Basics of franchising

The Franchising World (TFW) had for the past eight years been serving as a platform for individuals associated with franchising, whether they are franchisors, franchisees or aspiring entrepreneurs.

In 1999, when the first issue of TFW was published, there were very few people who could understand franchising. Slowly and gradually, franchising has evolved in India and the magazine has played a significant role in this evolution. TFW made people understand the meaning of franchising and taught them how to franchise. Today, the magazine is celebrating its golden jubilee. To mark its 50th issue, let`s brush up our memories and glance through the basics of franchising.

Franchising is a business model in which you purchase a licence of a specific business.

The Franchise Fee (Licensing fee) gives you the right to open a franchise of that particular business, using trademarks, signage, products, software, business systems etc.

There are franchises available in almost every business area that one can think of, in all price ranges. And as franchising involves low risk of failure, the chances of the business being a success are extremely high. The experience that the franchisor has gained in making his business a success helps the new entrepreneur to eliminate the mistakes one would most probably make if it were an independent business.

Rationale of franchising From a franchisor`s perspective:

For a company with a product or service to sell, franchising provides an excellent opportunity for rapid expansion without an enormous outlay of capital. It is a distribution system that allows a business to conserve capital, and at the same time achieve fast market penetration, making it a very attractive proposition to most business owners. One of the greatest advantages to them is that they get 100 per cent commitment from their franchisees who have a stake in the business rather than staff or managers who simply work for a salary and may be less motivated.

From a franchisee`s perspective:

Franchising offers an opportunity to own a business whilst at the same time minimising the risk that is inherent in opening an entirely new business from a scratch. It allows an opportunity to dabble in a tried and tested business system, which greatly improves the chances of success, as the statistics prove.

Laws of franchising

Franchising has been specifically regulated in only a few countries. The complexity of the relationship between a franchisor and a franchisee and the large number of areas it involves, is partly to blame for the non-promulgation of franchise laws in these countries.

Countries that have laws to govern franchising businesses are, to a large extent, detailed and restrict any malpractices in the franchising business relationship. These laws had become necessary because of the practice of some franchisors to circumvent the franchisee`s rights to disclosures of a franchisor`s business performance, and restrict management and product support.

International laws

Competition law or anti-trust themes:

Competition law is designed to eliminate activity and conduct that is likely to limit the free play of competition in the marketplace. While most of the nations have adhered to this concept in varying degrees and have devised ways to keep the competition free, India is yet to fully embrace this approach but is likely to do so in due course.

Focus on the conduct:

When considering the expansion of business through franchising, one should review the business practices and focus on the conduct in five main areas. These are:

Horizontal restrictive agreements:

These are agreements between competitors that limit competition or fix prices.

Exclusive dealing:

This arrangement occurs when a franchisor refuses to deal with a prospective franchisee unless the franchisee buys all its requirements of a particular product or service from the franchisor or does not acquire such products from the franchisor`s competitors.

Tied selling:

Tied selling or `full line forcing` is an arrangement where the sale of one product is conditional upon a requirement to purchase another product.

Territory or customer restrictions:

Most franchisees demand exclusive territory rights in which they can carry out their franchised businesses and deal with the customers of their choice. It becomes unlawful if a restriction is placed upon the territory, customers or intellectual property rights.

Resale price maintenance:

Uniform pricing throughout the franchise network, though desired by franchisors, cannot be imposed upon the franchisees. Any attempt to influence or control the price at which the products or services are to be resold is deemed illegal under anti-trust laws.

Indian laws

Indian competition law:

In India, the Monopolies and Restrictive Trade Practices (MRTP) Act, 1969, has been enacted to prevent monopolistic, restrictive and unfair trade practices that distort free competition in the market. The Consumer Protection Act, 1986, and Part B of the MRTP Act, 1969, also provide remedies to individual consumers for deception, loss and injury suffered as a result of defective and substandard goods. Both these acts incorporate rules of strict liability against manufacturers, traders and sellers of goods and services to consumers. The first part of the MRTP Act is mainly directed against the franchisors, whereas the Consumer Protection Act and Part B of the MRTP Act are directed mainly at those master franchisees and franchisees that produce the goods for the Indian consumers.

Indian Consumer Protection Laws:

The Consumer Protection Act, 1986, covers a wide range of persons who may be liable, including manufacturers, assemblers, distributors, wholesalers, retailers and packers of defective goods. It may also extend to installers, erectors and repairers of goods.

Indian Intellectual Property Law:

The protection of Intellectual Property Rights is of utmost importance to both international and domestic franchisors that are franchising into a new territory, since their goods are prone to be copied and marketed or brand name misused. The Trademarks Act, 1999, was enacted to register and better protect the trademarks and to prevent the use of fraudulent marks on merchandise. In India, a franchisor can protect a trademark by registration. The Designs Act, 1911, is aimed at protecting the proprietors of novel or original designs and for enforcing those rights against infringements.

