Franchise Fee
Royalty Territorial Protection
Operational Standards
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Key Issues in Developing the Business Terms for Your FDD
Panel Participants Harold Kestenbaum Harold L. Kestenbaum P.C.
Franchise experience since 1977 Based in New York, but supports franchisors nationally Supports both new and existing franchisors Former General Counsel to Sbarro, Inc. Active in the American Bar Association and International Franchise Association Author and speaker on various franchising topics
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Panel Participants Dave Hood, Ph.D. President The iFranchise Group
Founded: 1997 The iFranchise Group assists both start-up and established franchisors 35 full time consultants focusing on strategy, operations, training and marketing Dave is the former President of Auntie Anne’s Soft Pretzels Board Member of Harris Research (ChemDry and N-Hance) Former member of IFA’s Supplier Advisory Board
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Essential Building Blocks for Creating Success What are the most critical things a new franchisor needs to do in order to be successful? Ensure the business decisions drafted in your FDD and Franchise Agreement are optimized for your business model, and will allow you and your franchisees to both succeed in the relationship. Make sure that you have sufficient capital to recruit franchisees and build a solid support infrastructure. Recruit franchisees using a targeted profile and a sound evaluation process. Provide strong leadership to your staff and the franchisee community. Understand and adopt best practices in franchising.
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The Importance of Planning for Growth
The business decisions in your FDD are important, because they: Help define the economics your franchisees will operate under Define the revenue you will receive as the franchisor Clarify the types of franchises you will award Summarize the pre-opening and ongoing support you will provide to franchisees Outline the broad operational standards franchisees must follow Clarify any restrictions on how the franchisee can operate their business Describe how disputes will be handled with your franchise owners
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Step One: Is Franchising the Right Expansion Vehicle?
Three Elements Define a Franchise Relationship Use of a Common Trademark
Payment of Fees or Mark-ups
Operational Control or Assistance
Franchisees operate under the franchisor’s trademark
Franchise fees
Operations manual
Renewal fees
Operational training
Transfer fees
Site approval
Royalties
Site design
Advertising fees
Hours of operation
Design service fees
Production techniques
Training fees
Accounting practices
Technology fees
Personnel policies
Help desk fees
Required marketing
Convention fees
Territorial boundaries Central websites
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Step One: Is Franchising the Right Expansion Vehicle? Alternative Independent Retail Strategies Name
Franchise
Name
Fee
Fee
System
System
Name
Business Opportunity
Name
Fee
Fee
System
System
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Trademark License
Dealer or Licensee
Step Two: Select the Right Franchise Expansion Model
Assuming franchising is right for you, what types of franchise opportunities should you offer? Will your business model perform better with owner-operators? Multi-unit owners? What skill sets are needed by your franchisees? What is the investment required to open a franchise? What are the potential economic returns from a single franchised location? How far away will you be developing markets? Are you developing new markets or ones where your brand already has some traction?
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Step Two: Select the Right Franchise Expansion Model Single Unit Franchising Advantages of Single Unit Agreements Greatest control over unit-level operations. Franchisor
Single Unit Franchise Agreement
Individual operators are more likely to be active in day-to-day operations and focused on the franchisor’s culture. Single store candidates are more easily identified than multi-unit prospects. High degree of control over the selection of existing franchise owners for additional locations.
