Understanding Franchise Models

by Julie Lusthaus

One of the most important decisions a franchisor must make is what type of franchise model to offer. The decision to go with one over another is strategic and requires a franchisor to consider how they want to expand their franchise

and what type of operators they want to have. There are four main types of franchise models for business format franchising: Single Unit, MultiUnit Development, Conversion, and Master Franchise.

This is the most common type of franchise. Essentially, the franchisor offers a franchisee the right to operate one franchise business. If the franchise requires a brick and mortar presence, then the single unit franchisee typically buys the right to operate at a physical location. In addition, the franchisee may receive some territorial protection prohibiting the franchisor or other franchisees from operating within that designated territory. Territories are typically defined as a radius surrounding the physical location (e.g., 1.5 miles), by zip code or by population. Where the franchise business is a service business that does not require a physical location, the franchisee is often provided a geographical territory within which it must operate. In a single unit franchise, the individual owner(s) of the franchisee entity often oversee the day-to-day operations of the business. Single-Unit

In this franchise model, the franchisor sells a franchisee the right to develop multiple locations within a designated territory. This is also known as an Area Development Franchise. Here, the area developer is typically granted an exclusive area in which to develop a specified number of franchised businesses pursuant to a negotiated schedule. The appeal for franchisees is that they can develop several franchises in a region to take advantage of market conditions, increase revenue quickly, improve efficiencies or reduce costs by running multiple local businesses. Franchisors benefit from having fewer franchisees to manage, receiving some compensation upfront in consideration for holding the territory open for the area developer, and expanding their franchise more rapidly. With a multi-unit offering, the franchisee (and/or developer) signs a franchise agreement for the first location as well as a development agreement pursuant to which the additional franchises will be developed. However, when it comes time to develop each additional franchise, the franchisee will also sign a separate franchise agreement for each such franchise. Multi-Unit Development

A conversion franchise is used when a franchisee already has an existing operating business but wants to convert it into a franchise. For example, a restaurant owner wants to buy the right to use the name and franchise system of a well-known restaurant franchise. The franchisee will likely have to make changes to its business, including a name change, possible renovations, new computer systems, etc. The franchisor will likely benefit from a quicker launch of the location. The franchisee may also have an established customer base which means more revenue for both parties.

Sometimes, a franchisor will want to sell a franchisee the right to offer and sell franchises to other franchisees. In this franchise model, the franchisor becomes a “master franchisor” and the franchisee assumes the role of a “master franchisee” (or “subfranchisor”). The master franchisee does not own the franchise system but acts as a middleman in developing additional franchises. These types of arrangements generally occur when a franchisor is a foreign company or unfamiliar with a particular region or market and wants to grant someone local the ability to sell and oversee franchises in a designated territory on the franchisor’s behalf. The master franchisee not only recruits franchisees but will also provide training and ongoing support. As a result of the extra layer of control required because of the master franchisee’s oversight, there may be some inefficiencies but the franchisor benefits from having the master franchisee assume the risks and obligations of supporting local franchisees. Master Franchise

Before preparing the FDD, franchisors should consider which franchise model to offer and develop an appropriate business expansion plan. This decision about a franchise model will affect the FDD significantly and may require preparation of additional disclosure documents and/ or agreements. Before you decide which one is best for your franchise, consult an experienced franchise attorney to evaluate the advantages and disadvantages based on your goals for your business and prepare the documents you need to protect your interests.

Julie Lusthaus represents franchisors, franchisees and independent business owners. To learn more, visit her website at www.lusthausfranchiselaw.com