The A-Z of Franchising – A Guide to Franchise speak

My A-Z of Franchising will  assist you to better understand the terminology used in the franchise sector.

Remember, this is just a guide – make sure you seek legal advice from a lawyer who has expertise in franchising if you are unsure about anything.

I’d be happy to recommend lawyers – click here to contact me. JB

A

Advertising Levy –                              The Franchise Agreement may provide for the contribution to an advertising fund by each Franchisee. See group Marketing Fund. The advertising levy may be a fixed fee, or more normally, a percentage of Franchisee turnover (Gross Revenue).

Administration Levy –                           See “Service Fee”

Arbitration –                                         The Franchise Agreement must provide for arbitration between the parties to the agreement. Arbitration (dispute resolution) is a form of dispute resolution in the event of a disagreement between the Franchisee and the Franchisor, and is normally chaired by a nominated individual or body, as determined under the ‘Franchising Code of Conduct’.

Approved Supplier –                            The Franchisor would normally prescribe approved suppliers for the Network who meet their quality, value and trading term requirements and Franchisees would normally be bound to use those suppliers; within the scope of the governing laws.

Approved products –                          Within the list of preferred suppliers there is often a list of specific products from each that are approved, and only those products can be stocked and sold by the franchisee. This is to ensure uniformity across the network.

Assignment –                                       The sale of a franchise by one Franchisee (assignor) to another (assignee) is called an assignment. The Franchisor will normally retain the rights to interview and accept any proposed buyer and may also retain the rights of buying the franchise back himself. The vendor Franchisee has the right to set the value of the franchise. It is normal for an assignment fee to be paid to the Franchisor, who will utilise those funds to train and induct the new Franchisee. See also Transfer.

B

Bank Guarantee –                               Many Franchisors today require a Bank Guarantee as security for the payment of fees and particularly if the Franchisor is also the Supplier of Products to the Franchises. The guarantee would normally be from the Directors of the Franchisee entity if it is a corporate structure. 

Bank Finance Package –                    A loan scheme by banks to provide the Franchisee with some of the finance required to buy the franchise. Often restricted to a maximum portion of the total investment. Some banks have off-the-shelf packages for specific franchise opportunities which they have evaluated and know. This is not a warranty by the bank, simply an acknowledgment that they have detailed information in-house about the business.

Business Format Franchise –                 A franchise in which the Franchisor provides the Franchisee with a complete format (blueprint) for the setting up and operation of the business, hence the name. Otherwise known as a ‘Business System’ franchise.

Business Development Council –         See Franchise Advisory Council.

Buy-out Clause –                                 The Franchise Agreement may include a clause giving the Franchisee the option to buy himself out of the franchise and continue to trade at the same site and in the same style of business, but as a totally independent owner. Such a clause is uncommon in Australian practice.

C

Capital – CAPEX –                               An accounting term that describes the sum of money invested to build a business. It does not include the money spent running the business from day One. It is purely the sum spent to establish the business up to Day One. Further clarification should be sought from your accountant.

Company Owned Units –                    Units of the franchise which are owned by the Franchisor and operate alongside the Franchisee’s within the group. Such company owned units are normally obliged to contribute to group expenses such as advertising and marketing. Such units allow the Franchisor the ability to pilot new ideas and products without detriment to the operation of any particular Franchisee owned business.

Covenants –                                        The terms, conditions, obligations, and agreements contained within the Franchise Agreement which the Franchisee must observe and/or perform to the satisfaction of the Franchisor.

D

Default –                                              Being in default means that a party is acting or performing in such a way as to be non-compliant with the prescribed franchise system and this places them in ‘default’. Notices of Default subsequently issued need to be taken seriously and dealt with within the specified timeframe, to avoid matters escalating and potentially leading to a more serious situation or ultimately Termination.

Disenfranchise –                                   The withdrawal of the franchise by the Franchisor from the Franchisee. This is likely to occur when there have been persistent breaches of the Franchise Agreement by the Franchisee and such breaches provide for Termination.

Dispute Resolution                                A mechanism for Franchisors and Franchisees to deal with disagreements. A requirement under the ‘2014 – Franchising Code of Conduct’.

E & F

Earnings Information –                         Earnings information is information provided to a prospective Franchisee that might portray historic financial performance of the franchise so that an assessment of viability can be made. It is unlikely that a prospective Franchisee would receive ‘projections’ as to the level of performance that they night achieve, and it would be wise not to base any decisions on those should they be provided. Not all Franchisors provide Earnings Information.

