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Franchising is a way for a business owner to expand a business. The business owner, or franchisor, licenses independent franchisees to use the business name, logo and method of operation to sell a particular product or service. In return, the franchisee is generally required to pay the franchisor a franchise fee and ongoing royalties.
Franchised businesses usually fall into one of three categories: distributorships, business format franchises, or manufacturing franchises. In a distributorship, the franchisor licenses another person to sell the franchisor’s product exclusively. In a business format franchise, the franchisee operates a business under the franchisor’s trade name and is generally required to follow the franchisor’s standardized operating procedures. Finally, in a manufacturing franchise, the franchisor provides the franchisee with the essential ingredients or formula for making a product. The franchisee then manufactures the product to the franchisor’s standards.
Fast food restaurants are common examples of franchises, but nearly any type of business can be franchised. Franchised businesses may sell products or services, at retail or wholesale, from a storefront or from home. Examples of franchised businesses include bakeries, printing services, construction firms, hotels, furnishing outlets, pharmaceutical companies, cleaning businesses, restaurants and fitness centers.
The Franchise Disclosure Document (FDD) is a legal document that franchisors must provide to franchisees under Federal Trade Commission rules. The franchisor must give the FDD to prospective franchisees at the first meeting with the prospective franchisee. The FDD provides franchisees with an opportunity to study the investment and evaluate the franchisor before buying. It includes a listing of all current (and recently departed) franchisees and information about the operation of the franchise. FDDs also include information on litigation history, the franchisee’s initial investment, operating expenses, advertising and termination policies.
All franchisees must sign a franchise agreement (sometimes called a “license agreement”) that describes the basic relationship between the franchisor and franchisee. There may also be collateral agreements covering issues such as noncompetition, software licensing, powers of attorney, technology and collateral issues. The owners of the franchise entity may also be required to sign personal guarantees for certain aspects of the franchise’s performance. Franchisees may also be required to enter into contracts with third parties such as landlords and vendors.
Franchising is regulated by the U.S. Federal Trade Commission (FTC) and by various state agencies. The FTC Franchise Rule applies everywhere in the United States, but a state’s franchise laws usually apply only if the offer or sale of a franchise is made in the state, the franchised business will be located in the state, or the franchisee is a resident of the state.