Franchising 101

If you’re new to franchising, there’s a lot to learn. While it may seem confusing or overwhelming initially, franchise industry jargon, and the franchise model itself, is actually quite straightforward to understand! 

Whether you’re a franchise owner, a new potential franchise buyer, or a new franchisor, the below should serve as a very basic explainer of common terms you may hear, as well as definitions written in our words! 

Let’s start with the most basic areas of franchising…

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Franchisees versus Franchisors 

Franchisees (commonly referred to as “Zees”) are business owners who pay a franchisor a franchise fee and ongoing royalties (and potentially other ongoing fees), in exchange for the right to use the franchisor's brand name, proprietary business model, and access to training & ongoing support. 

‍Franchisors (commonly referred to as “Zors”) is a company that licenses their brand, business model, and support team to entrepreneurs in exchange for franchise fees and ongoing royalties. 

The Zee - Zor relationship is what makes or breaks a franchise brand. 

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Royalties

Royalties are the fees you pay as a franchisee, to your franchisor, on an ongoing basis in exchange for their support and the right to operate their brand, as well as leverage any other resources provided by the Zor. 

Royalties are typically charged as a percentage of the revenue you earn, and can be anywhere from 4-10% of your revenue, but generally are in the 6-8% range. Most brands collect royalties monthly, while some charge them weekly. 

Note: there may be other fees you have to pay on a routine basis as a franchisee, such as a marketing fee, technology fee, and others. 

While having to pay fees may seem like a negative signal, the key is in understanding what you are truly getting in exchange for the fee you pay. 

Franchise Fee

The franchise fee is the initial fee you have to pay in order to officially become a franchisee. Most brands often give “volume discounts” based on how many locations you sign on to open. 

For example, the initial franchise fee may be $50,000 for your first location, but if you sign on open 2 locations, you'd likely pay $85,000 - $90,000 to buy the rights to open those locations.

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Units

“Units” are synonymous with locations. In other words, someone who owns two locations of a franchise will often be referred to as a “two unit owner”. 

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Franchise Agreement

The franchise agreement is the contract you sign that defines all of your rights and obligations as a franchisee, as well as the rights and obligations of the franchisor. It is highly recommended that you have a franchise agreement vetted by a franchise attorney before you become a franchisee. 

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Single Unit versus Multi-Unit Owner

Single unit franchisees only own one location

Multi unit owners own multiple locations.

Area Developers will own a territory (multiple towns, a region, or maybe even an entire state). They are then responsible for recruiting franchisees in their territory, and providing some level of local support to them. They receive a portion of the franchise fee for every franchisee they recruit, in addition to a minority percentage of royalties from those locations. Area developers often (but not always) have to own at least 1 location themself. 

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Protected Territory 

A protected franchise territory refers to a specific area that you can operate in as a franchisee. The protected territory offers protection from other franchisees being able to enter your market. 

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FDD - Franchise Disclosure Document

A franchise disclosure document is a lengthy document that every single franchisor has to register in all 50 states, as per the Federal Trade Commission’s regulations (the FTC regulates the franchise industry).

Anyone buying a franchise must be disclosed with an FDD by a licensed seller at the franchisor, for at least 14 days before they can officially purchase a franchise. 

The FDD contains a lot of important data that can form the basis for your franchise due diligence of a brand. Some of the critical information you may find in an FDD includes:

• Lawsuits the franchisor has been in 
• Investment costs to build a location, including the initial franchise fee
• Ongoing costs to run the business (including how much your royalty and any other fee costs)
• Required products or services you have to purchase if you’re a franchisee
• Disclosures from the franchisor on any and all revenue they make from required purchases of franchisees
• Territory structures and sizes
• Financial performance representations (about 50% of brands include financial performance data from the previous fiscal year) Unfortunately this information may not be as helpful as it appears on the surface, but that’s why we’re here to help (and why speaking to franchisees of a brand is the most important evaluation step as a buyer)

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Chains versus Franchises - What is the Difference?

Put simply, franchises are owned by small business owners (often locally), whereas chains are owned by corporations. 

For example - the vast majority of McDonald’s locations are owned by individuals, whereas every single In-N-Out burger location is owned by the company itself. 

There are pros and cons to each business model. Chains require the company to invest all the money required to build every location, where as franchises outsource the capital for new locations to the franchisees.

Chains own 100% of the profits every store generates, while franchises main income stream is the royalty they charge from franchisees. 

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Franchise Sales Organizations

Franchise Sales Organizations, (FSO’s for short) are companies that partner with emerging franchises to develop their brand. In other words, FSO’s recruit new franchisees on behalf of brands, and in exchange receive a percentage of the franchise fee, and sometimes a minority percentage of royalties for every unit they sell. 

FSO’s provide value because it can be difficult for a new franchisor to continue running their local business, while also trying to launch a franchising entity, and all the rules, regulations, expertise, and capital investment it requires.

With that said, it is very important to understand the nature of an FSO’s agreement with a brand you are evaluating, as some FSO’s offer very unfavorable terms to franchisors that can put those brands in a bad financial position, which ultimately impact you as a franchisee. 

Overall, FSO’s can be a net positive so long as they align their interests with the long-term interests of the franchisor and their franchisees.

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Franchise Consultants / Brokers

Franchise brokers, or consultants, represent a large variety of franchises, and are paid by franchisors in exchange for introductions to people that eventually become a franchisee.

‍Example: FranDawgs offer brokerage services to prospective clients who want to own a franchise. If you speak with us, and we introduce you to a few brands that match your criteria, and you go on to become a franchisee of one of those brands, that brand would pay us a referral fee.

Franchise Consultants Versus FSO’s - What’s the Difference?

The key differences between brokers and FSO’s are as follows:

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Brand partnership volume 

FSO’s represent a few brands, to as many as roughly 20, whereas brokers are part of organizations that have agreements with as many as 1,500+ franchises

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Depth of Brand Partnerships 

FSO’s are companies with W2 employees who have in-depth relationships with partner brands, and typically include advisory and other services as part of their agreements. 

Brokers however are individuals who largely work with other individuals looking to buy a franchise brand (similar to real estate agents). Some FSO’s make it a point to develop relationships with specific brokers as a way to source candidates for their brand. 

In these scenarios, the FSO will pay a portion of the franchise fee they receive back to the broker, if the candidate was originally introduced via the broker. 

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Compensation

As mentioned above, FSO’s are paid via a mix of franchise fees, royalties, and sometimes even direct equity in the brand, whereas franchise brokers are paid entirely via commission for successfully placed clients. 

At FranDawgs, we do our best to recommend the best franchise for you (and in some cases may recommend an alternative path if franchising doesn’t seem like a fit for you). But it is still important for you to understand the nature of our business so that you can factor that into consideration as part of your due diligence 

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