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The goal of most franchise systems is to expand the business beyond a single unit. There are different ways of setting up a franchise system to achieve this goal.
This is the most prevalent of the three franchise arrangements. In unit franchising, the franchisor simply licences the franchisee to operate the franchised business at a single location. The franchisor and franchisee enter into a franchise agreement that governs their relationship and the operation of the franchised business. The key advantage to unit franchising is that it gives the franchisor maximum control over expansion of its franchise system. The key disadvantage is slower growth, since the franchisor uses its own time and resources to expand and oversee its system.
In this arrangement, the franchisor grants the franchisee (known as the “area developer”) the right to establish and operate more than one franchised unit within a specifically defined region or territory. The area developer enters into an area development agreement with the franchisor and usually pays a development fee for the right to develop the franchise system in the specific territory. The area development agreement usually deals only with the expansion aspects of the franchise, often setting out a schedule for the opening of individual franchise units in the area developer’s territory. The operation of each franchise unit within the territory is usually governed by a separate franchise agreement. The key advantages of this arrangement is the potential for faster growth and increased revenues, both development fees and increased royalty fees, as the system expands. One of the disadvantages is that this arrangement requires an additional contractual relationship and, where franchise disclosure laws are applicable, additional disclosure.
In sub-franchising, also known as “master franchising”, the franchisor licences the franchisee (in this arrangement commonly known as the “sub-franchisor”) the right to grant, within a defined territory, unit franchises to other persons (known as “sub-franchisees”) for its own account. In effect, the sub-franchisor takes on many, if not most, of the responsibilities of the franchisor in the defined territory or region. At the top of the structure is a contractual relationship between the franchisor and sub-franchisor (often referred to as a “master franchise agreement”), governing the development of the territory (usually pursuant to an agreed-upon schedule) and setting out the responsibilities of the franchisor and sub-franchisor in the territory. Below this is a separate contractual relationship (the “franchise agreement”) between the sub-franchisor and the sub-franchisee governing the operation of the franchised business. The main advantage of sub-franchising is that it permits for rapid expansion of the franchise system, particularly to territories where the franchisor may not know the laws, customs or demographics, or have the desire or time to establish a presence itself. Thus, master franchising has been used when expanding outside of one’s national borders, as when a franchisor based in the United States of America desires to expand into Canada. The main disadvantage is the franchisor’s loss of control when placing another person between itself and the franchisees.
Choice of structure depends on many factors, including the maturity of your franchise system, the control you wish to maintain, the territories or regions into which you wish to expand, the opportunity for expansion, and even the necessity to expand, to name a few. Also, each arrangement has numerous variations, each with its advantages and disadvantages. The choice of the appropriate structure should be made carefully in consultation with an experienced franchise lawyer.
Louis Vouloukos practises franchise law at Lawrence, Lawrence, Stevenson LLP. He can be reached at (905) 452-6883 or email@example.com