Franchising in Canada
Franchising in Canada
Welcome to Franchising in Canada
Are you tired of reading all about the US world of franchising? Are you frustrated with not being able to find enough Canadian content about franchising on the web? Then you will appreciate the following information, which has been specifically developed for the Canadian franchise marketplace by BetheBoss.ca. This section of our site provides you with a basic knowledge of franchising in Canada so that you can explore the opportunities that franchising offers and make an informed decision about if you are suited to franchising and which franchise is bet suited for your particular requirements.
The Growth of Franchising in Canada
· Canada is one of the franchise capitals of the world led only by the U.S.
· A Canadian franchise opens every 2 hours 365 days a year
· Franchising represents over $100 billion in sales annually and continues to grow
· Franchising employs over 1.5 Million people in Canada
· Total number of units in Canada is 75,809
· Approximately 500 of the largest U.S. franchisors have introduced their franchise systems to Canada
What is Franchising?
It helps to begin with an understanding of what ‘franchising’ really means. In basic terms, franchising is a form of distribution or marketing. It is a method of doing business by which the franchisee is granted the right to offer, sell or distribute goods or services under a marketing plan or system prescribed in substantial art by the franchisor. It is a strategy for successfully penetrating, developing, dominating and achieving a disproportionately large market share.
The franchisor is the company that owns and controls the franchise system and grants the license to operate the franchise according to a certain method, and with the products and/or services that have been developed by the franchisor.
The franchisee is the company or person who pays the franchisor for the franchise and the right to use the system.
The franchise is the right to use the trademarks and systems, and to promote the products and/or services.
Types of Franchises
The term “franchise” is used to describe several different types of agreements, although its current definition places the emphasis on the continuing relationship between the franchisor and the franchisee. Most franchises fall under the classification of product or service, or business format. Although franchises will generally lean more heavily towards one or the other, they typically combine characteristics from both categories.
Product or Service Franchise
Early franchises were generally “Trade Name” franchises. The franchisor allowed the franchisee to distribute goods utilizing the franchisor’s trademark. This type of licensing arrangement includes such business as car and truck dealers, soft drink bottlers, home entertainment stores and service stations.
Generally, the franchisee was required to conform to certain standards relating to the quality of the product or service, but apart from that he or she was free to carry on business without any control or guidance from the franchisor.
Business Format Franchise
Business-format franchising is the most common form of franchising and involves not only the licensing of a product or service, but provides the method for running the business. Real estate companies, diet centres and travel agencies are examples of business-format franchises. Fast food franchises often combine product and business-format franchising. In fact, most of today’s franchises combine product and business formats.
The Pros and Cons of Buying a Franchise
Pros of Franchising
Reduced Risk
Franchising does not guarantee success, but a good franchise should help reduce the chances of failure.
A Proven System
With a tried and tested operating system, the franchisee loses the obstacles and gains the opportunities. A franchisee should receive a completely proven system that includes initial training, opening assistance, accounting systems, established suppliers, manuals and use of the trademarks. The all important "learning curve" helps prevent the franchisee from repeating previous mistakes and provides information on inventory levels, store design, competition, pricing structure and operational data drawn from the entire system.
Easier Access to Financing and Reduced Cash Requirements
Financial institutions prefer to lend to established franchised systems because of their higher success rate. The consumer awareness created by national or regional name recognition can reduce the costs of grand-opening promotional activity and advertising start-up. As well, the purchasing power of the franchisor can reduce the franchisee's initial outlay for equipment and supplies.
Purchasing Power
Collective purchasing power on products, supplies, extended health and insurance benefits, equipment and advertising can easily offset any ongoing royalties paid by the franchisee.
Site Selection Assistance
Franchisors can provide expert site selection assistance based on their operating experience and demographic knowledge. Landlords and developers prefer to deal with someone who has an established track record. This enables franchisees, as part of an established franchise system to obtain locations in major malls and other developments that otherwise would not be available to them as an independent operator.
Advertising Clout
Most independent businesses cannot afford the services of advertising and promotional experts. Consequently, their advertising is often poorly conceived and inconsistent. They also cannot afford to invest in the level of advertising required to maintain a commanding presence in the marketplace. In a franchise system, the advertising cost is spread over many units enabling the franchisor to achieve economies of scale. This also allows the franchisee to create well-conceived promotional campaigns and place the advertising in the most effective medium.
Building Equity
Because of the national or regional name recognition, and territorial exclusivity, a franchised business should sell faster and for a higher value than an independent business. A buyer is often motivated to buy the franchised business for the same reasons as the original franchisee and may perceive a higher value associated with a recognized name and system.
Stress Reduction
The ability to operate more effectively and efficiently can relieve many pressures of business. Systems that control job scheduling, cash flow and inventory levels allow the franchisee to run the business instead of the business running them.
Cons of Franchising
Loss of Independence
The loss of independence can be viewed negatively by some franchisees. Although most franchisees invest in a franchise because they want the guidance of the franchisor, the moment they enter the franchise system they want to make changes. Unless you are capable of working within a system and can accept a certain amount of regimentation, you should think long and hard before entering into a franchise relationship. One of the greatest strengths of franchising is consistency amongst units, and with consistency must come compliance.
Franchisor's Failure to Perform
Some franchisors don't deliver what they promise for a couple of reasons. A common reason for failure is the franchisor’s shortage of available capital, which can be caused by:
(a) The franchisor’s unrealistic franchise sales projections;
(b) The franchisor underestimating the expenses associated with the development of the franchise system;
(c) The franchisor’s failure to meet franchise sales projections, or
(d) High franchisee attrition.
