What Is Franchising?

Franchising is a distribution method.

A franchise is an license agreement between two parties which gives a person or group of people (the franchisee) certain rights to market a product or service using the trademark of another business (the franchisor).

Typically the franchisee markets the product or service using the operating system or methods provided by the franchisor. For the use of the trademark, operating systems and methods, the franchisee has the obligation to pay the franchisor certain fees and royalties.  The franchisor generally has the obligation to support the franchisee.  In this business relationship, both the franchisor and franchisee have a vested interest in the success of the brand and their mutual business.

There are two types of franchise methods: business format franchising and product and trade name franchising.

Business Format Franchising

This type of franchise offers a variety of support and services to the franchisees, including: the use of trade marks and logos, a system of doing business, site selection assistance, hiring and training, advertising and marketing, product supply and more.  The franchisee pay both an up-front franchise fee and  continuing royalties to the franchiser.

Examples of business format franchising are fast food restaurants, automotive services, lodging, real estate agents, convenience stores and tax preparation services.

Product & Trade Name Franchising

These type of franchises are generally associated with industries like petroleum and soft drink. This type of franchising does not include royalty fees. The franchiser provides primarily product in addition to trademarks, logos, and national advertising campaigns.

The Uniform Franchise Offering Circular (UFOC )

Starting in 1979 the Federal Trade Commission (FTC) starting regulating the franchise industry in the United States.  In addition, several states also regulate franchising in their respective state.  The primary 'tool' of the FTC is Uniform Franchise Offering Circular (UFOC) which the franchisor is required to provide a prospective franchisee.

The UFOC provides a prospective franchisee with detailed information about the franchisor as well as the franchise being offered, fees to be paid, obligations and agreements between the franchisor and the franchisee, audited financial statements of the franchisor and a complete copy of the franchise agreement among other things. (See UFOC)

In addition to simply providing the document, the franchisor must provide it at the first personal meeting, or at least ten business days prior to signing the franchise agreement or taking any form of payment for the franchise.

If a franchisor also makes any projections as to what the franchise might earn or earnings claims, they must also provide an Earnings Claim (Item 19 in the UFOC) that substantiates the claims with actual facts. In the US, only about 20% of franchisors make an earnings claim, but for those that do, be sure to verify where the claim came from and talk to existing franchisees to determine their experience.

Although franchising is regulated by the FTC and requires the disclosure of material facts, it does not regulate the substantive terms of the franchisor-franchisee relationship and it does not require registration of the offering or filing of any documents with the FTC in connection with the sale of the franchise.

However, if you are located in one of the following states; California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, , Rhode Island, South Dakota, Virginia, Washington and Wisconsin, the franchisor is required to file the UFOC document with the specific state agency regulating franchising in that state. Check with you local state agency to verify registration or filing by the franchisor if you are located in one of the above listed states.