Entrepreneurship:

Successfully Launching
New Ventures, 1/e
Bruce R. Barringer
R. Duane Ireland

Chapter 15

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 Chapter Objectives
(1 of 2)

1. Explain what franchising is and how it differs from other

forms of business ownership.
2. Describe the differences between a product and trademark
franchise and a business format franchise.
3. Explain the differences among an individual franchise
agreement, an area franchise agreement, and a master
franchise agreement.
4. Describe the advantages of setting up a franchise system as
a means of firm growth.
5. Identify the rules of thumb for determining when franchising
is an appropriate form of growth for a particular business.

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 Chapter Objectives
(2 of 2)

1. Discuss the factors to consider in determining whether

owning a franchising is a good fit for a particular
person.
2. Identify the costs associated with buying a franchise.
3. Discuss the advantages and disadvantages of buying a
franchise.
4. Identify the common mistakes franchise buyers make.
5. Describe the purpose of the Uniform Franchise
Offering Circular.

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 Introduction to Franchising

• Introduction
– Franchising is a popular method of business expansion and
is growing in popularity.
– In 1950, fewer than 100 franchisors existed in the U.S.
Today, there are roughly 1,200.
• The number of franchise systems grows by about 200 per year.
• History
– The word “franchise” comes from an old dialect of French
and means privilege or freedom.

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 What is Franchising?

• Franchising
– Franchising is a form of business organization in which a
firm that already has a successful product or service
(franchisor) licenses its trademark and method of doing
business to other business or individual (franchisee) in
exchange for a franchise fee and an ongoing royalty
payment.
– Some franchisors are established firms (like McDonald’s)
while others are first-time enterprises being launched by
entrepreneurs.

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 Types of Franchise Systems
(1 of 2)

• Product and Trademark Franchise

– An arrangement under which the franchisor grants to the
franchisee the right to buy its products and use its trade
name.
– This approach typically connects a single manufacturer
with a network of dealers or distributors.
• For example, General Motors has established a network of dealers
that sell GM cars and use the GM trademark in their advertising
and promotions.
• Other examples of product and trademark franchisors include
agricultural machinery dealers, soft drink bottlers, and beer
distributorships.

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 Types of Franchise Systems
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• Business Format Franchise

– An arrangement under which the franchisor provides a
formula for doing business to the franchisee along with
training, advertising, and other forms of assistance.
– Fast-food restaurants, convenience stores, and motels are
well-known examples of business format franchises.
• Business format franchises are by far the most popular form of
franchising, particularly for entrepreneurial firms.
• Business format franchisors obtain the majority of their revenues
from their franchisees in the form of royalties and franchise fees.

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 Types of Franchise Agreement

• Individual Franchise Agreement

– The most common type of agreement—involves the sale of
a single franchise for a specific location.
• Area Franchise Agreement
– Allows a franchisee to own and operate a specific number
of outlets in a particular geographic area.
• Master Franchise Agreement
– Similar to an area franchise agreement, with one major
difference.
• In addition to having the right to operate a specific number of
locations in a particular area, a master franchisee has the right to
offer and sell the franchise to other people in its area.
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 When to Franchise?
(From the Franchisor’s Point of View)
(1 of 2)

• Approach Franchising With Caution and Care

– Establishing a franchise system should be approached
carefully and deliberately.
– Franchising is a complicated business endeavor, and an
entrepreneur must look closely at all its aspects before
deciding to franchise.
• Regulations
– An entrepreneur should also be aware that over the years a
number of fraudulent franchise organizations have come and
gone and have left financially ruined franchise owners
behind.
• As a result, franchising is a heavily regulated path to business growth.
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 When to Franchise?
(2 of 2)

• When Is Franchising Most Appropriate?

– Franchising is most appropriate when a firm has a strong or
potentially strong trademark, a well-designed business
method, and a desire to grow.
– A franchise system will ultimately fail if the franchisee’s
brand doesn’t add value for customers and its business
method is flawed or poorly developed.

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Advantages and Disadvantages of Franchising
As a Method of Business Expansion
Advantages Disadvantages

• Rapid, low-cost market expansion • Profit sharing

• Income from franchise fees and royalties • Loss of control
• Franchisee motivation • Friction with franchisees
• Access to ideas and suggestions • Managing growth
• Cost savings • Differences in required business skills
• Increased buying power • Legal expenses

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 Buying a Franchise
(From the Franchisee’s Point of View)
(1 of 2)

• Buying a Franchise
– Purchasing a franchise is an important business decision
involving a substantial financial commitment.
– Potential franchise owners should strive to be as well
informed as possible before purchasing a franchise and
should be well aware that it is often legally and financially
difficult to exit a franchise relationship.
• Close scrutiny of a potential franchise opportunity includes
activities such as meeting with the franchisor, reading the Uniform
Franchise Offering Circular (explained later), soliciting legal and
financial advice, and talking to present and former franchisees of
the system you are interested in.