Alternatively, it could be that the franchisor is just not capable of providing the support and assistance, or does not possess the ability to operate a franchise organization.
Misunderstanding the Franchise Agreement
Confusion over the interpretation of certain aspects of the franchise agreement can result in a problem with either the franchisor or the franchisee. A potential franchisee has probably never encountered a document anywhere near similar to a franchise agreement. A franchise agreement requires careful explanation and scrutiny, and failure to do so will inevitably result in a conflict that may end up in the courts.
Misrepresentation by the Franchisor
Misrepresentation by the franchisor can be intentional or unintentional. Projections of income and expense can be provided to the franchisee in good faith, but may turn out to be inappropriate for the location because of the franchisor's inexperience or unfamiliarity with the area's demographics. Conversely, the figures may be total fabrications simply to get the franchisee to sign on the dotted line and hand over the initial franchise fee.
Caveat Emptor (let the buyer beware), applies to franchising as it does to any consumer purchase or investment; however, consumers are often their own worst enemy, choosing to ignore cautionary advice and warning signals, and basing their investment decision on emotion without balancing it with logic.
Payment of Fees
The franchisee typically pays an initial fee for being granted the franchise, using the system, and receiving initial training. Typically, single-unit franchise fees are in the range of $25,000 to $35,000. The initial fee is paid only once during the term of the agreement; however, franchisors may charge a nominal renewal fee at the commencement of each new term of the agreement. The typical term for a franchise agreement is 5 or 10 years but may vary to coincide with the terms of a lease. Franchisors sometimes charge a site selection fee of $5,000 or more, in addition to the initial fee, which offsets their costs of site selection and lease negotiation.
In addition to the initial fee, some form of ongoing royalty is paid by the franchisee to the franchisor. In most instances, the royalty is based on a percentage of the Franchisee’s gross sales, which vary from1% to10%, or even higher, with a median range of 3% to 6%; however, units with high sales volumes often pay 1% or 2% less.
Franchisees are also required to contribute to a national or regional advertising fund, which is in addition to any requirement that the franchisee invests a minimum amount on local advertising.
Investigate Before You Invest
Every year, thousands of Canadians from all walks of life respond to the call of entrepreneuralism. Many people are attracted to franchising as a method of doing business because of what they perceive to be a greater chance of success than going it alone as an independent operator.
Unfortunately, a large number of people view franchising as some sort of magic wand or guarantee of success. Franchising is usually a safer investment than opening a similar independent business, if the franchise is part of a solid franchise system. In fact, studies show that 86% of franchises that opened in Canada within the last 5 years were still under the same ownership and 97% of them were still in business; whereas, a large percentage of independent businesses that started during the same period have gone out of business. It is generally accepted that 40% of all non-franchised businesses don’t make it to the end of their first year of operation, and 80% fail within their first 5 years. Even the 20% that survive are not safe, as 90% of them will fail within their next 5 years.
When considering a franchise it is essential that you carry out proper due diligence. Success in franchising is based on mutual dependence, so it naturally follows that the search for a franchise is a mutual investigation process. It is important to evaluate both the franchisor and the franchise. Reputable franchisors go to great lengths to select a franchisee. If a franchisor fails to investigate you as thoroughly as you investigate them, be cautious. If a franchise is awarded to a franchisee that is unable to operate it successfully, the franchisor will suffer almost as much as the franchisee that fails. Not only does the franchise unit fail to produce an ongoing revenue stream for the franchisor, but it can also take up a tremendous amount of the franchisor's time and effort to either salvage or resell the franchise.
A franchisor is obviously not gambling its entire reputation on you; however, you are probably betting a good deal of your future on the franchisor, so don't hesitate to ask a lot of questions. A franchisor that is offering a legitimate opportunity and has nothing to hide should have no hesitation in providing the necessary information to a qualified franchise prospect and should respect the fact that you are investigating them in much the same manner as you are being investigated.
Balance Your Decision-Making
To be a successful franchisee you must:
(a) Have a passion for the business,
(b) Understand the business, and
(c) Be capable of financing it.
Obviously, you should not consider a franchise that is beyond your financial means. Emotion and logic should be equally balanced when making the final decision about purchasing the franchise. You should feel good about the people involved in the franchise, and excited about the opportunity, however, logic has to be applied to the decision-making process in such areas as consumer acceptance, risk analysis, availability of product, demographics etc. Ask yourself, "Does this all make sense?” Your emotional commitment is only one of the essential elements, and if any of these elements is missing, the franchise is probably not right for you.
The Critical Factors
There are four critical factors that combine to make a good franchise system:
1.The Organization
Does the franchise organization have the ability to develop and maintain a franchise network? It is one thing to build and operate successfully a couple of retail outlets; however, it requires a different set of skills completely to build a network of several hundred stores.
Is there a strong management team that understands the particular industry and possesses the skills necessary to build the franchise organization?
How long has the franchise company been in business? What are the depth and quality of the franchisor's management team and field-support people?
What business is the company really in? Is it more interested in selling franchises than operating a solid franchise system? How does the company make its money - from "up-front" fees or from continuing royalties? Does the franchisor have adequate financial backing or is it relying on the sale of franchises to develop the system? How long has the franchise concept been tested?
2.The Product or Service
Does the product or service have a widespread consumer demand? Selling a new concept to the general public can be expensive and risky. Ideally, consumer demand for the product or service should have already been established. Some potential franchisees, thinking that the market is saturated, shy away from franchise opportunities that are already well represented by other companies. If there is an established consumer demand for a product or service, it then becomes a matter of gaining market share rather than gaining market acceptance.
