This note is designed to provide some preliminary guidance to businessmen considering becoming Franchisors or Master Franchisees.

The first and most important point to understand is that Franchising is a business in its own right. It should be clearly distinguished from the running of the underlying business. Grasp this point and your chances of owning a successful franchising business will be considerably greater.

There are several highly attractive features of franchising, including:

• Franchise businesses generally grow quicker and last longer than independently owned businesses;
• Once established, a successful network of sub-franchisees should provide a healthy income stream for little ongoing effort and outlay;
• Franchising provides a relatively inexpensive way to expand the geographical coverage of your already established and successful business model;
• If you can raise a reasonable amount of up front equity investment and have strong management skills, becoming a Master Franchisee in the UK for, say, as US Franchisor can provide a relatively straightforward means to considerable returns on your investment;
• As an alternative to business acquisitions and organic growth, franchising can be a relatively inexpensive way to grow your business quickly and may suite the CEO whose preference is not to manage new outlets on a day to day basis;
• An opportunity to be self-employed, whilst having the comfort of delivering a proven business concept; and
• A variety of exit options:
• Further indemnity – trade sale to competitor
• Flotation (e.g. Dominos Pizza)
• Supervise the network and continue to receive dividends (successful sub-franchisee networks are highly cash generative).

What are the Different Types of Franchise Business?

The Franchisor has a proven and successful business model, typically consisting of a strong brand, business processes and good prospects for growth. The business to be franchised will currently have a limited geographical presence.

The Franchisor will recruit a network of appropriate sub-Franchisees and license then to operate new outlets for the business provided that they follow the Franchise Rules strictly. Each sub-Franchisee will cover a specific geographical area.

Typically, each sub-franchisee will pay to the Franchisor an up-run, one off licensing fee of approximately £10,000. This covers the Franchisor’s costs (for example for training the sub-Franchisee) and ensures the sub-Franchisee’s commitment. The principal income, however, is an ongoing annual management fee – typically at the rate of 8% but varying between 2% and 30% (depending upon the individual business).

The relationship between the Franchisor and sub-Franchisee is governed by a Franchise Agreement which should be tailored by a good lawyer to reflect the business and the Franchisor’s needs. More important is the Franchise Manual which sets out the rules and guidelines which the sub-Franchisee must follow if he is to keep the Franchise.

Master Franchisee

The Master Franchisee is both the Franchisor and the Franchisee. If, for example, an established American Business wants to launch in the UK, it might appoint a Master Franchisee. The Master Franchisee is the Franchisee since he is given the Franchisor’s system and brand to exploit in the UK. However, the Master Franchisee will also be a Franchisor because he will be authorised to establish a network of sub-Franchisees to cover the UK. Nowadays, the more sophisticated US Franchisors will often set up their own outlet or outlets in the UK as a first step – just to test the market and establish the viability of their business in the UK. Many Franchisors will demand this in order to assess the Master Franchisee’s ability to run the Master Franchise successfully in the UK. Sometimes the Franchisor will prefer to set up a joint venture with the Master Franchisee in the UK, sharing income streams. Also, a Master Franchisee will very often open and run a limited number of their own outlets – either in tandem with or as a precursor to appointing a sub-Franchisee network. Clearly, there is no better way to get to know the underlying business than to run one yourself! This stage is usually referred to as the Pilot Stage. Here, we re-iterate, however, that a Master Franchisee is in the business of running a Franchise Network. He is not in the business of operating the underlying trade of the Franchise – be it fast food outlets or fitness clubs or anything else.

The attraction for the Master Franchisee is that he has the (usually exclusive) right to exploit an establish business model in the UK and to appoint a network of sub-Franchisees to grow the business market share. As stated above, the Franchise Network should, once established, generate a good, continuing income stream for relatively little effort. The Master Franchisee will have to make a significant upfront equity investment in return for this expected return. Every case is different, but an up front investment of between £500,000 and £1million could be required of a Master Franchisee. Occasionally as little as £200,000 is required. This would cover the Franchisee fee payable to the US Franchisor but, more importantly, pay for the Master Franchisee’s own outlets, business infrastructure and management team necessary to run an affective sub-Franchise Network.

Generally, you will find that the high street banks will be keen to lend to your Master Franchise business – but only once the initial and even the Pilot Stage have been successfully completed. Even then, in the development stage, (which is the stage following the Pilot Stage, when the Master Franchisee establishes his sub-Franchisee Network) they are likely to demand security over property or other available assets as a condition of lending. In the development stage, banks might lend up to 70% of the Master Franchisee’s funding requirement. In the Pilot Stage this will typically be restricted to 50%. It is worth remembering that banks will generally be interested in designing a lending package for the Master Franchisee to role out to his sub-Franchisees.

The skills and resources generally required of a successful Master Franchisee are: -

• Sharing the Franchisor’s vision and passion for the business.
• A track record of success (not necessarily in the same market).
• The ability to build and execute a good business plan.
• Access to sufficient capital (usually equity) to develop and National Franchisee Network.
• The management skills necessary to build the Master Franchisee’s own team and the sub-Franchisee Network. Most banks who agree to fund Master Franchisee’s will expect the Master Franchisee to have employed a Franchising Consultant to help them, such as the international Franchising Centre. www.franchise-consultants.com.

Finance

Like a sub-Franchisee, the Master Franchisee will pay fees to the Franchisor. Firstly, the upfront fee: typically 50% of the Franchisee fee that the Master Franchisee gets from each of his sub-Franchisee. Thereafter, management fees are payable to the Master Franchisee to the Franchisor: typically 10% of the Master Franchisee’s receipts, but this percentage can vary widely according to the particular circumstances of the Franchise.

For further advice contact our team direct or talk to your usual contact in the firm.