Encumbrance –                                   Means a mortgage, charge, lien or security of any kind taken over the business assets by the Franchisor or any lending party.

Fixed Service Fee –                              The Franchisor may choose to obtain his continuing income from the Franchisee through a fixed amount monthly or weekly payment, or through a service fee calculated as a percentage of turnover but sometimes carrying a minimum or maximum payment amount. Such arrangements are seen by their critics as a form of setting performance targets, which some would find unacceptable. The argument is that the Franchisee/Franchisor relationship is a partnership where both parties share the risks and rewards of success and failure. It is not uncommon to find a fixed service fee where the Franchise business revenues are generated by way of small cash payments from customers, which in itself would prove difficult for the Franchisor to audit or monitor.

Franchisee Advisory Council –             The Franchise Agreement may provide for the formation of a Franchisee Advisory Council with the role of assisting the Franchisor with marketing or advertising decisions. Such agreements may allow for the annual election of Franchisees to this council. Sometimes known as the Business Development Council or similar.

Franchise Agreement –                        The contract entered into by the parties to the franchise in which all the obligations and responsibilities of each party should be clearly defined. Normally such contracts are forty pages or more in length and it is of vital importance that any party consult with a legal adviser prior to signing such. The Franchise Agreement is normally signed leading up to or on the day of settlement, from which time the Franchisee owns the rights

Franchise Fee –                                    The up-front payment by the Franchisee to the Franchisor for the granting of the franchise rights. This fee is paid upon the settlement of the franchise on the Franchisee, once the Franchise Agreement is signed. See also Initial Franchise Fee.

Franchisee –                                         The Person or Partnership, or Company and/or Trust which buys a franchise from the Franchisor. Also sometimes referred to as a licensee, or franchise owner. Although Franchisees are normally individuals, they are in some instances major public companies. Where a company or trust enters into a Franchise Agreement, the Franchisor would normally require that the individuals behind it also guarantee the performance of the corporate Franchisee.

Franchisor –                                          The franchising company which owns and manages the Network of franchises in its system to Franchisees. The creator of a business format franchise system. A Franchisor should prove the success of his concept and his ability to pass his operating system to others by running company owned or pilot franchised operations before generally offering the franchise to the public.                     

Franchising Code of Conduct –           Means the Code as prescribed under Section 51E of the Australian Competition and Consumer Act 2010, in December 2014.

Franchise Council of Australia Ltd –     The Franchise Council of Australia Ltd (The FCA) is a single organisation comprising of Franchisors, Franchisees, and advisors, who meet regularly in each State of Australia. The FCA has been established since 1982 and has produced a growing range of publications on the various aspects of franchising, as well as coordinating exhibitions and conventions. The FCA is recognised as the Peak Industry Body for franchising in Australia.

Franchise Model –                                This is the term used by a Franchisor, a banker, lawyer or an accountant to describe the ideal financial model for a franchise. It can also be used to describe other legal and/or systemic operational elements that together make up the full operating model of a franchise.  

G

Goodwill –                                            The value of goodwill in a business is normally only applied once a business is operational, and is judged on the value of trade already established and which is likely to continue to the benefit of the new business owner. Goodwill is a sum calculated once an operating franchisee is assessed for overall Market Value including Inventory, Plant & Equipment and other assets to be transferred to a new owner upon sale and settlement.

Group Marketing Fund –                     See Marketing Fund

Gross Revenue –                                  Typically means the aggregate of all monies received as sales revenue or other sources of income, within a franchised outlet/Unit Net of GST, (unless otherwise described within the Franchise Agreement).

 H & I

Information Statement –                      Means the written statement to be issued by a Franchisor to a prospective Franchisee at the earliest indication of their serious consideration or interest in buying a franchise. This is a document prescribed in ‘form and content’ under the terms of the Franchising Code of Conduct 2014.

Intellectual Property Rights –                Trade marks, service marks, know-how and copyright. These often form an important component of the franchise system and are normally owned by the Franchisor or an Associate entity of the Franchisor.

Initial Franchise Fee –                           This is the fee payable by the Franchisee for the Grant of the franchise rights under the terms of the Franchise Agreement. This sum does not include payment for any other matter. See also Franchise Fee.

Initial Contribution to Group Marketing Fund –                     This sum is normally paid by the incoming Franchisee direct to the Marketing Fund as an initial contribution to boost the finances of the fund and in partial recognition of pre-existing goodwill. This sum is not paid to the Franchisor as revenue for them.