Is the product or service marketable in your area? Will there only be a seasonal demand? Is this a trend or a fad? Can the concept be taught or is it a skill unique to the franchisor? Is it recession proof? If the franchisor is the only source of supply for the product, what alternatives are there if the franchisor should fail and the supply of product is terminated?
3.The Competitive Edge
Does the franchise offer a better way of providing that product or service to the consumer?
What makes the product or service unique and does it satisfy a particular need in your market? Can it be easily copied by a competitor? Will you have many competitors? Is it protected by a trademark or copyright? Is the price competitive? Is there a fully developed business format (system) for you to follow? What assurance do you have that the franchisor will be able to continue getting you the product at a fair price?
4.The Entrepreneurial Opportunity
Will the level of investment, the nature of the industry and the appeal of the franchise itself attract enough other people to become franchisees, to ensure that the system will grow and the franchise can be re-sold in the future?
Most people do not enter a business with the thought of selling it in the future; however, it is a sensible approach to develop a business with the intention of resale in the future. You must have a way of liquidating your asset and unless you are planning to list your company on a pubic exchange the only way of realizing the increase in your equity is through the eventual resale of your business. In most cases a franchised business should sell faster and for a higher price than an independent business by virtue of its exclusivity, name recognition and other franchise advantages.
On average, franchises change hands every five years. The reasons for the change of ownership are varied; people want a fresh challenge; the transfer of a spouse to a new city; an inability to run the business profitably; illness, retirement, personal problems; or simply a franchisee's desire to capitalize on their efforts and make a profit.
A franchisee must look at the broad appeal of the franchise opportunity to other would-be franchisees, taking into consideration all of the factors that will influence the growth of the total franchise system. Unless the system grows, many of the benefits of franchising such as advertising clout and purchasing power will be lost.
Franchise Legislation
Until 1997, Canada had been relatively free of franchise legislation, with Alberta being the only province in Canada to have legislation directed specifically at franchising. However, the increasing number of law suits between franchisor and franchisee has prompted other provinces to re-assess the need to introduce some form of franchise legislation. On May 17, 2000 the Arthur Wishart Act (Franchise Disclosure), 2000 (the " Ontario Act”) was passed by the Ontario Legislature and came into force on January 31, 2001. In substance, the Ontario Act is very similar to the Alberta Act.
Disclosure Requirements
If the franchisor is operating in Alberta or Ontario, if you are a resident of those provinces, or have a permanent residence in those provinces, the franchisor is required to provide you with a copy of their disclosure document at least 14 days before the signing of any agreement relating to the franchise, or the payment of any consideration relating to the franchise, whichever is earlier. If you are investigating a franchise in a province other than in those provinces, and the franchisor is operating in provinces, you can request a copy of the franchisor's disclosure document that the franchisor is required to provide in those provinces. The disclosure document must contain copies of all proposed franchise agreements, financial statements of the franchisor, reports and other documents in accordance with the regulations. A certificate must be signed by at least 2 officers or directors of the franchisor, which states that the disclosure document contains no untrue statement of a material fact and does not omit to state a material fact. The information contained in the disclosure provides a good basis for assessing the merits of a franchise operation but don’t assume that the franchisor’s compliance with disclosure or registration requirements implies that the regulatory authority has approved or recommends the franchise in any way. It is essential that you verify the information disclosed by the franchisor by speaking with existing franchisees, your lawyer, your accountant, or a franchise consultant.
Earnings Claims
Both Acts require the franchisor to provide details of any earnings claims information used by the franchisor, including material assumptions underlying its preparation and presentation, whether it is based on actual results of existing outlets and the percentage of outlets that meet or exceed each range of results. The earnings claim information must have a reasonable basis at the time it is prepared. The disclosure documents must also state the place where substantiating information is available for inspection by franchisees. If the information is given in respect of a franchisor-operated outlet, the franchisor must state that the information may differ in respect of a franchisee outlet. Earnings claims consist of information from which a specific level or range of actual or potential sales, costs, income or profit from franchisee or franchisor outlets can be ascertained.
Franchisee’s Right of Rescission
If a franchisee suffers a loss because of a misrepresentation contained in a disclosure document, the franchisee has a right of action for damages against the franchisor and every person who signed the disclosure document. If the franchisor fails to provide the disclosure document within the time requirements, the prospective franchisee may rescind the agreement by giving notice of cancellation no later than 60 days after receiving the disclosure documents, or no later than 2 years after the granting of the franchise. A franchisor must, within 30 days of receiving a notice of cancellation, compensate the franchisee for any net losses the franchisee has occurred in acquiring, setting up, or operating the franchised business.
The Franchise Agreement
A franchise agreement is a contract, which is entered into between the franchisor, and the franchisee and sets out the relationship between the franchisor and franchisee. The franchise agreement will usually appear biased towards the franchisor, which is necessary for the franchisor to maintain control over the franchise system. A franchisor is risking its name and reputation on the franchisee’s performance, so it is only fair and reasonable that bit has the right to place certain obligations on the franchisee. Consistency amongst franchise units is a cornerstone of successful franchising – and consistency requires compliance.
Despite common beliefs, there is no such thing as a standard franchise agreement, and no two franchise agreements are alike. This is understandable because franchises cover many types of business in many different industries and have different characteristics. A franchise agreement will be just one of the documents that a franchisee will be required to sign. These may include a non-disclosure/confidentiality agreement, offer to purchase agreement, lease (or sublease) agreement, and a security agreement.
Checklist of Basic Franchise Agreement Terms and Conditions
As franchise agreements vary from franchise to franchise it would be impossible to identify every term and issue that should be considered in every situation. However, this checklist should be a valuable tool if you're interested in buying a franchise.
