How Do Franchises Work?

A franchise is a business model where a franchisor grants a franchisee the right to operate under their brand, using the franchisor’s business systems, products, and intellectual property. In exchange for this right, the franchisee typically pays initial and ongoing fees to the franchisor, who continues to offer support, training, and brand management. While the franchisee is responsible for the day-to-day operations and assumes financial risk, they benefit from the backing of an established brand and proven business model. 

What Is a Franchise and How Does It Work?

A franchise works by allowing individuals (franchisees) to operate their own business using the name, branding, and established business model of another company (the franchisor). The franchise model is a system that has been used by many, offering franchisees an opportunity to enter the market without starting from scratch.

Franchisees operate as business owners but are contractually obligated to follow the operational guidelines, maintain brand standards, and pay specific fees to the franchisor. Common industries using this model include fast food, travel, and home services.

Franchise agreements govern the relationship between the franchisor and franchisee. This legal document outlines expectations on both sides, from the operational guidelines to financial obligations. It’s critical for franchisees to thoroughly review the Franchise Disclosure Document (FDD), a detailed document that includes financial statements, franchise system operations, and legal considerations. This ensures franchisees know what they are getting into before committing to the franchise system.

The Franchise Agreement: A Critical Component

The franchise agreement forms the backbone of the relationship between the franchisor and franchisee. It outlines specific expectations, legal requirements, and the scope of the franchisee's rights, ensuring that both parties are protected.

Key components of the agreement typically include:

• Brand standards: Franchisees must maintain the operational procedures and quality standards set by the franchisor.
• Franchise fee: An upfront cost, often referred to as the initial franchise fee, that the franchisee pays to acquire the rights to operate under the franchisor’s brand.
• Ongoing royalties: A percentage of revenue that franchisees regularly pay to the franchisor. This royalty fee supports the continuous benefits provided by the franchisor, such as marketing, training, and ongoing support.

Franchise agreements also include other ongoing costs, such as advertising fees, which contribute to the franchisor’s national marketing campaigns, and operational guidelines that ensure brand consistency across all franchise locations.

The Roles of the Franchisor and Franchisee

The franchisor and franchisee have distinct roles within the franchise system, but their success is deeply interconnected.

The Franchisor

The franchisor provides a proven business model, systems, training, and ongoing support. They are responsible for maintaining brand integrity and ensuring that franchisees comply with the established procedures. Franchisors often offer guidance on marketing strategies, real estate selection, and operational best practices to help franchisees thrive.

The Franchisee

The potential franchisee takes a financial risk to open and operate a business. They must follow the franchisor's guidelines and maintain the established brand standards, and are responsible for day-to-day management, hiring, and ensuring profitability. Franchisees also benefit from access to the franchisor’s intellectual property and ongoing support, which may include regional training sessions or operational updates.

In some cases, a master franchise may be involved. A master franchisee operates in a larger territory and can sub-franchise to others, adding another layer of oversight to ensure that the franchise system operates smoothly within that region. 

Why the Franchise Model Is Valuable

Franchising offers an opportunity for those who want to own a business but prefer the structure and support that come with an established brand. Franchisees can gain access to a trusted brand name, proven systems, and often benefit from strong support networks, which can make it easier to launch and operate the business.

Building a successful business by franchising is helped by its combination of independence and support. Franchisees can enjoy the autonomy of owning their business while benefiting from the franchisor’s training, support, and established reputation. Understanding the financial structure, roles of the franchisor and franchisee, and the critical elements of the franchise agreement is essential for any prospective franchisee. This partnership can lower the risks associated with starting a business from scratch and increase the potential for long-term success. 

IFA Is Here to Support You

If you’re considering a franchise business, the International Franchise Association offers comprehensive resources to help you evaluate franchise opportunities, including understanding the franchise agreement and disclosure document requirements, as well as the ongoing responsibilities of both parties. Learn more today!