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Franchise Glossary – What is Franchising

Franchising can be a very complex subject.  To make sure you fully understand what you are getting yourself into, we have put together a list of common franchise terms complete with their definitions.

Advertising fee – This is a contribution franchisees are required to make to the network’s advertising fund. This fund, which is usually administered by the franchisor, is used to fund national advertising and marketing programmes. It is either a percentage of sales, typically ranging from 0,5% to 3%, or a fixed monthly fee. Not all franchisors charge an advertising fee or similar levy, this will be set out in the network’s disclosure document and cemented in the franchise agreement.

Advertising fund – See advertising fee.

Approved supplier – Supplier accredited by the franchisor to supply goods or services that are required in the day-to-day conduct of the franchised business to the network. In many instances, the franchisor will negotiate favourable prices and terms with these suppliers, for the benefit of all members of the network.

Area developer – The area developer acquires the right to develop the brand within a defined geographical area. Most often, this takes the form of the developer setting up a predetermined number of branches in the area and operating them for its own account.

Business broker – An individual or company retained by the franchisor to market the franchise on the network’s behalf, usually on a commission basis. If recruited by a broker, you should proceed in the same way as explained in the section headed Evaluating a franchise offer. More specifically, you should insist on intensive personal interaction with the franchisor prior to the signing of any binding agreement.

Business format franchising – An arrangement whereby the originator of the franchise, known as the franchisor, grants others, known as franchisees, the right to conduct business under the franchise’s name using proprietary products, systems and procedures. The franchisee is required to make a significant investment into the business and conduct operations in accordance with the franchisor’s guidelines. The franchisor is obliged to provide substantial initial and ongoing support to franchisees and has the right to enforce adherence to agreed standards.

Business plan – A plan that outlines the objectives of a business and the steps that will be implemented to achieve those objectives, including a marketing plan and financial projections. If you are seeking funding from a bank, they will demand that you present them with a business plan. Indeed, banks offer advice on the compilation of a realistic business plan, and even templates.

Company-owned unit – This is a unit that operates under the network’s brand but is owned by the franchisor. Franchisors use company-owned outlets to test new products and systems before implementing them across the franchised outlets within the network.

Conversion franchise – A Unit franchise, the difference being that instead of recruiting a newcomer to the sector and setting him or her up in the business, the franchisor invites an established operator to join the network. The franchisor gains access to a going-concern business, the franchisee benefits from bulk purchasing and marketing activities.

Cooling-off period – FASA stipulates that a minimum period of two weeks must elapse between the day a prospective franchisee receives the disclosure document and the day he or she signs the agreement and/or makes any payments to the franchisor.

Copyright – Legal protection granted to the originator of a work. In the context of franchising, aspects of corporate identity, trademarks, systems, manuals and marketing materials can be protected by copyright, subject to certain conditions being in place.

Designated supplier – See Approved supplier.

Development type – This is the franchise model chosen by the franchisor to expand the network. See unit franchise, multi-unit franchise, area developer, regional franchisee and master franchisee.

Disclosure document – This document provides qualified prospects and their professional advisors with sufficient information to enable them to make an informed assessment of the franchise offer. It contains confidential information and the franchisor is well within his right to insist on the signing of a secrecy undertaking. Guidelines for the compilation of disclosure documents are set out in Appendix A to FASA’s Code of Ethics and Business Practices.

Distributorship – A manufacturer or wholesaler grants permission to businesses and individuals to sell a range of products, usually within a protected territory. A distributorship arrangement does normally not qualify as a franchise.

European Franchise Federation (EFF) – An umbrella body for national franchise associations, primarily those situated within the European Union (EU). It was established to promote franchising and represent the interests of its members vis-a-vis governments, the media and the public.

Exclusive territory – A franchisee may be granted exclusivity within an area. It should be noted, however, that such an arrangement could be seen as infringing competition legislation and the franchisor’s ability to enforce it, for example against other franchisees within the network, may be limited.

FASA – See Franchise Association of Southern Africa.

FASA Code of Ethics – Code of good franchise practice first published by FASA in 1979 and updated several times since. This code is designed to ensure fair dealings within the franchise fraternity and is binding on FASA’s members.

Field Service Consultant (FSC) – Individual employed by the franchisor, primarily to provide assistance to franchisees in his or her care. Ideally, the FSC represents franchisees’ interests vis-à-vis the franchisor and vice versa, often with a slight bias in favour of franchisees.

Fractional franchise – The franchise is housed in a clearly demarcated area of an established business, usually one that is active in a related sector. An example is a car wash facility set up within the precinct of a petrol station. Certain facilities like reception, cash tills and the like can be shared.