Fees, Royalties and Other Costs
How much is the initial franchise fee?
Is any part or the entire initial franchise fee refundable under any circumstances?
What is the total initial investment?
What are the terms of payment?
Does the franchisor offer any financing, or provide assistance in finding financing?
How much are the ongoing royalties and how are they determined?
How and when are sales and royalties reported, and how are royalties paid?
Is the franchisee required to contribute to an advertising fund administered by the franchisor? If so, how much?
How is the advertising fund administered? Is it National, regional or local?
What are the franchisor’s responsibilities regarding accounting of the advertising fund?
Franchisor’s obligations to the Franchisee
Are accounting/bookkeeping services included or available?
What degree of control does the franchisor have over franchise operations, particularly in maintaining franchise identity and product quality?
Does the franchisor provide an initial training program? If so, where and when is it presented, what is the duration and is the franchisee responsible for any costs such as travel, accommodation and living expenses.
What ongoing management support, assistance and training programs are provided by the franchisor? Are there any additional costs involved?
Does the franchisor provide promotional aids, point-of-purchase materials, mail programs, etc. and at what cost?
Franchisee’s Obligations
Is the franchisee required to maintain a specific amount of working capital?
Is the franchisee required to commit full time and best efforts to the operation of the franchised business?
Is the franchisee required to purchase equipment or supplies from the franchisor, or from a supplier approved by the franchisor?
Is the franchisee required to purchase a minimum product quota?
Is the franchisee required to meet specific performance requirements? If so, what are the penalties for not meeting them?
What controls does the franchisor have out concerning facility appearance, equipment, fixture and furnishings, and maintenance or replacement of the same?
Is the franchisee required to purchase all, or some of their products from the franchisor?
Is the franchisee required to obtain insurance coverage as specified by the franchisor?
Is the franchisee required to name the franchisor as an ‘additional named insured’ on the franchisee liability coverage?
Is the franchisee required to expend a minimum amount with respect to local advertising?
Are operating hours and days set out in the franchise agreement?
Are there restrictions on what the franchisee can sell?
Premises, Locations and Territory
Are premises required?
Is the franchisee required to lease or sub-lease premises from the franchisor?
If there is a lease, does it coincide with the term of the franchise agreement?
Who is responsible for site selection and lease negotiation?
Does the franchisor determine the plans and specifications for the premises?
Is the franchisor or the franchisee responsible for the development of the premises?
Is the franchisor responsible for supervision of development of the premises?
Who is responsible for selecting the contractor?
How is the development of the premises financed?
Are there any restrictions on remodeling or redecorating?
Does the franchisee receive an exclusive territory?
Is the size of the exclusive territory subject to reduction or modification under certain conditions?
Does the franchisee have a first refusal option as to any additional franchises in the original territory if it is not exclusive?
Termination and Renewal
Under what circumstances can the franchisor terminate the franchise agreement?
Does the franchise agreement spell out the terms under which the franchisor may repurchase the business?
Does the franchisor have an option or duty to buy any or all of the franchisee's equipment, furnishings, inventory, or other assets in the event the franchise is terminated for good cause, by either party? If so, how is the value determined and what are the payment terms?
What provisions are there in the event of the death or permanent incapacity of the franchisee? Is the franchise assignable to heirs, or may it be sold by the franchisee's estate on death or disability?
Is the franchisee restricted from engaging in a similar business after termination or expiration of the franchise agreement? If so, for how many years and in what area?
Are there alternative methods for resolving a dispute e.g. mediation and arbitration
Term, Renewal and Assignment
Can the franchisee sell the franchised business and assign the franchise agreement to the buyer? If so, what are the conditions of assignment?
Is the franchisee required to pay an assignment fee?
Does the franchisor have the first right of refusal in the event of an assignment?
What is the initial term of the agreement?
What are the terms of renewal?
Is the franchisee required to pay a renewal fee?
Other Points to Consider
Are all trademarks, trade names, or other marks registered to the franchisor?
Has the franchisor met all provincial legal requirements regarding full disclosure?
What is Considered Negotiable in a Franchise Agreement?
Franchise agreements can generally be considered non-negotiable except for items such as location, exclusive territory and opening date. Most franchisors are generally willing to clarify genuinely ambiguous clauses or correct errors in the franchise documentation. A franchisor may negotiate a point that is specific to a particular franchisee, but will be unwilling to make any changes that will violate the integrity of the franchise system. There may be more flexibility, or opportunity for negotiation, with a new franchisor whose agreement is still evolving and has not yet stood the test of time or the scrutiny of a number of franchise lawyers reviewing it on behalf of prospective franchise buyers.
On the other hand, a franchisor that is so inept that he concedes more than he should or is unwilling to seek proper legal advice suggests that he will be an incompetent manager of the franchise system. A franchisor that in the course of negotiations demonstrates a lack of concern for the well-being of other franchisees or the franchise system as a whole, by agreeing to modifications that will likely adversely affect other franchisees simply to close a sale, may be a franchisor that has no intention of abiding by its contract or is only concerned with its short term gain and not the success of its franchisees.
Franchising in Canada - To learn more about this author, visit Rob Lancit's Website.
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Franchising in Canada
Welcome to Franchising in Canada
Are you tired of reading all about the US world of franchising? Are you frustrated with not being able to find enough Canadian content about franchising on the web? Then you will appreciate the following information, which has been specifically developed for the Canadian franchise marketplace by BetheBoss.ca. This section of our site provides you with a basic knowledge of franchising in Canada so that you can explore the opportunities that franchising offers and make an informed decision about if you are suited to franchising and which franchise is bet suited for your particular requirements.
