Franchise Basics Series: Franchise Relationships
When first starting to franchise your business model, it may be difficult to wrap your head around the complexities of franchise relationships. The type of franchise relationship you are most familiar with is probably single-unit franchising. This is the classic form of franchising where there are only two parties involved – you and the franchisee, who only owns one unit. You put time and effort into selling each individual franchise unit and have ongoing control over your brand and system. Single unit franchising is a good way for you to evaluate a franchisee before you approve that franchisee purchasing more units. On the other side, franchisees can evaluate whether the business model is right for them before expanding. However, single unit franchising can be time consuming and expensive. The franchisor is responsible for selling franchises, monitoring franchisees’ compliance, and developing multiple territories, among other responsibilities. Those franchisees only interested in purchasing a single unit may not have the financial resources or ambition that an owner of a multi-unit franchise may have. Additionally, single unit franchisees may be dissatisfied with the financial returns from owning only one unit. While there are advantages to single-unit franchising, more and more franchise systems are moving to a multi-unit structure.
The NASAA Multi-Unit Commentary suggests the terms to be used when describing franchise relationships. According to Fundamentals of Franchising, there are three types of multi-unit franchising systems: (1) area development; (2) master franchise; and (3) area representation. Rupert M. Barkoff et al., Fundamentals of Franchising §2 (2016). An Area Developer will have the right to develop more than one unit in a specific territory in accordance with a development schedule that will specify a minimum or maximum number of units. There are only two parties to this relationship: the franchisor and the area developer. The franchisor expands its business more quickly than with single-unit franchising and the area developer gets to know the brand and business model more quickly than as an owner of a single unit. Additionally, the franchisor retains some control over the development of the territory. However, keeping the area developer on track with the development schedule can be challenging. Additional training at the start of the relationship may be necessary because not only is the area developer learning the brand in system, but is also learning how to effectively run more than one unit.
Often used in international franchising, Master Franchisees (or subfranchisors) will have the right to offer and sell unit franchises or unit subfranchises within a territory, pursuant to a development schedule. The franchisor will enter into an agreement with the subfranchisor, who will in turn enter into agreements with subfranchisees. In this type of relationship, the franchisor’s responsibilities are limited and there is not as much of a need for the franchisor’s resources because the subfranchisor uses its time, effort, and funds to find new franchisees, propel growth, monitor franchisees’ compliance, and manage advertising campaigns in the country or region. However, the franchisor loses a good amount of control over the brand and the system, and underdevelopment is also a concern. Subfranchisors may lack experience; or may not devote sufficient time to the development schedule.
In the third type of multi-unit franchising, Area Representatives have the right to solicit and recruit prospective franchisees. The franchisor will enter into an agreement with the area representative, and will also independently enter into agreements with unit franchisees referred to the franchisor by the area representative. Their goals can be measured by the number of recruits they refer to the franchisor or minimum number of units continually operating in the territory. Initial and ongoing support, site selection, and grand opening assistance may also be included in their duties. Under an Area Representative Agreement, franchisors maintain control in that they have final approval over units being opened. As with other multi-unit franchise relationships, underdevelopment and failure to meet schedules can be challenging. You may have liability issues with Area Representatives because they are often seen as agents of the franchisor. Thus, it is critical for franchisors to educate Area Representatives on rules and regulations governing disclosure and franchise sales.
For more information on what franchise system is right for your business model, please contact your franchise lawyer today.