Disadvantages of Single Unit Agreements Franchisee
Slower rate of growth compared to more aggressive sales strategies. Ongoing support is more expensive given the large number of individual franchise owners that must be supported
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Step Two: Select the Right Franchise Expansion Model Area Development Franchise Structure Franchisor Payment of Fees and Royalties
Area Development Agreement
Area Developer Franchisee Single Unit Franchise Agreements
Direct-Owned Franchise
Direct-Owned Franchise
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Direct-Owned Franchise
Step Two: Select the Right Franchise Expansion Model
Area Development Franchising Advantages of Area Development Agreements Ability to work with more sophisticated owners Fewer franchise relationships for the franchisor to manage, lowering the franchisor’s support costs Potentially faster growth within a market Greater consistency in advertising since one franchisee can advertise across multiple locations
Disadvantages of Area Development Agreements Area developers likely to act more independently than single unit owners Risk that development schedules are not met
Risk that the area developer may not be a strong operator or a positive contributor to the franchise community
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Step Two: Select the Right Franchise Expansion Model Area Representative Agreement Structure Franchisor Area Representative Agreement & Fees Unit Franchise Agreement
Area Representative
Unit Franchisee
Unit Franchisee
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Royalty Payments
Unit Franchisee
Step Two: Select the Right Franchise Expansion Model
Area Representative Franchising Advantages of Area Representative Agreements Faster growth Less capital intensive for the franchisor Area reps are locally based in each market
Disadvantages of Area Representative Agreements Highly complex form of franchising Fees are split with the area representative, lowering revenues for the franchisor Less control over quality in unit-level operations Need to develop separate training and support systems for area representatives Requires the use of a totally separate FDD dedicated to area representative sales
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Overview of Key Business Terms for the FDD
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Federal Disclosure Requirements There are 23 separate items of disclosure required under the Federal Trade Commission’s mandated disclosure format. Those items include:
Information about the franchisor and any parent or affiliate companies
Details of the anticipated investment to open a franchised location
Status of any trademarks held by the franchisor
Information on past financial performance of franchised or company-owned locations
Business experience of the franchisor
Restrictions on sources of products and services
Status of any patents or copyrights held by the franchisor
Information on the number of locations in operation
Past litigation
Franchisee obligations
Obligation of the franchisee to work directly in the business
Financial statements of the franchisor entity
Details of any bankruptcies
Franchisor provided financing
Restrictions on what the franchisee can sell
Other contracts/exhibits the franchisee may need to sign
Initial fees to be paid
Franchisor assistance
Contract renewal and transfer provisions
A copy of a receipt to be signed by the franchisee
Ongoing fees to be paid
Territorial protection offered
Use of public figures in the franchise program
As a franchisor, you must provide the disclosure document to the franchisee candidate at least 14 days prior to the execution of the agreement or the payment of any fees.
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The Geography of Franchise Legislation in the US
Franchise Legislation Within the US - 2016
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Business Terms Defining the Early-Stage Relationship
Site Location: Assigning responsibilities for the site selection process Designated or approved vendors the franchisee must use Site criteria Process for site selection Site acceptance process
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Business Terms Defining the Early-Stage Relationship
Lease Development: Defining the process to be followed Letter of intent stage Required lease inclusions Requirement for the franchise owner to have their own real estate attorney Franchisor review of the lease before execution Maintaining copies of fully executed leases
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Business Terms Defining the Early-Stage Relationship
Facility Design: Need for written design criteria What flexibility should be given to franchisees in terms of design options? Will the franchisee be permitted to use their own architect? Who pays for the cost of design documents? How are approvals for the franchisee’s store design handled?
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Business Terms Defining the Early-Stage Relationship
Facility Construction: Standards for contractors to be used by franchisees Recommended bid process Mandating suppliers of construction items that franchisees must use Franchisor visits to the site during construction Approving the location for opening Required timeframe for completing construction and opening for business Tracking construction costs to ensure Item 7 of the FDD is updated as needed
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Business Terms Defining the Early-Stage Relationship Pre-Opening Training Process:
Pre-Work Prior to Attending Training
Training at the Franchisor’s Location
Training at the Franchisee’s Opening
Brand History
Duration of Training
Length of Onsite Training
Product Knowledge
Who Must Attend
Operations Overview
Details of Training Schedule
Composition of the Franchisor’s Opening Team
Web-Based Learning Initial Testing
Information About the Franchisor’s Trainers
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Certification Standards That Must be Met
Business Terms Defining the Early-Stage Relationship Setting expectations (or requirements) regarding how active your franchisees must be in their business:
Mandated Involvement
Absentee Owners
Part-Time Involvement
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Business Terms Defining the Early-Stage Relationship Mandating Sources of Supply:
Products Specified, but not the Suppliers
Approved Suppliers
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Designated Suppliers
Determining the Initial Franchise Fee Issues to consider when setting your franchise fee:
Franchisor’s Value Proposition
Cost to Onboard a New Franchisee
Impact on the Franchisee’s ROI
Competitive Franchisee Fees
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Determining the Initial Franchise Fee
The franchise fee should typically cover the franchisor’s cost to…. Recruit the candidate and put them through the evaluation process Finalize the franchise agreement (e.g., outside legal costs) Assist the candidate with site selection and lease development Work with the candidate and their contractor as the franchised location is being constructed Assist the franchisee in setting-up their relationships with approved vendors Train the franchisee and their team at the franchisor’s training facility Provide initial training and opening support for the franchisee when they begin operating
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Determining the Royalty Fee
Royalties can be structured in many different ways Percentage of Gross Sales, Less Tax and Discounts Percentage of Gross Margin
Flat Dollar Fee
Variations of the Above
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Determining the Royalty Fee The final royalty structure and rate should be based on a financial analysis of both the franchisee’s and franchisor’s business.