The Growth of Franchising in Canada
· Canada is one of the franchise capitals of the world led only by the U.S.
· A Canadian franchise opens every 2 hours 365 days a year
· Franchising represents over $100 billion in sales annually and continues to grow
· Franchising employs over 1.5 Million people in Canada
· Total number of units in Canada is 75,809
· Approximately 500 of the largest U.S. franchisors have introduced their franchise systems to Canada
What is Franchising?
It helps to begin with an understanding of what ‘franchising’ really means. In basic terms, franchising is a form of distribution or marketing. It is a method of doing business by which the franchisee is granted the right to offer, sell or distribute goods or services under a marketing plan or system prescribed in substantial art by the franchisor. It is a strategy for successfully penetrating, developing, dominating and achieving a disproportionately large market share.
The franchisor is the company that owns and controls the franchise system and grants the license to operate the franchise according to a certain method, and with the products and/or services that have been developed by the franchisor.
The franchisee is the company or person who pays the franchisor for the franchise and the right to use the system.
The franchise is the right to use the trademarks and systems, and to promote the products and/or services.
Types of Franchises
The term “franchise” is used to describe several different types of agreements, although its current definition places the emphasis on the continuing relationship between the franchisor and the franchisee. Most franchises fall under the classification of product or service, or business format. Although franchises will generally lean more heavily towards one or the other, they typically combine characteristics from both categories.
Product or Service Franchise
Early franchises were generally “Trade Name” franchises. The franchisor allowed the franchisee to distribute goods utilizing the franchisor’s trademark. This type of licensing arrangement includes such business as car and truck dealers, soft drink bottlers, home entertainment stores and service stations.
Generally, the franchisee was required to conform to certain standards relating to the quality of the product or service, but apart from that he or she was free to carry on business without any control or guidance from the franchisor.
Business Format Franchise
Business-format franchising is the most common form of franchising and involves not only the licensing of a product or service, but provides the method for running the business. Real estate companies, diet centres and travel agencies are examples of business-format franchises. Fast food franchises often combine product and business-format franchising. In fact, most of today’s franchises combine product and business formats.
The Pros and Cons of Buying a Franchise
Pros of Franchising
Reduced Risk
Franchising does not guarantee success, but a good franchise should help reduce the chances of failure.
A Proven System
With a tried and tested operating system, the franchisee loses the obstacles and gains the opportunities. A franchisee should receive a completely proven system that includes initial training, opening assistance, accounting systems, established suppliers, manuals and use of the trademarks. The all important "learning curve" helps prevent the franchisee from repeating previous mistakes and provides information on inventory levels, store design, competition, pricing structure and operational data drawn from the entire system.
Easier Access to Financing and Reduced Cash Requirements
Financial institutions prefer to lend to established franchised systems because of their higher success rate. The consumer awareness created by national or regional name recognition can reduce the costs of grand-opening promotional activity and advertising start-up. As well, the purchasing power of the franchisor can reduce the franchisee's initial outlay for equipment and supplies.
Purchasing Power
Collective purchasing power on products, supplies, extended health and insurance benefits, equipment and advertising can easily offset any ongoing royalties paid by the franchisee.
Site Selection Assistance
Franchisors can provide expert site selection assistance based on their operating experience and demographic knowledge. Landlords and developers prefer to deal with someone who has an established track record. This enables franchisees, as part of an established franchise system to obtain locations in major malls and other developments that otherwise would not be available to them as an independent operator.
Advertising Clout
Most independent businesses cannot afford the services of advertising and promotional experts. Consequently, their advertising is often poorly conceived and inconsistent. They also cannot afford to invest in the level of advertising required to maintain a commanding presence in the marketplace. In a franchise system, the advertising cost is spread over many units enabling the franchisor to achieve economies of scale. This also allows the franchisee to create well-conceived promotional campaigns and place the advertising in the most effective medium.
Building Equity
Because of the national or regional name recognition, and territorial exclusivity, a franchised business should sell faster and for a higher value than an independent business. A buyer is often motivated to buy the franchised business for the same reasons as the original franchisee and may perceive a higher value associated with a recognized name and system.
Stress Reduction
The ability to operate more effectively and efficiently can relieve many pressures of business. Systems that control job scheduling, cash flow and inventory levels allow the franchisee to run the business instead of the business running them.
Cons of Franchising
Loss of Independence
The loss of independence can be viewed negatively by some franchisees. Although most franchisees invest in a franchise because they want the guidance of the franchisor, the moment they enter the franchise system they want to make changes. Unless you are capable of working within a system and can accept a certain amount of regimentation, you should think long and hard before entering into a franchise relationship. One of the greatest strengths of franchising is consistency amongst units, and with consistency must come compliance.
Franchisor's Failure to Perform
Some franchisors don't deliver what they promise for a couple of reasons. A common reason for failure is the franchisor’s shortage of available capital, which can be caused by:
(a) The franchisor’s unrealistic franchise sales projections;
(b) The franchisor underestimating the expenses associated with the development of the franchise system;
(c) The franchisor’s failure to meet franchise sales projections, or
(d) High franchisee attrition.
Alternatively, it could be that the franchisor is just not capable of providing the support and assistance, or does not possess the ability to operate a franchise organization.
Misunderstanding the Franchise Agreement
Confusion over the interpretation of certain aspects of the franchise agreement can result in a problem with either the franchisor or the franchisee. A potential franchisee has probably never encountered a document anywhere near similar to a franchise agreement. A franchise agreement requires careful explanation and scrutiny, and failure to do so will inevitably result in a conflict that may end up in the courts.
