.
5. Do you have the capital required to franchise your business?
While expanding a brand via franchising can cost less than building new locations on your own, it does come with costs. I mentioned some of them in consideration number 4 above. Also, a franchisor will incur the costs of working with an attorney to create contracts and other legal documents, accounting and tax advisory fees, and other expenses associated with getting the company franchise-ready. If you don’t have the funds readily available, you’ll need to consider financing options if you want to franchise your business.
Checklist for Starting a Franchise
Depending on the type of activities the business performs and the states where franchise units will operate, the rules and requirements vary when franchising a business. Generally, here are the major steps involved:
1. Hire an attorney and accountant
Both federal and state laws regulate franchising. Growing a business through franchising requires the expertise of a knowledgeable attorney who will ensure all legal aspects of the process are covered. Likewise, there are financial and tax matters to address when franchising a business. An accountant or tax advisor with experience working with franchisors can offer valuable insight.
2. Prepare a franchise disclosure document
A franchise disclosure document (FDD) is a legal document required by federal and state law. It gives a business a legal foundation for selling franchise units. A franchised business must provide its FDD to prospective franchisees at least 14 days before signing an agreement with or accepting payments from a franchisee.
An FDD consists of 23 mandated sections (items), which inform prospective franchisees about the franchise, the franchisor, and the legal responsibilities of both the franchisor and franchisees. Some of the important details that an FDD addresses include:
- Overview/history of the company
- Information about the franchise’s key officers, directors, and others with management responsibilities
- Disclosures of any past or present litigation that the company or key stakeholders have been a part of
- Initial fees that franchisees must pay to start a franchise and fees for ongoing operation (such as royalties, advertising, renewal, etc.)
- The territory of the franchise (what sales territory may the franchisee target, is the territory exclusive to the franchisee, etc.)
- Whether a single franchisee can buy multiple units (multiple franchise locations)
- Contractual obligations between the franchisor and franchisees
- Support and resources the franchisor will provide to franchisees (training, marketing assistance, technology platforms, etc.)
- Exit strategy if a franchisee wishes to cease operating a franchise
- Dispute resolution process if franchisor and franchisee disagree about contractual responsibilities
- Information about the financial performance of franchise units
- Details about the contracts (e.g., Franchise Agreement, property lease or rental agreement, marketing contracts, and possibly others) required to become a franchisee
- Descriptions of the franchise’s products and services
- Status of trademarks, patents, and copyrights belonging to the franchise
As you can see, there are numerous decisions to be made and work to do when creating an FDD. It will require a good deal of research about franchising in general, your market and industry in areas beyond your existing business location, your competition, legal and tax-related implications, and more. At the end of this article, I’ve provided a list of resources that offer information about how to franchise a business.
An FDD does not get registered or filed with any government agency at the federal level. However, it may need to be registered or filed with a state agency, depending on where the franchisor plans to offer its franchises for sale. In franchise registration states, a franchisor must register its franchise with the state and file its FDD annually. In franchise filing states, a franchisor must do a one-time or annual FDD filing. In other states, franchisors may offer franchises if their franchise disclosure document is current and complies with federal law. In all states, franchisors must disclose their FDD to prospective franchisees at least 14 days before the offer or sale of a franchise.
3. Create an operations manual for your franchisees
An operations manual provides details and instructions that franchisees need to know to run their franchise units. This document is critical because it helps ensure uniformity of service and quality across franchises owned by different franchisees. It is essentially a how-to guide that covers day-to-day procedures, production, and delivery of products and services, payroll and accounting, software and technology platforms, customer service expectations, customer complaint resolution, employee training, and more.
4. Apply for your brand trademarks
Brand assets are of the utmost importance when scaling a business through franchising. Franchisors can protect their brand name and logo design (and secure their right to use them in all 50 states) by registering for federal trademarks through the United States Patent and Trademark Office (USPTO).
5. Discuss and possibly change the business entity type for your franchise
Franchisors can benefit from talking with an attorney and accountant or tax advisor about this important decision. They can advise whether a franchisor’s company’s current entity type is appropriate for a franchised business or if a change in entity type will serve them better from a legal and tax perspective. If a change is in order, depending on the state of registration, it might require converting the business from one entity type to another or dissolving the original entity and forming another.
