If you are considering opening up a franchise the fist step is to understand all of the specific franchise terminology being used. With so much industry specific terminology it can sometimes feel like a different language is being spoken all together. To clear things up take a look at this essential terminology guide, covering the ten essential terms that every prospective franchisee should know.
Franchise Disclosure Document: The Franchise Disclosure Document (often referred to as the FDD) is the legal document that the franchisor must to provide to a prospective franchisee. In the United State all franchisors are required by the U.S. Federal Trade Commission to provide this document. Updated annually the document is comprised of twenty-three distinct sections, which are called items. These items provide a comprehensive overview of the company and its franchise system, including company history, fees and costs, contractual obligations, unit data, etc. If you are considering purchasing a franchise the first step is always an extensive and thorough review of this document. If you are having trouble understanding everything it never hurts to contact a lawyer.
Franchise Fee: This is the initial fee paid to a franchisor to become a franchisee. This fee is outlined in Item 5 of the Franchise Disclosure Document. It is important to note that while some franchises have a standard fee for all prospective franchisees other franchises will vary the fee based on franchisee factors such as experience or location. Many franchisors also offer discounts on the franchise fee for veterans, minorities, or franchisees looking to open up a second unit.
Startup Cost: Sometimes also known as the initial investment, start-up cost refers to the total amount required to open up a franchise. This total amount is outlined in Item 7 of the Franchise Disclosure Document. This cost includes the franchisee fee as well as startup expenses such as real estate, equipment, supplies, business licenses and working capital.
Royalty Fee: In exchange for being a part of a franchise each franchisee must pay a royalty fee to the franchisor. This fee is always paid on a regular, pre-determined interval (typically annually, monthly, or weekly). While the royalty fee is typically a percentage of the franchisee’s sales some companies mandate a flat royalty fee.
Franchisee Agreement: Once you have decided to open a franchise you will need to sign a franchise agreement with the franchisor. This agreement can be found in the Franchise Disclosure Document and outlines the specific responsibilities of both the franchisor and the franchisee. This franchise agreement will also typically specify the term of agreement, or the length of time the franchisee agreement is valid. This term is typically somewhere between five and twenty years. However, if you are in good standing with your franchisor at the end of your term you will typically be allowed to renew the agreement.
Company-owned Units: Company-owned units are locations that are owned and run by the parent company (the franchisor), rather than by franchisees.
Conversion: When a franchisor allows an entrepreneur to convert his or her existing independent business into a franchise this is known as conversion. In the conversion process the franchisee still needs to sign a franchise agreement and agree to the payment of both franchisee fees and royalty fees. However very often the conversion process in less costly in terms of start-up costs as the business is essentially already up and running.
In-house Financing: In-house financing is essentially a loan offered by the franchisor to help the franchisee with start-up costs. If in-house financing is not offered the franchisee will need to seek out third party financing. In this case many franchisors have connections with banks who can provide you with loans.
Absentee Ownership: When an owner is an absentee he or she owns the franchise but is not directly involved with its day-to-day management.
Master Franchise: A master franchisee serves as a sub franchisor for a certain territory (a specific geographical area as defined by the franchise). Master franchisees can issue FDDs, sign up new franchisees, provide logistical support and also typically receive a cut of the territory’s royalties.
Article by Jason Duncan, CEO/Founder of ManagerComplete.com. ManagerComplete is an online software application that helps multi-unit franchises manage operations effectively. Follow him on Twitter for latest updates.