Misrepresentation by the Franchisor
Misrepresentation by the franchisor can be intentional or unintentional. Projections of income and expense can be provided to the franchisee in good faith, but may turn out to be inappropriate for the location because of the franchisor's inexperience or unfamiliarity with the area's demographics. Conversely, the figures may be total fabrications simply to get the franchisee to sign on the dotted line and hand over the initial franchise fee.
Caveat Emptor (let the buyer beware), applies to franchising as it does to any consumer purchase or investment; however, consumers are often their own worst enemy, choosing to ignore cautionary advice and warning signals, and basing their investment decision on emotion without balancing it with logic.
Payment of Fees
The franchisee typically pays an initial fee for being granted the franchise, using the system, and receiving initial training. Typically, single-unit franchise fees are in the range of $25,000 to $35,000. The initial fee is paid only once during the term of the agreement; however, franchisors may charge a nominal renewal fee at the commencement of each new term of the agreement. The typical term for a franchise agreement is 5 or 10 years but may vary to coincide with the terms of a lease. Franchisors sometimes charge a site selection fee of $5,000 or more, in addition to the initial fee, which offsets their costs of site selection and lease negotiation.
In addition to the initial fee, some form of ongoing royalty is paid by the franchisee to the franchisor. In most instances, the royalty is based on a percentage of the Franchisee’s gross sales, which vary from1% to10%, or even higher, with a median range of 3% to 6%; however, units with high sales volumes often pay 1% or 2% less.
Franchisees are also required to contribute to a national or regional advertising fund, which is in addition to any requirement that the franchisee invests a minimum amount on local advertising.
Investigate Before You Invest
Every year, thousands of Canadians from all walks of life respond to the call of entrepreneuralism. Many people are attracted to franchising as a method of doing business because of what they perceive to be a greater chance of success than going it alone as an independent operator.
Unfortunately, a large number of people view franchising as some sort of magic wand or guarantee of success. Franchising is usually a safer investment than opening a similar independent business, if the franchise is part of a solid franchise system. In fact, studies show that 86% of franchises that opened in Canada within the last 5 years were still under the same ownership and 97% of them were still in business; whereas, a large percentage of independent businesses that started during the same period have gone out of business. It is generally accepted that 40% of all non-franchised businesses don’t make it to the end of their first year of operation, and 80% fail within their first 5 years. Even the 20% that survive are not safe, as 90% of them will fail within their next 5 years.
When considering a franchise it is essential that you carry out proper due diligence. Success in franchising is based on mutual dependence, so it naturally follows that the search for a franchise is a mutual investigation process. It is important to evaluate both the franchisor and the franchise. Reputable franchisors go to great lengths to select a franchisee. If a franchisor fails to investigate you as thoroughly as you investigate them, be cautious. If a franchise is awarded to a franchisee that is unable to operate it successfully, the franchisor will suffer almost as much as the franchisee that fails. Not only does the franchise unit fail to produce an ongoing revenue stream for the franchisor, but it can also take up a tremendous amount of the franchisor's time and effort to either salvage or resell the franchise.
A franchisor is obviously not gambling its entire reputation on you; however, you are probably betting a good deal of your future on the franchisor, so don't hesitate to ask a lot of questions. A franchisor that is offering a legitimate opportunity and has nothing to hide should have no hesitation in providing the necessary information to a qualified franchise prospect and should respect the fact that you are investigating them in much the same manner as you are being investigated.
Balance Your Decision-Making
To be a successful franchisee you must:
(a) Have a passion for the business,
(b) Understand the business, and
(c) Be capable of financing it.
Obviously, you should not consider a franchise that is beyond your financial means. Emotion and logic should be equally balanced when making the final decision about purchasing the franchise. You should feel good about the people involved in the franchise, and excited about the opportunity, however, logic has to be applied to the decision-making process in such areas as consumer acceptance, risk analysis, availability of product, demographics etc. Ask yourself, "Does this all make sense?” Your emotional commitment is only one of the essential elements, and if any of these elements is missing, the franchise is probably not right for you.
The Critical Factors
There are four critical factors that combine to make a good franchise system:
1.The Organization
Does the franchise organization have the ability to develop and maintain a franchise network? It is one thing to build and operate successfully a couple of retail outlets; however, it requires a different set of skills completely to build a network of several hundred stores.
Is there a strong management team that understands the particular industry and possesses the skills necessary to build the franchise organization?
How long has the franchise company been in business? What are the depth and quality of the franchisor's management team and field-support people?
What business is the company really in? Is it more interested in selling franchises than operating a solid franchise system? How does the company make its money - from "up-front" fees or from continuing royalties? Does the franchisor have adequate financial backing or is it relying on the sale of franchises to develop the system? How long has the franchise concept been tested?
2.The Product or Service
Does the product or service have a widespread consumer demand? Selling a new concept to the general public can be expensive and risky. Ideally, consumer demand for the product or service should have already been established. Some potential franchisees, thinking that the market is saturated, shy away from franchise opportunities that are already well represented by other companies. If there is an established consumer demand for a product or service, it then becomes a matter of gaining market share rather than gaining market acceptance.
Is the product or service marketable in your area? Will there only be a seasonal demand? Is this a trend or a fad? Can the concept be taught or is it a skill unique to the franchisor? Is it recession proof? If the franchisor is the only source of supply for the product, what alternatives are there if the franchisor should fail and the supply of product is terminated?
3.The Competitive Edge
Does the franchise offer a better way of providing that product or service to the consumer?
What makes the product or service unique and does it satisfy a particular need in your market? Can it be easily copied by a competitor? Will you have many competitors? Is it protected by a trademark or copyright? Is the price competitive? Is there a fully developed business format (system) for you to follow? What assurance do you have that the franchisor will be able to continue getting you the product at a fair price?