Initial Term –                                         Means the first term only of the total term of the Franchise Grant. The total term of the Franchise Agreement is normally split into several shorter terms (years), with conditional renewal rights as prescribed within the agreement.

J, K & L

Lease Franchise –                                 The Franchisor leases the premises to the Franchisee at a rental, based on turnover, which also covers the management services fee. This is close to approaching a landlord/tenant arrangement and may present problems in Western Australia because of that State’s particular Retail Tenancy Act.

Licensee –                                            See Franchisee or master licensee.

Local Area Marketing (LAM) –             Local Area Marketing is the activity conducted by the Franchisee at their expense within the area as prescribed in the Franchise Agreement.

M

Management Service Fee –                See “Service Fee” and “Fixed Service Fee”

Marketing Fund –                                Means the separate ‘fund’ and bank account held and managed by the Franchisor on behalf of the Network. Such funds are to be used for marketing purposes only unless otherwise stated within the terms of the Franchise Agreement.

Marketing Manual –                            A manual of information often provided to guide a new franchise owner in how to promote and effectively market their products or services into the community. Traditionally such manuals will provide bromides of forms and posters to be used, together with details of how to monitor performance of the promotions conducted. Many systems today have this material available on-line via a Network Intranet. 

Master Franchisee/Licensee/Sub Franchisor –                                   Franchisors sell master licences to operate their systems in other countries, regions or States. Thus, an Australian Sydney-based Franchisor may allow his business to expand into Western Australia by the appointment of a Western Australian based Master Franchisee (Licensee), who in turn has the rights to sell franchises in Western Australia, providing it all of the local support services. Franchise agreements in such a situations are normally between all three parties, The National Franchisor, The Master Licensee, and the Franchisee. There are many variations to this model so take notice of the structure you are looking at, and seek clarity where required.

Minimum Performance Criteria –         It is normal for the Franchisor to prescribe certain performance standards and financial thresholds to be attained by a Franchisee during the term of the franchise. These often will change from year to year and be the subject of annual reviews. Non-attainment may lead to a review and further action.

Multi-Level Marketing –                        A form of direct selling by distributors to the public in their homes. Not a business format franchise.

Multi-Unit Franchise –                           A Franchisee with more than one unit. Such Franchisees are usually a sign of the successful franchises which have proved their ability to be run under management, for naturally a Franchisee cannot actually operate in more than one place at one time. Vary common in the U.S.A. and growing in number in Australia. Some Australian Franchisors actually prohibit ownership of more than one unit to ensure that the Franchisee is running the business on-site and on a daily basis.

Multiple Franchisors –                           Franchisors offering more than one franchise concept or Brand.

N & O

Network –                                            A term used to describe the entire group of franchises/company owned stores or business units.

Offer to Franchise –                              Any written agreement where the Franchisee and Franchisor purport to agree to enter into a Franchise Agreement.

Opening promotion Sum –                  The sum of money which a Franchisee must have available to expend on the opening promotional activities for their new franchise. Mostly controlled by the Franchisor and accounted for should they hold the money and control the expenditure.      

Operations Manual –                           Manuals supplied by the Franchisor to the Franchisee as part of the franchise package to provide them with a step-by-step instruction (the business system) on how to set up and operate the business to the correct specification and standards required. The manuals are copyright of the Franchisor and as they contain the very essence of how to duplicate the business, they have to be treated with the utmost care and confidentiality. These are often on-line and should be updated by the Franchisor as policy or procedures change.

P

Party Plan Selling –                              A form or direct selling to the public through “parties” in their home. Not a business format franchise.

Pilot Unit –                                             A unit of the franchise run by the Franchisor or under their close supervision during the “proving” time of system development, to demonstrate that the concept, system and procedures will provide a successful business and that the know-how can be transferred successfully to an inexperienced Franchisee. The pilot unit is also the ultimate test bed for the Franchisors training methods and manuals.

Plant and Equipment –                        The plant and equipment required by the Franchisee within the franchised business to operate the business in the manner laid down by the Franchisor. Normally sourced paid for at settlement or immediately prior to possession of premises.

Product Supply –                                 The Competition and Consumer Act 2010 prohibit the fixing of a line of supply or prices. Most Franchisors with a business which supplies products or goods do however wish for a standard range of products to be supplied by their Franchisees. The Franchise Agreement may provide for the supply of products through a nominated supplier, and set guidelines for the acceptable standards of products to be used in the Franchisees business. Should the suppliers nominated not be able to supply, a Franchisee would typically have the rights to seek other suppliers, provided that the goods meet the standards set and only with prior approval from the Franchisor.

