The term “franchise” gets thrown around a lot in business, sports, entertainment, and the like. But what does it truly mean? What constitutes a franchise, at least in the traditional business sense?
Even the most seasoned entrepreneurs can get confused about franchising and how it really works. It’s pretty easy to do – after all, there’s a lot of different components and terms to understand both individually and as a whole!
To that end, here’s a closer look at just what constitutes a franchise, including who the key players are and how the franchising works!
What Makes a Business a Franchise?
According to the Federal Trade Commission (FTC), a business is considered a franchise if it meets the following three requirements:
- The business must have an associated trademark with it
- The business provides authority and assistance
- A contractual payment method between the franchisee and franchisor must exist
Here’s a closer look at them below!
A registered trademark or other symbol associated with the business must be provided to the franchisee. After a franchisee purchases a franchise unit, they gain the legal right to sell and use products using the trademark.
Authority and Assistance
This means that the franchisor has the ultimate control over how their business is operated on a day-to-day basis. Some examples of this include hours of operation, site approval and construction, business practices, and the like. In short, the franchisor establishes how the business operates, while the franchisee executes it with both initial training and ongoing assistance from the franchisor.
Although this varies by franchise, the franchisee is expected to pay the franchisor various fees, often in the form of an initial franchise fee, royalties, and any additional fees as required by the franchise agreement.
If a business is able to meet all of these requirements, it’s considered a franchise under FTC Franchise Rule guidelines.
In addition, many states also have their own unique definitions of what constitutes a franchise. However, they still generally still must consist of a marketing plan, association with a trademark, and required fees in order to qualify as a franchise in the following states, in addition to adhering to the FTC guidelines above.
These states include:
- North Dakota
- Rhode Island
Here’s a quick look at these franchising aspects:
Each franchise develops its own marketing plan to help sell its products or services. Often, the franchisor takes on the bulk of the advertising operations so franchisees can focus on selling and the daily operations of their franchise unit. Notably, in Hawaii, Minnesota, Mississippi, Nebraska, and South Dakota, a franchise needs to have an association with a community of interest or target demographic as opposed to a marketing plan.
Association with a Trademark
Just like the FTC, these states require that a franchise be clearly associated with a registered trademark. Any franchise units owned and operated by a franchisee must also be associated with the trademarks.
These states also specifically require that franchisees pay a franchisor to establish a franchise unit in their name.
Franchisee-Franchisor Relationship is Crucial
In franchising, the franchisor-franchisee relationship is key. The franchisor provides not only the rights to legally use its trademarks and business plan, but also offers ongoing training and assistance to the franchisee. In exchange, the franchisee pays the franchisor an initial franchise fee upfront, plus ongoing royalties.
The franchisor isn’t generally involved in the day-to-day operations of running a franchise unit, which is a responsibility that falls on the franchisee. However, they do provide ongoing help for franchisees, usually in the form of:
- Marketing and advertising assistance
- Operational support
- Site selection and design
Franchisees, meanwhile, oversee daily franchise unit operations. These typically include:
- Hiring staff members
- Determining employment standards and practices
- Employee discipline issues
Key Franchise Terms to Know
What constitutes a franchise can seem complex, even for those with extensive business experience. Ultimately, it all comes down to the main players and how they relate to each other in the franchising system. In addition to understanding what makes a business a franchise, it’s important to know these key terms. Here’s a look at them in detail to help you better understand how franchising works!
A franchisor is a person or business who sells the right to sell its products or services using its brand, business model, and intellectual property in exchange for fees and royalty payments.
A franchisee is an entrepreneur who purchases the rights to use a franchisor’s trademarks, brand name, and proprietary knowledge to sell their products or services.
Trademarks also play a key role in franchising.
A trademark is a phrase, word, or symbol used to identify a business’ services or products. Franchisees pay franchisors for the right to open and operate franchise units bearing their trademarks.
A franchise’s business model is another key component of what constitutes a franchise. A business model is defined as the plan a company uses to succeed, focused mainly on how to generate revenue, acquire customers, sell its products and services, and finance itself.
Fees are another part of franchising and are paid by the franchisee to the franchisor in exchange for the rights to operate a franchise unit under their name, trademarks, and business model. Almost all franchises require the franchisee to pay an initial franchise fee, typically a one-time flat rate fee paid upfront after signing a franchise agreement, as well as ongoing royalty payments on a monthly or quarterly basis in most cases.
Training and Assistance
Training and assistance also play a critical role in the franchise model. Franchisors provide training and ongoing assistance to franchisees to help them run their franchise units, often in the form of marketing campaigns, financial help, assistance with site selection and construction, and the like.
Understand What Constitutes a Franchise to Succeed as an Entrepreneur!
Having a strong grasp of who the different players in franchising are and how they relate to each other is crucial in understanding what constitutes a franchise. By understanding what makes a business a franchise, you can better prepare yourself to follow your dreams and become your own boss as an entrepreneur!