4.The Entrepreneurial Opportunity
Will the level of investment, the nature of the industry and the appeal of the franchise itself attract enough other people to become franchisees, to ensure that the system will grow and the franchise can be re-sold in the future?
Most people do not enter a business with the thought of selling it in the future; however, it is a sensible approach to develop a business with the intention of resale in the future. You must have a way of liquidating your asset and unless you are planning to list your company on a pubic exchange the only way of realizing the increase in your equity is through the eventual resale of your business. In most cases a franchised business should sell faster and for a higher price than an independent business by virtue of its exclusivity, name recognition and other franchise advantages.
On average, franchises change hands every five years. The reasons for the change of ownership are varied; people want a fresh challenge; the transfer of a spouse to a new city; an inability to run the business profitably; illness, retirement, personal problems; or simply a franchisee's desire to capitalize on their efforts and make a profit.
A franchisee must look at the broad appeal of the franchise opportunity to other would-be franchisees, taking into consideration all of the factors that will influence the growth of the total franchise system. Unless the system grows, many of the benefits of franchising such as advertising clout and purchasing power will be lost.
Franchise Legislation
Until 1997, Canada had been relatively free of franchise legislation, with Alberta being the only province in Canada to have legislation directed specifically at franchising. However, the increasing number of law suits between franchisor and franchisee has prompted other provinces to re-assess the need to introduce some form of franchise legislation. On May 17, 2000 the Arthur Wishart Act (Franchise Disclosure), 2000 (the " Ontario Act”) was passed by the Ontario Legislature and came into force on January 31, 2001. In substance, the Ontario Act is very similar to the Alberta Act.
Disclosure Requirements
If the franchisor is operating in Alberta or Ontario, if you are a resident of those provinces, or have a permanent residence in those provinces, the franchisor is required to provide you with a copy of their disclosure document at least 14 days before the signing of any agreement relating to the franchise, or the payment of any consideration relating to the franchise, whichever is earlier. If you are investigating a franchise in a province other than in those provinces, and the franchisor is operating in provinces, you can request a copy of the franchisor's disclosure document that the franchisor is required to provide in those provinces. The disclosure document must contain copies of all proposed franchise agreements, financial statements of the franchisor, reports and other documents in accordance with the regulations. A certificate must be signed by at least 2 officers or directors of the franchisor, which states that the disclosure document contains no untrue statement of a material fact and does not omit to state a material fact. The information contained in the disclosure provides a good basis for assessing the merits of a franchise operation but don’t assume that the franchisor’s compliance with disclosure or registration requirements implies that the regulatory authority has approved or recommends the franchise in any way. It is essential that you verify the information disclosed by the franchisor by speaking with existing franchisees, your lawyer, your accountant, or a franchise consultant.
Earnings Claims
Both Acts require the franchisor to provide details of any earnings claims information used by the franchisor, including material assumptions underlying its preparation and presentation, whether it is based on actual results of existing outlets and the percentage of outlets that meet or exceed each range of results. The earnings claim information must have a reasonable basis at the time it is prepared. The disclosure documents must also state the place where substantiating information is available for inspection by franchisees. If the information is given in respect of a franchisor-operated outlet, the franchisor must state that the information may differ in respect of a franchisee outlet. Earnings claims consist of information from which a specific level or range of actual or potential sales, costs, income or profit from franchisee or franchisor outlets can be ascertained.
Franchisee’s Right of Rescission
If a franchisee suffers a loss because of a misrepresentation contained in a disclosure document, the franchisee has a right of action for damages against the franchisor and every person who signed the disclosure document. If the franchisor fails to provide the disclosure document within the time requirements, the prospective franchisee may rescind the agreement by giving notice of cancellation no later than 60 days after receiving the disclosure documents, or no later than 2 years after the granting of the franchise. A franchisor must, within 30 days of receiving a notice of cancellation, compensate the franchisee for any net losses the franchisee has occurred in acquiring, setting up, or operating the franchised business.
The Franchise Agreement
A franchise agreement is a contract, which is entered into between the franchisor, and the franchisee and sets out the relationship between the franchisor and franchisee. The franchise agreement will usually appear biased towards the franchisor, which is necessary for the franchisor to maintain control over the franchise system. A franchisor is risking its name and reputation on the franchisee’s performance, so it is only fair and reasonable that bit has the right to place certain obligations on the franchisee. Consistency amongst franchise units is a cornerstone of successful franchising – and consistency requires compliance.
Despite common beliefs, there is no such thing as a standard franchise agreement, and no two franchise agreements are alike. This is understandable because franchises cover many types of business in many different industries and have different characteristics. A franchise agreement will be just one of the documents that a franchisee will be required to sign. These may include a non-disclosure/confidentiality agreement, offer to purchase agreement, lease (or sublease) agreement, and a security agreement.
Checklist of Basic Franchise Agreement Terms and Conditions
As franchise agreements vary from franchise to franchise it would be impossible to identify every term and issue that should be considered in every situation. However, this checklist should be a valuable tool if you're interested in buying a franchise.
Fees, Royalties and Other Costs
How much is the initial franchise fee?
Is any part or the entire initial franchise fee refundable under any circumstances?
What is the total initial investment?
What are the terms of payment?
Does the franchisor offer any financing, or provide assistance in finding financing?
How much are the ongoing royalties and how are they determined?
How and when are sales and royalties reported, and how are royalties paid?
Is the franchisee required to contribute to an advertising fund administered by the franchisor? If so, how much?
How is the advertising fund administered? Is it National, regional or local?