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 Buying a Franchise
(2 of 2)

Answering the following questions will help determine if

franchising is right for you.

• Are you willing to take orders? Franchisors are typically very particular about how
outlets operate.
• Are you willing to be part of a franchise “system” rather than an independent
businessperson?
• How will you react if you make a suggestion to your franchisor and your suggestion
is rejected?
• What are you looking for in a business? How hard do you want to work?
• How willing are you to put your money at risk?
• How will you feel if your business is operating at a net loss but you still have to pay
royalties on your gross income?

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 The Cost of a Franchise
(1 of 1)

Costs involved with purchasing and owning a franchise

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 Advantages and Disadvantages of Buying a
Franchise
Advantages Disadvantages
• A proven product or service within an • Cost of the franchise
established market • Restrictions on creativity
• An established trademark or business
• Duration and nature of the commitment
system
• Risk of fraud, misunderstandings, or lack of
• Franchisor’s training, technical support,
franchisor commitment
and managerial experience
• Problems of termination or transfer
• An established marketing network
• Poor performance on the part of other
• Franchisor ongoing support franchisees
• Availability of financing (in some cases) • Potential for failure
• Potential for business growth

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 Watch Out! Common Misconceptions
About Franchising
Common Misconceptions About Franchising

• Franchising is a safe investment

• A strong industry ensures franchise success
• A franchise is a “proven” business system
• There is no need to hire a franchise attorney or an accountant
• The best systems grow rapidly and it is best to be part of a rapid-growth system
• I can operate my franchise outlet for less than the franchisor predicts
• The franchisor is a nice person—he’ll help me out if I need it

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Legal Aspects of the Franchise Relationship
(1 of 2)

• Federal Rules and Regulations

– The offer and sale of a franchise is regulated at the federal
level.
• According to Federal Trade Commission (FTC) rule 436,
franchisors must furnish potential franchisees with written
disclosures that provides information about the franchisor, the
franchised business, and the franchise relationship.
• In most cases, the disclosures are made through a lengthy
document referred to as the Uniform Franchise Offering Circular
(UFOC).
• The UFOC contains 23 categories of information that give a
prospective franchisee a broad base of information about the
background and financial health of the franchisor.
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Legal Aspects of the Franchise Relationship
(2 of 2)

• State Rules and Regulations

– In addition to the FTC disclosure requirements, 17 states
have laws providing additional protection to potential
franchisees.
• The states include California, Florida, Hawaii, Illinois, Indiana,
Maryland, Michigan, Minnesota, New York, North Dakota, Rhode
Island, South Dakota, Texas, Utah, Virginia, Washington and
Wisconsin.
• In most of these states, a franchisor is required to file its UFOC
with a designated state agency, making the UFOC public record.

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 More About Franchising
(1 of 3)

• Franchise Associations
– Many franchise systems have organized franchise associations to
represent the franchisees’ collective interests and to provide a forum
for franchisees to communicate with each other.
• Franchise Ethics
– The majority of franchisors and franchisees are highly ethical. There
are certain features of franchising, however, that make it subject to
ethical abuse. These features are as follows:
• The get rich quick mentality, the false assumption that buying a franchise
is a guarantee of business success, and conflicts of interest between
franchisors and franchisees.

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 More About Franchising
(2 of 3)

• International Franchising
– International opportunities for franchising are becoming
more prevalent as the markets for certain franchised
products in the U.S. have become saturated.
– For example, heavily franchised companies, such as
McDonald’s and KFC, are experiencing much of their
growth in international markets.
– Foreign firms are also taking advantage of the trend
towards globalization and are offering franchises in the
U.S.

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 More About Franchising
(3 of 3)

For U.S. citizens, these are some of the steps to take before buying a franchise

• Consider the value of the franchisor’s name in the foreign country

• Get a good lawyer

• Determine whether the product or service is salable in the foreign country
• Uncover whether the franchisor has experience in international markets
• Find out how much training and support you will receive from the franchisor
• Evaluate currency restrictions

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