Pyramid Selling –                                 An arrangement, often associated incorrectly with franchising, which involves the selling of territorial rights through a pyramid, or tiered sub-licence structure. The promoters rely for their income on the sale of the tiered territories, rather than the sale of product or the success of the territory owner to provide service fees. Such schemes are now illegal in some countries. This is mostly an unlawful business model and great caution is warranted should you sense that this is the case.

Q & R 

Renewal –                                            Franchise agreements are normally granted by the Franchisor for a specific period. (See Term and Initial Term). That period is broken down into units of time, perhaps five years, at which point renewal of the franchise is required. If the Franchisee has been in repeated breach of the agreement then the Franchisor may exercise any rights he may have under the agreement not to allow such renewal, in which case the franchise will lapse. If the Franchisee has performed to the agreement, then the right of renewal is granted, subject to any newly written Franchise Agreement being put in place. That new agreement may be in different wording, but may not alter substantially from the original agreement made at the outset. Royalties, service fees and advertising levies may change? A renewal fee may be applied to cover the Franchisors costs at renewal, but again that amount is stipulated in the original Franchise Agreement. Legal costs will apply in most cases.

Royalties –                                            Another term for Service fee but in fact a misnomer because service fees are calculated on the same basis as royalties (percentage of gross turn-over). In essence, royalties are a form of passive income which requires little or no effort from the recipient. Examples are copyright or patent royalties.

Restraint –                                            Mostly described within the terms of the Franchise Agreement as a restraint on the outgoing Franchisee upon their departure, within a geographic area and for a period of time.

Return on Investment –                        Accounting terminology, which in its abbreviated form (ROI) means to determine the rate at which a financial business model returns a profit to the owners, against the sum of money invested (Capital), and expressed as a percentage. There are several ROI models in the market so it is important to seek clarification from your accountant if you are uncertain about which to apply to your business.

S

Service Fee –                                        The Franchisor will obtain his continuing income, necessary to support the Franchisee, by way of a weekly or monthly fee, normally expressed as a percentage of Franchisee turnover. Sometimes known as franchise royalty.

Service Marks –                                    Similar to trade marks, but applicable to services rather than actual products. The granting by the Franchisor to the Franchisee of the rights to use their service marks, trademarks and copyright material (operations manuals, etc.) is a basic element of a franchise package. One important obligation of the Franchisor is to prevent their marks from being used by any unauthorised person in order to protect the interests of all other Franchisees, who, in their franchise fee, have paid for the right to use those exclusively. There are laws which protect service marks similar to trade marks.

Sub-Franchises –                                  Sub-franchises are franchises granted within the territory of an existing Franchisee, and are usually allowed to be granted when the original Franchisee reaches a point in business development whereby they cannot sustain any further growth from the one unit or outlet. Each agreement will vary but it can occur for a Franchisee who owns a territory to be permitted to offer the sub-franchise to another and derive some revenue from that offering. Such structures will be outlined within the terms of the Franchise Agreement. However, it is often the case where the Franchisor actually grants the new franchise, and to also receive revenue to cover training and induction of the new franchise owner.

T

Term –                                                  The period of time for which the franchise is granted. “Old fashioned” franchising concepts used to grant terms as short as one, three or five years. Modern thinking is to grant terms of ten, or more years where the business model can be considered a long term proposition.

Termination –                                       At the end of the term of a Franchise Agreement it is considered ‘terminated’. This can also be the term used when a Franchisee is removed from a franchise network as a consequence of a serious dispute with the Franchisor.

Territory –                                              Few Franchise Agreements will provide an ‘exclusive’ geographic area or territory in which the Franchisee may operate without fear of competition from within his own group. Mostly it is ‘non-exclusive’ however with certain structural elements to provide the appropriate levels of protection. This may not always be possible, so be sure to find out what your rights are.

Transfer –                                              The term used to describe the sale of an existing franchise to a new Franchisee. It would be normal for the outgoing Franchisee to pay the Franchisor a Transfer Fee upon transfer of their rights and entitlements. See also Assignment.

Turn-Key Operation –                           A franchise model in which the business is completely fitted out, equipped and stocked for the Franchisee, ready for opening day. This term is often applied to retail franchised operations.

U

Up-Front Fee –                                      See Franchise Fee and Initial Franchise Fee.