Your Must-Know Glossary of Common Franchise Terms
If you want to invest in a franchise, you'll need to know these terms so that you know what you're signing up for.
Every business niche has its own lingo, and franchising is no different. Because not many people know about this area of entrepreneurship, the language surrounding it isn’t well known, either. In fact, it seems that industry professionals go to great lengths to coin their own franchise terms for the otherwise standard ones that most of us are more familiar with.
Starting, buying, and even selling a franchise is a lengthy process, with its fair share of contracts and paperwork. As such, you’ll want to have legal representation standing with you every step of the way. Online resources such as LegalZoom can also provide help in sorting out legal details.
I’ve also compiled the following glossary of common franchise terms with the help of Tom Scarda, a certified franchise coach for the Franchise Academy. Becoming familiar with these terms can set you up to better understand franchise opportunities you come across. And hopefully this glossary can also help you to decipher what marketing materials and representatives are speaking about before you get too far down any one franchise path.
The following people are key participants in a franchise system. Contracts usually refer to them by name in the first part of a contract, and then by these designations later on.
The franchisor owns the business system, processes, and associated trademarks or trade names. McDonald’s and Merry Maids are good examples.
Franchisors allow franchisees to use these intellectual properties under license in a designated area and for a fee.
Once an agreement is signed, the franchisor usually offers some level of support in getting the new franchise up and running, as well as with day-to-day processes as the business grows. The other term for this is franchise company.
If you bought a franchise, you would be a franchisee. The other name for this is franchise owner. A franchisee is a person or group of people who own and operate their business under the licensing agreement granted by the franchisor (mentioned above). When signing up to own a franchise, he or she usually gets to:
- Use the franchisor’s trademark and trade name
- Build equity in the business
- Get access to proprietary training
- Sell and market the franchise products and services
- Have advertising support
With a franchised restaurant, for example, the franchisee can use the marketing materials of the company (usually okayed in advance); order supplies from the approved vendors at a set price; use the franchise company’s “secret” sauce on the hamburgers; have training support for new products that may be launched; and buy into advertising and business promotion, such as commercials, at agreed-upon rates. Such benefits are only available to an official franchisee of the company.
If you want to own several franchises in one geographic area, you need to secure the designation of area developer. This grants you the right to operate more than one unit within a defined area. Many chain restaurants, for example, are owned by an area developer within the same city.
Also known as a broker, this independent agent, or middleman, acts as an intermediary between the franchisor and a prospective franchisee.
The franchise consultant earns his money based on how well the franchise does.
He gets paid by the franchisor. Considered an agent of the franchisor, this coach is bound by the laws and rules that regulate the sale of franchises.
While contracts’ terminology can vary depending on the industry, these common, generally recognized franchise terms mean the same thing to everyone.
This is the contract between the franchisee and franchisor that covers everything about the sale and ongoing partnership of the business. It includes many factors, but most standard agreements contain the following:
- Rights and obligations of the franchisee and the franchisor
- Territory parameters
- Quality control
- Location of the business
- Training offerings
- Management requirements
- Renewal options
- Termination requirements
- Dispute resolution
- Supplier agreements
- Product standards
Many other facets of the business may be included, based on the type of business.
An area developer (mentioned above) usually agrees to establish a specific number of franchised units within a certain geographic area, called a development area, according to an agreed-upon schedule. For example, this could be two new restaurants in two years.
Each franchise unit in the area will still need to have its own franchise agreement, as well as pay a development fee before it opens. Sometimes a part of the development fee can be credited to the franchise fee, lessening the overall fees due.
Franchise Disclosure Document
Also known as an FDD, this important form is required by the FTC under its Franchise Rule. It must be provided to anyone interested in buying a franchise.
An FDD shares information on the business in a way that can be easily compared with other franchise disclosure documents.
It’s designed to help potential franchise owners understand the opportunity and risk of investing.
The FTC Franchise Rule
The FDD is a result of nationwide regulation by the Federal Trade Commission (FTC) that principally requires franchisors disclose certain information to interested investors. This rule was issued in 1978, took effect in 1979, and was extensively amended in 2007. The FDD doesn’t have to be provided to the FTC, only the interested investor.
Due diligence is the process of making sure that someone is who she claims to be and has the authority to do what she claims to be able to do. It’s a common legal term that applies to all business and consumer arrangements, not just franchises.
Royalty fees commonly cover the use of the franchise’s intellectual property — logos, trademarks, and processes — and can include payment for services provided by the franchisor. These services may include marketing, payroll, training, and the use of proprietary software systems.
The fee is also sometimes called a service fee or license fee.
Group Purchasing Power
One of the ways franchisees can get a good price on goods and services needed to run their businesses is through group purchasing power. Because a group of store operators can buy in considerably large quantities, they can keep costs lower and service timelier. This franchise term refers to the influence of the group to obtain these privileges.
Before buying into a franchise, potential franchisees will often investigate the opportunity by interviewing current and past franchisees to get honest feedback on the quality of the opportunity. This is referred to as franchisee validation.
This franchise term refers to the visual appearance of an item that’s aesthetic and not related to functionality. (Product packaging is one example.) Trade dress denotes signals to consumers that the establishment, products, or services are associated with a particular brand. This is a crucial part of owning a franchise. It may even include how employees are dressed, the way the exterior lighting looks, and how signage is hung in-store. Trade dress may be an enforceable part of a franchise agreement.
Other Franchise Terms and Details
There may be many other terms in a standard franchise agreement — covering, for example, the length of a contract or how partnership financing the will be obtained. However, these are the ones unique to the franchise business.
Because some franchises offer financing and partial loans for their franchisees, there is also the potential for a contract to include a lending agreement. If you need additional help financing your franchise, companies like Kabbage and LendingClub can help.
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