What is a franchise and how does it work?

Franchising is a business model in which you can sell products or services using the brand name and systems of a proven business. In return, you pay a management fee to the business owner, also known as the franchisor.

The franchisor provides you with an operating system, support, training and marketing. The most valuable aspect is the franchise brand, and you must deliver it to a required standard. You will build relationships with your customers to maintain their loyalty, but meeting brand expectations will always be at the heart of the business.

The franchise agreement

The franchisor owns the business’s intellectual property, which includes the brand, systems, and manuals, and this intellectual property is licensed through the franchise agreement.

The franchise agreement outlines the roles and responsibilities of both the franchisor and franchisee and must comply with the Consumer Protection Act (CPA). Agreements are generally valid for five years, with the option to renew if the franchisee meets all of the requirements outlined in the agreement.

Consumer Protection Act 

Franchisees are protected by the CPA in two major ways:

1. Prospective franchisees must receive a disclosure document upfront, which includes:
   
   
   • The total number of franchise outlets;
     
     
   • The previous financial year’s growth in the franchisor’s net profit and number of outlets;
     
     
   • An auditor’s statement confirming the franchisor’s ability to meet financial obligations, as well as the most recent financial statements;
     
     
   • Financial projections for the franchise plus the assumptions; and
     
     
   • A list of all the franchisees and their contact details.

2. There must be a cooling-off period where a franchisee can cancel without penalty within ten days of signing the agreement.

If a franchisor is a member of the Franchise Association of South Africa (FASA), a voluntary organisation, they must provide prospective franchisees with information in a comprehensive disclosure document. This is outlined in the FASA Code of Ethics and Business Practice, which includes a 14-day cooling-off period for all sales.

Costs of buying a franchise

On joining a franchise, you pay an upfront fee that grants you access to intellectual property, training and franchisor assistance, allowing you to start your business. This fee differs depending on the type of business, the brand and even the location.

Then there are various ongoing fees, which can include:

• Management or royalty fee: usually paid monthly based on a percentage of turnover;
  
  
• Marketing fee: this covers national advertising costs and is based on sales or is a fixed fee, depending on the franchisor;
  
  
• Other fees: this can include purchasing fees for bulk stock purchased by the franchisor or other special services provided by the franchisor;
  
  
• Renewal and refurbishing costs: some franchisors charge a fee to renew the agreement. Franchisees must also maintain the appearance and equipment in line with the franchisor’s requirements, and some franchisors charge a monthly refurbishment fee to help franchisees save for this.
  
  

Operational costs

Over and above the franchise-specific costs, you will also need to fund the setup and day-to-day running costs of your business.

Business support

The franchisor will support you in many areas, including:

• An established brand name;
  
  
• Site selection and lease negotiations;
  
  
• Advice and assistance with recruitment;
  
  
• Training for yourself and your staff;
  
  
• Advice around setting up the premises;
  
  
• Access to bulk buying discounts;
  
  
• New product development and innovation; and
  
  
• Ongoing operations system development and updating.

Financing your franchise

You will need to have liquid capital equal to between 40 percent and 60 percent of the cost of a franchise, and the remainder can be funded with a loan.

Franchisors set this limit to ensure that there is adequate gearing and that the business is successful. Lenders are also more willing to invest in your business if you have personally invested in it.

A franchise is typically easier to finance than your own small business because the franchise support reduces the lender’s risk.

Most banks have a franchise division that handles financing. Applications are channelled through relationship managers at a regional level and processed centrally. If your franchise is already established and you require additional financing, having a relationship manager who understands your business can make the process easier.

It is not easy to change your mind

Signing a franchise agreement is a serious commitment, as it can be binding for up to 10 years. If there’s a lease agreement included, these are typically for five years with an option to renew.

If you want to exit the agreement, your best option is to sell it to another franchisee. The franchisor will draw up a new agreement with them, and new lease agreements will be negotiated.

If you simply close your business, the franchisor can claim royalties for the remaining term of the agreement, while the landlord will collect the rental due for the remaining lease period.

Preventing over-exposure

Most franchise agreements limit the number of franchises that can operate in a given area or how close they can be located to each other, thereby preventing excessive competition.

When signing your agreement, always include a right of first refusal, so that if another franchise outlet is registered near you or a franchise becomes available near you, you will have the first option to buy.

To find out more, visit the FASA website www.fasa.co.za