If you’ve decided to make an entity change after discussing your options with your lawyer and accountant, my team at CorpNet can save you time and money by preparing and filing your business formation documents for you.
6. Register or file your FDD with the state, if required
Whether or not a franchisor must file its FDD in a state depends on whether or not the state is a franchise registration state, a franchise filing state, or neither. If a franchisor neglects to follow a state’s rules, it legally may not offer or sell franchise units in that state.
7. Find potential franchisees
I recommend that franchisors develop a marketing and sales plan to help guide their efforts in finding prospective franchisees. It may be helpful to work with a marketing agency that specializes in assisting franchisors with creating sound marketing strategies.
How Long Does It Take to Create a Franchise?
Many factors (such as the states involved, the industry, the complexity of the business, how well-defined the business’s processes and systems are, etc.) will affect how long it will take to complete all of the legal requirements. A reasonable estimate would be between three to six months. Consulting with a business coach experienced in franchise development may provide insight into how to move the process forward as efficiently as possible.
How Much Does It Cost?
This can vary wildly depending on the legal and accounting assistance required, development of training programs, professional marketing strategy assistance, business formation needs, state franchise registration and filing fees, technology enhancements, and other requirements to scale the business as a franchise. Doing lots of research into what it will take to franchise your business in the areas where you intend to offer franchises will help you get a handle on what you can expect to spend initially and on an ongoing basis.
Digging Deeper into Business Structures
While there’s no one-size-fits-all answer to this question, generally the answer falls into one of two camps: the S Corporation or the Limited Liability Company (LLC).
Both of these business structures provide protection for your franchise, as well as your personal assets. If you choose no business structure, you’ll operate as a Sole Proprietor, and you’ll put yourself at risk. If your franchise is ever sued, your personal assets can be taken to cover costs. On the other hand, with both the S Corporation and the LLC, your personal assets can’t be touched, because you’re considered separate from your business entity.
The difference between the S Corporation and LLC
While there are a lot of similarities between these two business structures, including pass-through tax treatment, protection of personal assets, and unlimited duration, there are a few key differences.
The S Corporation tends to require more rigid paperwork and processes. You’ll need to assign a Board of Directors and meet with them annually, as well as file an annual report. The LLC will also require an annual report, but overall, it has less formality.
Also when it comes to owners, the S Corporation only allows US citizens or residents to be owners, and limits shareholders to 100. An LLC may be owned by other LLCs or corporations, and the owners do not have to be US citizens or residents. You can have an unlimited number of owners in an LLC.
The best place to register the franchise
You may hear that certain states are better to form a business structure in, even if you don’t do business there. Yes, some states have low or zero state taxes, but that doesn’t make them the best place to form a business entity.
My advice is to form your corporation or LLC in the state you plan on running your franchise. Otherwise you may have to file additional forms and pay extra fees to register in a state other than where you do business, and in my mind, it’s not worth the hassle.
Options for registering the new entity
You’ve got several options here. If you’re all about DIY and don’t mind a little paperwork, you can download the appropriate form for your business structure from your state’s Secretary of State website. Some websites even let you file online. You’ll need to provide basic information about your business including contact information, officers’ names, and the nature of your business. You’ll pay your incorporation or filing fee, which is usually between $100 and $300.
If you’d rather let someone else handle the work, you can employ a business filing services company that will take care of the paperwork on your behalf.
Depending on how busy your Secretary of State’s office is, you can expect to get your business structure approved in a month or two. If you work with a filing service, you can expedite the process to get it approved within a matter of days.
Resources to Help You Understand How to Franchise a Business
Below are several resources and publications where you can find helpful information and tips related to how to franchise a business.
- Federal Trade Commission’s Franchise Rule Compliance Guide
- International Franchise Association (IFA)
- The Franchise King – Joe Libava
- FranchiseOpportunities.com
- Franchising.com
- Franchise Direct
- Franchising World
You might also consider signing up to attend seminars, webinars, and conferences that are focused on the education and professional development of franchisors.
And, of course, my team at CorpNet is here to assist you and your franchisees with your business formation and compliance filings in all 50 states. Contact us to learn more about how we can help you move your franchising dreams forward!