Franchise – The right granted to a franchisee to offer specific products or services, usually within a certain area or from a certain location and valid for a stipulated period of time.

Franchise agreement – Outlines the rights and obligations of the parties to the arrangement. It usually covers territorial rights of the franchisee, location requirements, training schedules, initial and ongoing fees, general obligations of the franchisee and general obligations of the franchisor.

Franchise Association of Southern Africa (FASA) – This organisation was established in 1979 and has as its objective the promotion of franchising in South Africa. It is a membership-based association not for gain, funded by its members. Membership is open to bona fide franchisors, their franchisees and professional entities who provide services to the franchise sector. The FASA Code of Ethics, which is binding on its members, aims to protect the interests of franchisees and is acknowledged as being among the most progressive worldwide. FASA is a member of the World Franchise Council.

Franchise broker – See Business broker.

Franchise fee – see upfront fee and management services fee.

Franchisee – The operator or owner of a franchised business.

Franchisee Representative Council – Body of franchisees elected by franchisees within a network to represent their interests. Increasingly, forward-looking franchisors encourage the establishment of such a body because it provides a channel for the orderly exchange of information and ideas.

Franchise resale – A franchised business that is already operational and is up for sale. Franchisees sell their franchises for a number of reasons including retirement, another business venture, emigration etc. The total investment may be higher than that required to set up a comparable new unit but the business is a going concern, with established local clientele, and therefore likely to generate more predictable returns from day one.

Franchising – This is a method of expanding a business that involves at least two parties, namely the franchisor and the franchisee.

Franchisor – The parent company or person that grants, in exchange for a fee and subject to other conditions, the right to use its name and system of business operations.

FSC – See field service consultant.

Initial investment – See total investment (Tot).

Investment franchise – This is usually reserved for operations where the franchisee invests a significant amount of money in the franchise such as a hotel. The franchisee is likely to work at arm’s length from the franchise and will employ a management team to operate it. In smaller operations, for example in retail, franchisors do not like such an arrangement because “having the franchisee behind the counter serving customers” is what makes these businesses successful.

Job franchise – See single unit franchise – manual.

Management franchise – The franchisee is expected to use his or her skills and experience to manage and market the business. However, the actual work will be carried out by trained staff the franchisee employs. The typical business of this kind requires office or light industrial premises rather than retail premises, and the bulk of its business will come from performing a service, often in the business-to-business sector.

Management services fee – Ongoing fee payable by the franchisee to the franchisor in exchange for receiving ongoing assistance in all aspects of operating the business. Usually calculated as a percentage of sales and payable either weekly or monthly. (This fee is sometimes described as a “royalty” but this is misleading.)

Marketing plan – The marketing plan should form part of your overall business plan. It defines the market for the product or service and describes the target customer base as well as competitor activities. It also contains strategies for attracting and keeping customers and for anticipating change.

Marketing services fund contributions – See advertising fee.

Master franchisee/licensee – This is a franchisee who has been granted the right to develop the franchise and recruit franchisees within a territory, usually an entire country. In effect, the master franchisee assumes the role of the franchisor within the territory.

Multi-level marketing – This is a form of distributorship. Participants earn commission on their own sales as well as on sales made by others they have recruited as distributors lower down the chain. Legitimate multi-level-marketing (MLM) schemes should not be confused with pyramid selling schemes (which are illegal). The main difference between these two concepts is in their focus: if participants’ major financial incentive comes from selling a viable product rather than territorial rights, the scheme is a legitimate MLM.

Multi-unit franchisee – The franchisor awards the right to a franchisee to operate more than one unit within a defined territory. Care should be taken if this is linked to a binding development schedule – the franchisee could be forced to establish further units before the original business has become viable.

Operations and procedures manual – This manual contains comprehensive guidelines for the establishment and operation of the franchised business. It covers all aspects of the business and may consist of separate manuals dealing, for example, with administration and accounting, HR issues, marketing, product information and equipment maintenance. It is customary for the operations and procedures manual to be an extension of the franchise agreement: the franchise agreement lays down binding principles while the operations and procedures manual provides detailed operating instructions.

Product (trademark) franchise – Grants the franchisee the right to trade under a common brand, provides some corporate identity and, above all, a range of products, usually on a mutually exclusive basis. Beyond that, however, the franchisor offers little if any operational assistance and the franchisee is left to fend for him/herself.

Renewal right – Most franchise agreements are valid for a fixed period. It is customary, however, to grant the franchisee the right to renew it for a further period, usually under similar conditions, once the initial term has expired. Renewal is often conditional upon the franchisee complying with certain requirements. For example, the franchisee may be compelled to update the unit’s appearance to match that of newer units in the network. Such conditions will be set out in detail in the franchise agreement.

