Is a franchise the best model for your business?
Which model of business is right for your company and what are the pros and cons of a franchise system?
There are many ways to commercialise and expand a business. Often growth is self funded which can lead to slow growth over time , or by bringing on partners or investors which means the owner relinquishes some ownership or control of its business.
If you are looking to expand at a more rapid rate without having to fund that growth, there are a number of ways to do so. Different rights can be granted to go to market such as a licence, or franchise right or a distribution or agency arrangement.
Each model and the rights created by that relationship, has advantages and disadvantages, risks and obligations.
Selecting the right model requires a detailed understanding of the existing business model the proposed market, and developing a business plan and strategy that will determine the right model for you.
This is difficult to do without experienced and independent advisors and consultants.
A licence is a contractual right granted by one party to another. It may for example give the licensee the right to use a parties brand, trade mark or design. An occupancy licence, for example, often granted under franchise agreements gives a franchisee a right to operate its business from a site, also known as an occupancy right. The franchisor generally holds the head lease and then licenses the right to occupy, to the franchisee.
The rights vest with the party that grants the license, the licensor. That contractual right can generally be terminated at short notice or in some cases without notice.
A licencee has no vested interest in the Lease merely a right to occupy. If they have invested a substantial amount of capital to start up their business the risk lies heavily with the licensee as the licence right can generally be terminated without compensation.
In some cases depending on the nature of the licence right granted, it may be deemed a franchise arrangement by reason of the broad definition of franchise arrangement under the Franchising Code of Conduct.
A franchise right is effectively a contractual licenced right, but with additional oblgiations on the franchisor and rights and protections to a franchisee. A franchise right grants the franchisee not only a licence to use the franchisors brand, trade marks and intellectual property, but also use of its operating business system and methodologies.
It gives the franchisee access to the franchisor’s supply chain, buying power and its marketing and branding power.
The franchisor will usually have negotiated approved supplier agreements for suppliers to provide products and/or services based on volume discounts or rebates negotiated by the franchisor.
In exchange for the grant of a franchise right the franchisee will usually pay the franchisor an upfront fee (franchise fee) and an ongoing royalty based on the franchisees gross turnover, or sometimes a fixed fee, as well as possible administration support, sofware licence and marketing fees.
The advantage of a franchise model is that the franchisee funds the set up and capital costs to establish the business, not the franchisor. The franchisor can therefore expand its brand quickly and in areas or states or territories, where it might not otherwise have thought it could operate.
Franchisees gain much more than a simple contractual right as they would under a simple license. They gain access to the brand and systems developed and training and support from the franchisor. The franchisor must also meet mandatory Code requirements for disclosure and there are certain restrictions on the franchisor’s rights, to terminate the franchise relationship which the franchisee has acess to mediation and dispute resolution processes.
Franchising rights can be exclusive or non-exclusive. Often rights are granted to a territory or a particular site.
Where they are not exclusive rights there may still be an exclusive marketing territory, in which the franchisor agrees not to compete nor allow other franchisees to compete.
The franchise agreement imposes greater obligations on the franchisee to ensure the franchisors systems are adhered to and the services to the end consumer are consistent and of unified standard. There may also be minimum performance criteria, imposed on a franchisee and consequences if they fail to meet them.
A distributor buys goods from a supplier or manufacturer, takes title of them and sells the goods to another reseller, retailer or directly to consumers.
The distributor is independent from the supplier and may distribute for a range of other suppliers and manufacturers. The supplier may appoint the distributor as its “sole” distributor for a country, area or region.
Under a distribution arrangement the distributor relies relying on the suppliers brand and may be given marketing collatoral and assistance by the supplier to market the products, however the distributor must actively market and promote the goods or services.
The distributor often provides after sale, service and support to the end customer.
Distributors generally add a margin to the price of the goods they purchase, and their fees are generally higher than an agent as they usually carry and hold stock and extend credit to the reseller or retailer.
Distributors do not generally pay an initial fee or ongoing royalties to the supplier as the distributor will buy product and/or services at an agreed list price, on which it places a margin for on sale to consumers or retailers.
Under the Australian Consumer Laws distributors may be liable to the reseller and or the end consumer for basic statutory warranties as to fitness for purpose or for the supply of a defective product.
Agents gain orders on behalf of their principal. The principal then generally delivers the goods directly to the end customer, and invoice the end customer directly.
Unlike distributors, agents do not hold goods. They are generally appointed to seek out customers and promote the principal products or services in a market.
Agents may act for more than one principal, on a non exclusive basis or they may be appointed as a sole agent for a particular product in a market.
Agents generally get paid either a commission on sales made, or an up-front retainer and part commission.
Unlike importers or distributors agents do not take legal possession of goods and agents disclose they are acting as a agent for a named principal to avoid direct liability.
Exclusive or non-exclusive rights
- Many agents and distributors seek exclusivity in a market or territory as they will invest considerable money and their own resources to create the market.
- The stronger the brand the more value an exclusive right will have to them.
- Exclusivity usually carries with it greater obligation and responsibility and usually the supplier imposes a minimum performance and sales criteria, with termination rights for non-performance.
- The chosen representative, agent or distributor should have experience and understanding of the market, knowing any competition in the market and pricing, and advise on product modifcations necessary for local conditions.
- They should also have an established network and trading history and be enthusiastic and active in marketing and promoting the brand or product or services.
- It is important when granting any rights that due diligence both finanical and business and personal is conducted on the party that will be representing your interests.
To be or not to be a franchise
No matter what the rights granted are called or the agreement is named, if it contains the elements of a franchise arrangement it will be caught and governed by the Franchise Code.
Whether it will be deemed a franchise arrangement will to a large degree depend on the degree of control and the rights and obligations granted under the arrangement. For example, many licence agreements incorporate and/or mirror many of the same obligations as a franchise arrangement and therefore will be caught under the Franchising Code.
Many distribution agreements have also been deemed to be a franchise arrangement due to the obligations imposed on the distributor.
A failure to comply with the mandatory Franchising Code in Australia since January 1, 2015, carries with it severe potential fines and penalties which may be imposed by the ACCC on the company and individual directors.
Seeking expert legal advice to ensure your compliance in the Australian market for local and overseas companies looking to grant rights, is now even more critical.