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Other Fees To Potentially Consider
Depending on the industry and business strategy adopted, the following types of fees may also be relevant to a franchisor: Training fees Grand opening marketing Local marketing fee Co-op marketing fee System marketing fund contribution Transfer fee Successor fee Relocation fee Technology fees Mystery shop/quality assurance fees Various fees for non-performance (e.g., insufficient funds, audits, etc.)
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Requirements for the Franchisee to Reinvest in Their Business
Day to Day Maintenance
Equipment & Technology
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Trade Dress Updates
Preparing the Estimated Range of Initial Investment ITEM 7 ESTIMATED INITIAL INVESTMENT YOUR ESTIMATED INITIAL INVESTMENT
Item
Estimated Cost
Method of Payment
When Due
To Whom Paid
$25,000
Lump Sum
On signing Franchise Agreement
Us
Leasehold Improvements (2)
$90,000 to $140,000
As Arranged
As Arranged
Independent Contractors
Lease Payments – 3 Months (3)
$4,500 to $22,500
As Arranged
As Arranged
Landlord
Security Deposits (4)
$1,500 to $7,500
As Arranged
As Arranged
Landlord, Utility Companies
Equipment/ Furniture and Fixtures (5)
$80,000 to $115,000
As Arranged
As Arranged
Approved Suppliers
Signage (6)
$8,000 to $12,000
As Arranged
As Arranged
Approved Suppliers
Initial Inventory (7)
$8,000 to $15,000
As Arranged
As Incurred
Us and Approved Suppliers
Initial Franchise Fee (1)
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Business Terms Limiting How and Where the Franchisee Operates
Territory Definition:
Restrictions on the Franchisee:
Will the franchisee receive a protected area?
Is the franchisee restricted from serving certain types of customers in their territory?
What protection is being given to the franchisee?
Can the franchisee market outside of their territory?
How will the geography of the protected area be defined?
Can the franchisee service customers outside of their territory?
Is the protection dependent on the franchisee meeting any minimum performance requirements?
Can the franchisee undertake any business within the territory, but outside of their four walls? How much flexibility can the franchisee have around the types of products they sell in their local market? Controls over retail pricing.
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Business Terms Limiting How and Where the Franchisee Operates
Minimum performance requirements: When are minimum performance requirements typically mandated? Options for establishing minimum performance
Revenues
Royalty payments
Product purchases
Sales calls
Marketing spend
Market share
Service crews/vehicles
Other
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Business Terms Limiting How and Where the Franchisee Operates
Social Media
Website Marketing
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Rebates From Suppliers to the Franchise System
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Accounting Standards for the Franchisee Why standards for accounting are important Evolution of standards within franchising Best practices today that should be documented in your FDD
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Franchise Agreement Term and Successor Agreement Options
Issues to Consider: Defining the initial term of the Franchise Agreement Successor Agreement terms Form of the successor Agreement document
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Item 19: Franchise Performance Representations
Why is this disclosure item so important? Do most franchisors provide historical performance information? What should I disclose?
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Item 19: Franchise Performance Representations If you don’t have an Item 19 disclosure
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Item 19: Franchise Performance Representations Sample Item 19 Disclosures:
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Item 19: Franchise Performance Representations Sample Item 19 Disclosures:
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Item 19: Franchise Performance Representations Use of Item 19 data within franchise advertising:
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Questions
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