Labour laws relating to franchising:

Labour laws are important for international and domestic franchises, especially in relation to the various outlets, shops and offices in which persons are employed. No franchising contract can deviate from the applicability of the labour laws. The labour laws govern the day-to-day conditions of employment that are particularly relevant in the context of franchising when an outlet is shut down or business is sold, in relation to the amount of compensation payable by the master franchisee, franchisor or franchisee.

Insolvency laws:

Insolvency becomes an issue if either the franchisor or one of its franchisees is unable to pay its debts. Clearly, the risk of insolvency for both the franchisor and franchisee in India will be greatly increased if the franchise concept is a foreign one and it has not been properly adapted for the Indian market. The laws that are relevant in India, in relation to insolvency, are found in the Companies Act, 1956, and the Provincial Insolvency Act, 1920.

Franchise documentation

Franchising involves a large number of documentation. In the Indian context, this might be limited to the franchise agreement and a few forms, but internationally, especially in countries that have franchising laws, the concept requires a sizable number of detailed plans and proposals, and business operations system. Let us have a look at them:

The manual:

The importance of the manual lies in the fact that it gives operational details and know-how of the franchise that enables franchisees to identify and use the know-how.

The likely contents of a manual, which are elaborate and detailed, are: shop layout, staff schedules, staff uniforms / appearances /etiquettes, staffing requirements of outlets, staff job descriptions, contracts of employment, disciplinary procedures, grievance procedure, training requirements, service standards, pricing policies, purchasing policies and standard form contracts, storage requirements, opening hours, stock rotation, accounting procedures, point of sale requirement, advertising and marketing practices, maintenance of equipment requirements, technical information about equipment used, cleaning routines, internal directory of franchisors` organisation, menu`s/recipes/variations, explanation of relevant laws, customer complaints procedures, guarantees/warranties, approved suppliers list.

Franchise agreement:

It is a written contract detailing the mutual responsibilities of franchisors and franchisees. It is usually for a several-year term, and when the term is up, the contract expires and must be renewed. Some state laws require the contract to be renewable at the franchisee`s option. Usually, a franchise agreement may not be sold, transferred, or otherwise assigned without the franchisor`s permission.

Lease agreement:

A typical lease will generally include the following provisions:

Abandonment of premises: Most leases deem you to be at default if you vacate all or a portion of the premises even if you continue to pay the rent. Try to eliminate this clause.

Lump sum rent: Most leases allow the landlord to collect the total rent due for the remaining lease period in the event of the tenant defaulting or prematurely terminating the lease. This could prove costly to you, so do not let this be a part of the lease.

Alterations and improvements: Include non-structural alterations and improvements to the premises in the lease after the approval of the landlord.

Assignment and subletting: Ensure you have the right to assign or sublease with the landlord`s consent. Negotiate a provision to allow an assignee to use the premises for any lawful purpose that is not in conflict with those granted by the landlord.

Attorney fees: In the event of the landlord suing you, ensure that the lease provides attorney payment by the losing party or by both separately.

Some leases give the landlord the right to audit books and records of the tenant. If the landlord retains the right to audit, ensure it is at his expense. Also ensure confidentiality is maintained regarding the results of the audit.

Broker: Use of a broker by any party should find mention in the lease. Ensure that the landlord pays the brokerage commission.

Commencement date: Ensure that the commencement date, that is the date on which you begin to pay rent, is applicable only if you occupy the premises. In case it is not ready or not vacated, reserve the right to terminate the lease. Try to negotiate a delay in paying rent for 60 to 90 days.

Condition of the premises: Thoroughly inspect the premises before signing the lease. For this you may hire a building inspector and give a list of items that need repair before you take occupancy. If equipment is included, it should be in good working condition.

Contingencies: Contingencies under which you may cancel the lease should be a part of the lease.

Default by landlord or tenant: Default is a breach of lease by one of the parties. Ensure that the lease covers default by landlord and not only by the tenant.

Exclusivity: You do not want a competitor next door. To ensure this, negotiate exclusivity to prevent the landlord from giving out his other outlets, in the same building or in the vicinity, to your competitors.

Force majeure: As explained earlier, it is an irresistible force which is beyond the control of the parties, like riots or earthquakes, floods and other acts of God. Insist on adding the force majeure provision in the lease to protect the interests of both the parties.

Hours of operation: The timing of opening of the building or shopping centre, particularly common areas, stairways and elevators, where your franchise is housed should be in consonance with your hours of operation. Furthermore, your time of opening and closing under the lease should be consistent with your franchise agreement.

Indemnification: Indemnification, as explained earlier, should not be one-sided requiring the tenant to fully indemnify the landlord for all liability. Renegotiate this provision, so that the landlord indemnifies you and your agents, employees and contractors.

Ingress and egress: An important aspect of running a successful business is easy accessibility of your premises by the customers. Consider this aspect thoroughly before signing the lease.

Landlord`s maintenance obligations: These obligations should include keeping the common areas up to a specified standard and should include exterior painting, landscaping, parking areas and walkways.

