What Is a Franchise?

A franchise is a business model where one party, the franchisor, grants another party, the franchisee, the rights to operate under its established brand and business system. The franchisor provides the brand name, logo, and operational structure, while the franchisee typically pays an initial fee and ongoing royalties to run the business using these resources.

In everyday terms, the word “franchise” often refers to the actual business the franchisee runs, though it technically means the contract that binds the franchisor and franchisee. This arrangement, where the brand and system are shared, is what’s known as franchising.

Types of Franchising

Franchising generally falls into two types: Business Format Franchising and Traditional (Product Distribution) Franchising.

What Is a Business Format Franchise?

In Business Format Franchising, the franchisor provides a complete business model, including branding, operational systems, and training. This format is common in industries like fast food, where the franchisee operates a franchise business that is nearly identical to others in the franchise system.

What Is a Traditional or Product Distribution Franchise?

Traditional Franchising is centered around the distribution of a specific product rather than an entire business format. The franchisee is granted the rights to distribute the franchisor's product while following certain brand guidelines but with fewer operational constraints. Industries like automotive and gasoline often follow this model.

Franchising Is Built on Relationships

The Role of Relationships in Franchising

Franchising goes beyond legal requirements; at its core, it's about relationships. Successful franchises rely on the bond between the franchisor and franchisee to uphold brand value and meet the franchise system's standards.

The Franchisor’s Support for Franchisees

Franchisors provide ongoing support to ensure franchisees meet brand standards, which builds trust within the franchise system. This relationship is key to delivering quality and maintaining brand reputation across locations.

Franchising Is About Brand Value

The Importance of the Brand

A franchise’s brand is its most valuable asset. Consumers choose franchises based on their trust in the brand, regardless of the specific business owner. For franchisees, this means building strong customer relationships while maintaining the brand’s quality and reputation.

Customer Loyalty, Brand Expectations, and Enforcing Standards

Franchisees are expected to uphold the brand’s reputation by consistently meeting consumer expectations. This trust in the brand is strengthened when franchisees provide high-quality service, creating a positive experience that benefits the entire franchise system. To protect both the brand and franchisees, franchisors enforce standards across all locations, ensuring consistency and reinforcing a trusted brand image that resonates with customers everywhere.

Franchising Provides Systems and Support

Great franchisors offer systems, tools, and support to help franchisees maintain brand standards. This support covers areas like site selection, training, and marketing, ensuring franchisees can deliver a consistent experience.

Common Services Provided to Franchisees

Franchisees typically receive a range of support, including:

• Recognized brand name
• Site selection and development
• Management training
• Research and development for new products
• Marketing and advertising assistance

Franchising Is a Contractual Relationship

Regulations ensure transparency, protecting both franchisors and franchisees. The FTC’s franchise rule requires franchisors to provide a Franchise Disclosure Document (FDD) to prospective franchisees before signing the franchise agreement. This document outlines crucial details such as start-up costs, operational expectations, and the franchise system structure.

Franchising Regulations in the United States.

In the United States, franchises are regulated by the Federal Trade Commission (FTC) and individual state laws. A franchise exists when:

• The franchisor grants use of its trade or service mark.
• The franchisee uses the franchisor's operating methods.
• The franchisor provides support and exercises control.
• The franchisee pays fees to the franchisor.

Varying Definitions by State

Franchise definitions can vary by state, sometimes including elements like a marketing plan. It's essential to understand both federal and state-specific definitions when exploring franchise opportunities.

The Franchise as a Contract

A franchise is a formal contract between the franchisor and franchisee that grants the franchisee rights to use the brand and business model. While a franchise is a type of licensing, specific regulations make it unique.

Franchise Agreements and Financial Structure

The Franchise Disclosure Document (FDD) 

The FDD is an essential tool for prospective franchisees. It provides comprehensive information about the franchise system, including start-up costs, annual report details, and the franchise fee. This document helps potential franchisees make informed decisions and is part of the disclosure requirement mandated by the FTC.

The Franchise Agreement

The franchise agreement is the binding contract that outlines the relationship between franchisor and franchisee. It specifies the trade name usage, territorial rights, and the franchisee's obligations, such as adhering to brand standards and operating within the franchise system.

Fees and Royalties

In return for brand access, franchisees pay an initial franchise fee and ongoing royalties to the franchisor. These fees support the franchisor's continued investment in the brand and franchise network.

Operational Independence with Brand Support

While franchisees run their businesses independently, they follow the franchisor’s guidelines to maintain brand quality. Success and risks are based on the franchisee's performance within this supported framework.

What is the Role of the Federal Trade Commission (FTC) in Franchising?

The FTC oversees franchise regulations in the United States, ensuring franchisors comply with transparency laws to protect prospective franchisees. These regulations ensure that all information, like the FDD and franchise tax report, is provided accurately.

Considerations for Prospective Franchisees

Evaluating Franchise Opportunities

Before investing, prospective franchisees should research the franchise system and consult a qualified franchise lawyer. A solid understanding of the franchise’s offerings and obligations is essential for success.

The Value of Guidance

Seek legal and financial advice to fully understand the franchise agreement and system expectations. This preparation ensures an informed franchise investment in a new business with a strong foundation for growth.

The International Franchise Association (IFA) is proud to provide industry-leading events, advocacy, education and growth opportunities to the franchise community. Check out our additional resources and upcoming events!

Find out more about franchising by visiting our frequently asked questions page here.