Franchising is a method of retail business in which the investor/franchisee makes an investment in the form of a franchise fee in exchange for the right to promote goods, services, and/or processes directly to the public. A franchise usually has a recognizable name or trademark. Franchising involves the integration of independent companies at different levels and in different areas of production and distribution. This integration permits more effective sales and advertising.
Franchises exist in at least three different forms:
1. The manufacturer-sponsored retailer system
An example of this arrangement is the car industry, where car manufacturers license dealers to sell its product. The dealers are independent businessmen who agree to meet certain standards and conditions of sales and service.
2. The manufacturer-sponsored wholesaler system
An example of this arrangement is the soft-drink industry, where soft-drink manufacturers license wholesale bottlers in various markets who buy the concentrate and then carbonate, bottle and sell the product to retailers in local markets.
3. The service-firm sponsored retailer system
Familiar franchises include auto rental, fast food, and motel businesses. Here, a service firm organizes a complete system for bringing its service effectively to consumers.
Pyramid schemes vs. Franchises
Legitimate franchises exist in all sorts of industries. There are also illegitimate, and illegal, businesses calling themselves franchises that are actually pyramid schemes. These schemes are not focused on selling products, but rather on getting other people to pay to join the scheme. This provides the organizers of the scheme with a lot of money, but usually does little or nothing for the investors. Be sure to investigate any franchise opportunity to make sure that it is not a fraudulent pyramid scheme.
Choosing a Franchise
Purchasing a franchise can be a good way to become an entrepreneur, and enter the world of business ownership. Potential investors should be cautious - like any other investment, there is no guarantee of success. While buying a franchise may reduce the risk of investment by enabling the investor to associate with an established company, it may be costly. Franchise owners may not control many aspects of their business, and be contractually obligated to the franchiser in a variety of ways.
A franchise typically enables the investor or "franchisee" to operate a business. By paying the franchise fee, which may cost thousands of dollars, the franchise may operate the business under the format developed by the company, or franchisor, the right to use the franchisor's name, and sometimes, assistance in setting up or marketing.
Prior to entering a franchise arrangement, the BBB recommends investors consider the following:
The Federal Trade Commission Franchise Rule
The Federal Trade Commission (FTC) Franchise Rule requires franchises, vending machine and display rack business opportunity ventures to disclose material facts in a prospectus, and further prohibits material misrepresentations in the offering and sale of franchises. The following types of businesses are covered by the FTC rule:
A. The franchisee sells goods or services that meet the franchiser quality standards or bear its mark; the franchiser exercises significant control over or extends significant help to the franchisee; and the franchisee is obligated to pay $500 or more to the franchiser within the first six months of commencing business; or
B. The franchisee sells goods supplied by the franchiser; the franchiser secures vending machine or rack display locations for the franchisee; and the franchisee is obligated to pay $500 or more within six months of beginning to do business; or
C. While the business opportunity does not actually fall within the above definitions, it is represented as falling within one of the above.
The following information must be furnished to prospective franchisees at least ten days before signing the contract:
Further, a franchiser (or a franchise broker) who makes an earnings claim through advertising or a direct sales pitch, must provide the prospective franchisee with a document which includes the following information:
While the franchiser is not required to provide the substantiation for such claims, he/she must have back-up material for each claim available to prospective buyers or the FTC upon reasonable demand. The rule also requires the franchiser to provide a copy of the franchise agreement to the prospective buyer at least ten days before the agreement is to be executed.
New York State Law
New York State law requires the franchiser to register a prospectus with the Department of Law, Franchise and Securities Division. The prospectus must disclose all of the above information, as well as the following:
1. if the franchiser is subject to a restrictive order barring the registration of such person as a securities broker or sales person.
2. the length of time the franchiser has conducted business of the type operated by the franchisees, has granted franchisees for such businesses, and has granted franchisees other lines of business.
3. the franchiser's most recent financial statement.
4. a statement as to whether franchisees or subfranchisers receive an exclusive territory.
5. a statement as to whether the franchisee is limited in the goods and services he/she may offer to customers.