Landlord`s right to access: Most leases give the landlord the right to enter the premises at any time without prior notice to repair, inspect or show the space to prospective tenants or buyers. Limit this right and insist upon reasonable notice to avoid disruption to your business.

Leasehold improvements: Closely scrutinise your and the landlord`s obligations with respect to leasehold improvements that include construction of the interior of the premises, including walls, shelving, flooring, partitions, and so on. Secure a signed, detailed work letter that lists out the tasks of the tenant and the landlord.

Maintenance and repair: The landlord should be responsible for the maintenance and repair of the structural elements and common areas.

Option to purchase: Draw a separate legal contract to give you a right to purchase the building at a specified price or at a specified time.

Option to renew: The renewal clause should be governed by the same terms as mentioned in the lease except for a reasonable change in rent.

Parking: Issues relating to parking arrangements for employees and customers, for other tenants, parking fees, etc. should be put in writing.

Rules and regulations: Rules and regulations governing the building or shopping centre should be reviewed carefully. They should be reasonable, non-discriminatory and uniformly enforced.

Services and utilities: Find out what utilities are available and if they are sufficient. Also, find out who pays for these services. Negotiate for increased service to the premises at the landlord`s expense. Install separate electric and water meters. Signage: The lease should allow displaying standard signage and graphics approved by the appropriate authority on pylon signage.

Term: The initial term of the lease must match the term provided in the franchise agreement.

Glossary Business format franchising: The franchisor licenses the franchisee a complete plan --- a business format, operating system and trademark to his/her franchisee, including step-by-step procedures for major aspects of the business and, anticipating most management problems, provides a complete matrix for management decisions confronted by the franchisees.

Conversion Franchise: A franchise that permits existing businesses to join a national franchise system to use its recognised name and trademark and operating system

Franchise: A franchise is a grant by the franchisor to the franchisee, entitling the latter to the use of a complete business package containing all the elements necessary to establish a previously untrained person in the franchised business, to enable him or her to run it on an ongoing basis, according to guidelines supplied, efficiently and profitably.

Franchisee: The franchisee buys the right to run the business using the trademark and trading system. The business is run according to the procedures set out in the franchise operating manual and under the terms of the franchise agreement.

Franchise agreement: It is a written contract detailing the mutual responsibilities of franchisors and franchisees. It is usually for a several-year term, and when the term is up, the contract expires and must be renewed. Some state laws require the contract to be renewable at the franchisee`s option. Usually, a franchise agreement may not be sold, transferred, or otherwise assigned without the franchisor`s permission.

Franchise fee: A one-time fee paid by the franchisee to the franchisor to `buy into` the franchise. Generally, the fee reimburses the franchisor for the costs of initial training and support for new franchisees.

Franchising: Neither an industry nor a business, rather franchising is a method of doing business within a given industry. At least two parties are involved in it: the franchisor and the franchisee. Technically, the contract binding the two parties is the franchise.

Franchise contract: It is a legal agreement between the parties that sets out the terms under which the franchisee will operate the business. The terms usually include the following:

Franchisor: The franchisor owns the business system and associated trademarks or trade names. Franchisors allow franchisees to use these under licence in a designated area and for a fee. They then support their franchisees, both in starting their business and in continuing to make it work.

Master franchisee: In master franchising, the franchisor grants the master franchisee the right to act as the franchisor in the target territory. The master franchisee may open his or her own outlets, sub-franchise or do both. The primary advantages to the franchisor of master licensing are: limited capital investment; tapping into the master franchisee`s knowledge of the local market and only having to deal with one party.

Multiple units franchising: The franchisor awards the right to a franchisee to operate more than one unit within a defined area based on an agreed upon development schedule. If the franchisor decides to expand into a new geographical area which may be a city or province and does have the resources or staff to handle this growth themselves, a Master Franchise, Sub-franchise or an Area Development agreement is structured with a party who will use their resources to develop the franchise network by granting unit franchises to others or establish their own outlets, provide the training and local ongoing support.

Royalty: A continuing payment to the franchisor that is payable on a periodic basis (usually weekly, biweekly, or monthly) throughout the term of the franchise agreement.

Uniform Franchise Offering Circular (UFOC): The US Federal Trade Commission enacted a rule in 1979 requiring the franchisor to give a written prospectus to prospective franchisees (see 10-day and 5-day Rules). The prospectus prescribed by the FTC is called the Uniform Franchise Offering Circular or UFOC. The UFOC contains explicit items of information related to the franchise, including the franchisor`s background; important provisions of the franchise agreement; amount and terms of the franchise fee (Item 5) and royalty and advertising-fund fee (Item 6); estimated start-up costs (Item 7); details on existing franchisees; the franchisor/franchisee relationship; audited financial statements for the last three fiscal years; and copies of all contracts that will be used.

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Factors for franchise growth

• Huge consuming class

• Fast growing consumerism

• Shift towards services from agricultural and manufacturing

• Franchising has already proven to be successful in several sectors

• Large entrepreneural pool

Challenges of Indian franchising

• Lack of regulatory framework

• Financing mechanisms not in place

• Skewed real estate markets

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