What is a Franchise?

 

The International Franchise Association (IFA) explains that “franchising is simply a method for expanding a business and distributing goods and services through a licensing relationship. In franchising, franchisors (a person or company that grants the license to a third party for the conducting of a business under their marks) not only specify the products and services that will be offered by the franchisees (a person or company who is granted the license to do business under the trademark and trade name by the franchisor), but also provide them with an operating system, brand and support.”

In other words, a franchisee pays a franchisor an initial fee and ongoing royalties in exchange for rights to the franchisor’s trademark, brand, and methods of selling its products and services.

The history of the franchise concept dates back to the mid-1800s and the sewing machine. Isaac Singer invented the sewing machine and used what we now refer to as a franchise system as a successful distribution method. Then in the 1930s, Howard Johnson Restaurants paved the way for restaurant chains and franchises, and ultimately gave way to the modern American fast-food industry.

Speaking of the fast-food industry, let’s take an easy example like McDonald’s to further explain the concept of franchising. If you’re interested in operating a McDonald’s restaurant, you are interested in becoming a franchisee, while McDonald’s is the franchisor. In this example, McDonald’s grants you the right to manufacture, operate, and sell McDonald’s-branded food. For this right, you pay McDonald’s an initial fee as well as ongoing royalty fees. Additionally, you will have signed a license agreement that allows McDonald’s to exercise control over operational and marketing rights.

Quick franchise-related definitions:

  • Franchisor: The company that is giving away the right to do business using their trademark and brand.
  • Franchisee: The person (or company) that is buying the right to do business under the franchisor’s trademark and branch.
  • Royalty fees: Regular payments based on a percentage of gross sales made by the franchisee to the franchisor.
  • Trademark: Legally registered word, name, or symbol.
  • FDD: A Franchise Disclosure Document (FDD) is the legal document that outlines franchisor information and franchisee rights.