Restraint of trade – Most franchise agreements contain such a clause. It means that the franchisee is not permitted to operate in opposition to the network, usually for a specific period and within certain boundaries. This clause is legally enforceable only if it is reasonable, both to its extent and duration.

Retail franchise – The franchisee occupies retail premises, selling products or services during retail hours to ‘walk-in’ customers. The business is totally dependent on the premises and turnover is achieved from passers-by who decide to enter the premises.

Royalty – See management services fee.

Secrecy undertaking – Legally binding document intended to ensure that individuals posing as prospective franchisees do not obtain confidential information on the pretext of being interested in the franchise offer and use it to damage the franchisor’s legitimate interests.

Single unit franchise – executive level – Sometimes referred to as a “white collar job franchise” because the franchisee will be working hands-on in the business, usually supplying, selling and delivering products or service. It may be mobile, home-based or requiring small office premises. The type of work to be carried out by the franchisee is similar to the work executives would carry out.

Single unit franchise – management level. The franchisee manages the business but hires staff to carry out the actual service.

Single unit franchise – manual level – Sometimes referred to as a “blue collar job franchise” because the franchisee will be working hands-on in the business, usually carrying on a trade or delivering a product or service. It may be mobile, home-based or requiring small office premises.

Social franchising – This is essentially a business format franchise. It differs in that initially, its operation will be subsidised, but with the overall aim that over time it becomes self-sustaining. An example is a health service in a rural area. An NGO (non-governmental organisation) acts as the franchisor and subsidises franchisees’ operations initially, on the understanding that the target population (which is poor) will be charged prices they can afford. Over time, the amount of subsidy paid per patient will be reduced and once the operation becomes commercially viable, it will be withdrawn.

Supplementary manual – A manual that forms part of the official operations and procedures manual (OPM). In many instances, such a manual is issued by a supplier to the network. The use of supplementary manuals offers several advantages. For example, an instruction manual that comes with the POS (point of sale) system can be made accessible to till staff virtually without restrictions. And if the supplier of the system develops an upgrade, it would come complete with a revised manual. The OPM, on the other hand, is confidential, and updates must be made by the franchisor.

Tandem franchising – A deserving individual, usually recruited from the ranks of the HDIs, is offered an opportunity to become a franchisee over time. Most if not all of the start-up capital is made available by a bank or donor organisation, often as a mixture of an unsecured loan and a grant. The franchisor makes a mentor available who guides the franchisee who acquires shares in the business out of profits earned. Over time, the franchisee is the outright owner of the business, and the mentor withdraws.

Termination clause – Refers to the legal provisions setting out the circumstances under which either party in the relationship may terminate the contract. An example is the “breach of contract” clause.

Territory/area – Denotes the ‘exclusive’ territory, be it national, regional/area, province or on a postcode basis, which is allocated to the franchisee. See: Exclusive territory.

Total investment (Tot)> – This is the amount of money required to join the network and set up the franchisee’s business. The amount is made up of the initial fee payable to the franchisor, investment in equipment and fixtures, other costs arising from setting up the business and an adequate amount of working capital.

Trademark franchise – See product franchise.

Turnkey package – A package prepared by the franchisor that includes premises, the equipment, systems and even initial stock required to “turn the key and start trading”.

Unit franchise – Also known as a single unit franchise, this arrangement entitles the franchisee to operate a single unit within the network. A unit franchisee may at a later stage obtain approval from the franchisor to open up further units but this is not part of the original agreement. Franchisees who operate several units within the same network are known as multi-unit franchisees.

Up-front fee – This is a fixed amount, usually payable upon the signing of the franchise agreement, in exchange for the right to use the network’s name, logo and business systems. A substantial portion of this fee is usually allocated to initial training, assistance with site selection and the establishment of the business, initial hand-holding and any other assistance given by the franchisor up to the stage when the business opens for trading.

Working capital – A major cause of business failure is not having enough working capital. Working capital can be made up of cash in the bank, trade credit, borrowing capacity (usually in the form of an overdraft arrangement) and cash flow (monies generated by the business). You need adequate working capital to meet start-up expenses and see the business through any unexpected dips in business activity. For example, funds are needed to pay rent and a rent deposit, utility deposits, license fees, wages during the training period etc. As it takes time to build up sales in a new business, the initial few months are likely to generate trading losses – all this needs to be financed.

World Franchise Council (WFC) – Federation of national franchise associations established to serve as a global platform for the promotion and orderly development of franchising. FASA is a full member of the WFC.