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Franchising 101 – Get Schooled on Franchise Fundamentals

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Dec 10

FRANCHISINGThe turnkey nature of a franchise can be a very attractive alternative to starting a business from the ground up.  Here’s the basics about franchise ownership and what the Federal Trade Commission (FTC) considers necessary to be considered a franchise.

 

According to the International Franchise Association a franchise is an agreement or license between two legally independent parties that gives:

 

  • a person or group of people (franchisee) the right to market a product or service using the trademark or trade name of another business (franchisor).
  • the franchisee the right to marketing a product or service using the operating methods of the franchisor.
  • the franchisee the obligation to pay the franchisor fees for these rights.
  • the franchisor the obligation to provide rights and support to franchisees.

 

Additionally, in the eyes of the Federal Trade Commission, defining a franchise involves answering questions around three legal elements:

·         Element 1: What is the trademark or legal brand with which the franchise will be associated?

·         Element 2: Will the business have significant assistance from its parent organization with regard to how it delivers its product or services?

·         Element 3: Is there a required payment, typically a franchise fee, as well as ongoing royalty or other fees based on sales?

Responses to these questions will help determine the business’ course and provide insight on the business model and if it’s a good fit for you. Franchises aren’t one-size-fits-all either.  There are numerous types of franchise structures and opportunities all with different cash down, financing and purchase requirements.

Product Distribution is a supplier-dealer type relationship where the franchisee sells the franchise’s products. Typical Product Distributions include soft drinks like Coca-Cola, automobile such as Maaco or Meineke, and gasoline franchises like Sunoco Gas.

 

Business Format Franchise – use a franchisor’s product, service and trademark along with the complete method for conducting business.  A wide range of product and service franchises work on this model such as fast food restaurants, lodging, maintenance and many others.

 

The business format relationship can also form in several ways including direct-unit and multi-unit franchises.

Single-Unit (Direct-Unit) Franchise – Just like it sounds, the single-unit franchise agreement permits ONE unit of a franchise.  Generally once the original unit begins to show a profit, additional units may then be purchased.

 

Multi-Unit Franchises are available in two subcategories: area development franchise and the master franchise.  The Area Development Franchise gives the franchisee rights to develop more than one unit within a specified time period usually associated with a territory or geographic region.  A Master Franchise agreement in addition to the Area Development Franchise agreement where the franchisee must open and operate a specific number of stores, the Master Franchise agreement also includes the right to sell those franchises to other individuals within the territory (sub-franchising). What is the difference? The Master Franchiser must then assume ownership of other tasks such as management, training and support to receive the franchise fees and royalties.

 

Conversion

When an established business assumes the trademark and brand of an existing franchise, a conversion of the established business occurs. Some typical independent business types that have successfully converted include florists, real estate firms, financial organizations such as retirement planning and investing, and even certain baked goods like cookie bouquets.

Deciding to buy a franchise isn't a small decision.  Take the time to research the franchise by talking with local owners, going to the franchise headquarters and meeting with the leadership team and fully understanding the terms of the franchise agreement.  Don't sign anything or write a check until you've brought all the information back and met with your own business consultant team consisting of a business lawyer, an accountant and/or small business advisor.  They can evaluate the offer with unbiased eyes and provide pros and cons for the opportunity. If you don't have a business team, talk with a PASBA Small Business Advisor in your area. 

PASBA member accountants bring the collective resources of a nationwide network of Certified Public Accountants, Public Accountants, Enrolled Agents and other practitioners available to answer your tax and financial questions and streamline your business accounting, bookkeeping, and payroll operations.

To find a trusted accountant in your area, visit www.SmallBizAccountants.com.

Please be advised that, based on current IRS rules and standards, any advice contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty that the IRS may assess related to this matter. Any information contained in this article, whether viewed or subsequently printed, cannot be relied upon as qualified tax and accounting advice. Any information contained in this article does not fall under the guidelines of IRS Circular 230.

 

Copyright Information 2014 Professional Association of Small Business Accountants 

 

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