What are the franchisor’s responsibilities regarding accounting of the advertising fund?
Franchisor’s obligations to the Franchisee
Are accounting/bookkeeping services included or available?
What degree of control does the franchisor have over franchise operations, particularly in maintaining franchise identity and product quality?
Does the franchisor provide an initial training program? If so, where and when is it presented, what is the duration and is the franchisee responsible for any costs such as travel, accommodation and living expenses.
What ongoing management support, assistance and training programs are provided by the franchisor? Are there any additional costs involved?
Does the franchisor provide promotional aids, point-of-purchase materials, mail programs, etc. and at what cost?
Franchisee’s Obligations
Is the franchisee required to maintain a specific amount of working capital?
Is the franchisee required to commit full time and best efforts to the operation of the franchised business?
Is the franchisee required to purchase equipment or supplies from the franchisor, or from a supplier approved by the franchisor?
Is the franchisee required to purchase a minimum product quota?
Is the franchisee required to meet specific performance requirements? If so, what are the penalties for not meeting them?
What controls does the franchisor have out concerning facility appearance, equipment, fixture and furnishings, and maintenance or replacement of the same?
Is the franchisee required to purchase all, or some of their products from the franchisor?
Is the franchisee required to obtain insurance coverage as specified by the franchisor?
Is the franchisee required to name the franchisor as an ‘additional named insured’ on the franchisee liability coverage?
Is the franchisee required to expend a minimum amount with respect to local advertising?
Are operating hours and days set out in the franchise agreement?
Are there restrictions on what the franchisee can sell?
Premises, Locations and Territory
Are premises required?
Is the franchisee required to lease or sub-lease premises from the franchisor?
If there is a lease, does it coincide with the term of the franchise agreement?
Who is responsible for site selection and lease negotiation?
Does the franchisor determine the plans and specifications for the premises?
Is the franchisor or the franchisee responsible for the development of the premises?
Is the franchisor responsible for supervision of development of the premises?
Who is responsible for selecting the contractor?
How is the development of the premises financed?
Are there any restrictions on remodeling or redecorating?
Does the franchisee receive an exclusive territory?
Is the size of the exclusive territory subject to reduction or modification under certain conditions?
Does the franchisee have a first refusal option as to any additional franchises in the original territory if it is not exclusive?
Termination and Renewal
Under what circumstances can the franchisor terminate the franchise agreement?
Does the franchise agreement spell out the terms under which the franchisor may repurchase the business?
Does the franchisor have an option or duty to buy any or all of the franchisee's equipment, furnishings, inventory, or other assets in the event the franchise is terminated for good cause, by either party? If so, how is the value determined and what are the payment terms?
What provisions are there in the event of the death or permanent incapacity of the franchisee? Is the franchise assignable to heirs, or may it be sold by the franchisee's estate on death or disability?
Is the franchisee restricted from engaging in a similar business after termination or expiration of the franchise agreement? If so, for how many years and in what area?
Are there alternative methods for resolving a dispute e.g. mediation and arbitration
Term, Renewal and Assignment
Can the franchisee sell the franchised business and assign the franchise agreement to the buyer? If so, what are the conditions of assignment?
Is the franchisee required to pay an assignment fee?
Does the franchisor have the first right of refusal in the event of an assignment?
What is the initial term of the agreement?
What are the terms of renewal?
Is the franchisee required to pay a renewal fee?
Other Points to Consider
Are all trademarks, trade names, or other marks registered to the franchisor?
Has the franchisor met all provincial legal requirements regarding full disclosure?
What is Considered Negotiable in a Franchise Agreement?
Franchise agreements can generally be considered non-negotiable except for items such as location, exclusive territory and opening date. Most franchisors are generally willing to clarify genuinely ambiguous clauses or correct errors in the franchise documentation. A franchisor may negotiate a point that is specific to a particular franchisee, but will be unwilling to make any changes that will violate the integrity of the franchise system. There may be more flexibility, or opportunity for negotiation, with a new franchisor whose agreement is still evolving and has not yet stood the test of time or the scrutiny of a number of franchise lawyers reviewing it on behalf of prospective franchise buyers.
On the other hand, a franchisor that is so inept that he concedes more than he should or is unwilling to seek proper legal advice suggests that he will be an incompetent manager of the franchise system. A franchisor that in the course of negotiations demonstrates a lack of concern for the well-being of other franchisees or the franchise system as a whole, by agreeing to modifications that will likely adversely affect other franchisees simply to close a sale, may be a franchisor that has no intention of abiding by its contract or is only concerned with its short term gain and not the success of its franchisees.
Franchising in Canada - To learn more about this author, visit Rob Lancit's Website.
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John PowerJohn Power, founder of Biltmore Franchise Consulting, has extensive experience developing and marketing franchises and business opportunities. He has been in and around franchising for over twenty years. From 1980 through 1990 he conceptualized, organized, and developed the American Video Association. He grew AVA to 2,000 national members, before selling the company it 1990. It was later merged into another home video marketing company. From 2000 to 2005 he worked as a contract marketing and human resources consultant to several local and national companies. In 2005 Mr. Power began working as a franchise development consultant on a full-time basis. Since that time he has helped more than three dozen companies initiate and develop their franchising program. He notes that there are many companies interested in developing a franchise program, and who need his specialized assistance. Mr. Power is a “hands-on” franchise consultant. He said, “I am the ‘nuts and bolts’ person who tends to the details for my clients.” Mr. Power holds a B.S. degree with a major in Marketing. See: www.biltmorefranchise.com You may contact Mr. Power at: jpower@biltmorefranchise.co - Visit John Power's Website |
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