The Most Frequently Franchising Asked Questions

Whatis a Franchise?

What is a Franchise?

How does a franchise differ from a business opportunity?

How does a licensee or agent system differ from a franchisemodel?

What is a master franchise?

What is a tandem franchise?

Research& Evaluation

As a prospective franchisee, is it advisable to requestaccess to the franchisor’s financial records to assess the stability of thecompany?

How should one go about evaluating a franchise opportunity?

What is usual practice when it comes to the franchisorscreening and vetting franchisees?

DisclosureDocument

What should a comprehensive Disclosure Document include?

When should I expect to see the Disclosure Document?

Will the franchisee have to sign a confidentiality agreementbefore the Disclosure Document is handed over?

TheFranchise Agreement

What are the typical terms and conditions of an agreement?What should a comprehensive Franchise Agreement include?

Are there particular clauses that prospective franchiseesshould be mindful of or look to include?

Do I need a lawyer to look at the agreement? What would theybe checking?

Do agreements have a cooling off period?

Legislation& Regulation

Is there legislation that governs franchising in South Africa?

What is the role of FASA in South Africa?

What is the criterion for membership for franchisors?

How will I, the franchisee, be affected by Capital GainsTax?

Will I, the franchisee, be affected by the New Credit Act?

TheFranchise Fees

What does the upfront fee cover?

When and how is the fee usually paid?

What does working capital cover and how much will thefranchisee need?

What can the franchisee expect to pay in terms of ongoingpayment?

TheFranchise Operation

What should new franchisees expect from the franchisor interms of an operations manual?

What should the new franchisee expect from the franchisor interms of scouting for and securing a location?

What should the new franchisee expect from the franchisor interms of training and support?

What should the new franchisee expect from the franchisor interms of marketing assistance?

TheBuy & Sell Options

Is there an ‘out’ of the agreement, should the franchiseewish to sell their franchise?

After what period is a franchisee able to sell theirfranchise?

How does a franchisee go about selling?

Is there a benefit to buying a re-sale franchise?

How should one evaluate a re-sale franchise?

Whatis a Franchise?

The Franchise Book of Southern Africa 2006notes that, according to FASA, “A franchise is a grant by the franchisor to thefranchisee, entitling the latter to the use of a complete business packagecontaining all the elements necessary to establish a previously untrainedperson in the franchised business and enable him or her to run it on an ongoingbasis, according to guidelines supplied, efficiently and profitably.”

You could compare franchising to a landlordand tenant situation: someone owns a house and lets someone else use it for afee. In a business setting, the ‘landlord’ would be the franchisor who owns abrand, copyright, trademarks, know-how and other intellectual property, andlets someone use them in return for reimbursement.

A franchise in its simplest form can be atrade name franchise, where the franchisee pays for the right to use acompany’s trademark and name – as in the case of many motor vehicle outlets –or a full business format franchise, which includes the use of a range ofintellectual property.

It’s a unique business model, because althoughthe franchisee owns his or her store, they’re merely renting or using theintellectual property.

The success of franchising often stems fromthe fact that consumers know that they can expect the same product, look andfeel and quality of service, no matter which franchise outlet they utilise.

Howdoes a franchise differ from a business opportunity?

Let’s take the example of starting your ownpizza restaurant, or buying a franchise outlet. When you buy a franchise, yourpurchase includes the right to use the franchise system’s methodologies,systems, recipes, copyright, brand and all other intellectual property. Thebrand name is hopefully already established and has recognition in themarketplace; and because of that, it has commercial magnetism – it will attractcustomers. The business model has also hopefully already been refined, and istherefore successful – it’s in a developed or advanced state of operation.

If, however, you’re starting your ownbusiness, you may have to go through the teething problems associated withdeveloping your own systems, recipes, brand and reputation.

Statistics show us that 80% of newfranchises are successful, compared to 20% of other new businesses.

At the same time, you must choose thefranchise you buy into with care. Factors like location, or appointing thewrong manager can impact on success. Also, if the franchise system is notrefined, you will duplicate the original mistakes or inadequacies in your ownoperation.

Howdoes a licensee or agent system differ from a franchise model?

Essentially, franchising is just asophisticated form of licensing. Under a license system, someone ownsintellectual property, and allows someone else to use it. Importantly, in afranchise system, the franchisor owns their own business, as does thefranchisee – they are two separate entities.

Under an agency system, an agent acts forand on behalf of the principal, as if he is the principal entity.

The two types of contract or structures aresimilar in that one will find similar types of contractual provisions in each.Both will have provisions such as who will do what, where and how.

Whatis a master franchise?

Imagine there is a franchisor operatingoverseas. They’re interested in setting up operations in South Africa,but they do not have the infrastructure or wish to establish a business herethemselves. They may therefore appoint a master franchisee, a person who willroll out the operation in this country and manage it. Master franchises areintermediaries – although not franchisors, they perform the same functions,opening stores, managing franchisees and so on.

Whatis a tandem franchise?

This is where two franchise systems havesome sort of symbiotic or complementary relationship, for example a fast foodoutlet next to a video hire outlet or a smaller franchisee outlet or kioskwithin a larger different franchise outlet.

As aprospective franchisee, is it advisable to request access to the franchisor’sfinancial records to assess the stability of the company?

Yes, but the franchisor may decide not togrant such access. That’s because you’re buying a franchisee outlet, so theinformation which is relevant to you is the viability, performance andfeasibility of that outlet and other outlets, not the financial records of thefranchisor company itself. It’s like buying a car – you need to know about thecar’s features, not the features or finances of the company that manufacturedit.

Howshould one go about evaluating a franchise opportunity?

A Disclosure Document is a key tool inevaluating a franchise and helping a potential franchisee make an informeddecision about buying into a specific franchise system. The document shouldinclude a feasibility study,  exactexpenses, start-up costs, the training furnished, employee requirements, andhow long it will take for the franchisee to break even.

You should also ask for the names andcontact details of other franchisees who will be able to tell you whether forexample, the actual performance of the business system meets its projectedtargets.

Whatis usual practice when it comes to the franchisor screening and vettingfranchisees?

Many franchisors have adopted assessmentmodels from industry consultants such as Franchize Directions and FranchisePlus. These may be compared to sophisticated application forms which screen outpeople who are unlikely to be successful as franchisees in that system; just asa company requests a potential employee to undergo a personality assessment.

This is important, because the success of afranchise often depends on the selection of the right type of person as afranchisee. Screening therefore aims to ensure a match between the strengths,skills and attributes of the franchisee and the requirements of the franchise.

Franchisors will look for people who canwork alone and are independent self-starters; a crucial factor, becausealthough your franchise is part of a broader network, it operates as your ownbusiness. As such, the ability to think as an entrepreneur is a plus. Considerwhether your interests are in tune with the business – if you’re consideringopening a DVD franchise, will you be prepared to chat to people about theirchoices when they ask for advice? Remember that your franchise will require alot of input, especially as many franchisors insist that franchisees managetheir outlets. Do you have what it takes to deliver on the business’srequirements, and are you prepared to put in the effort?

Whatshould a comprehensive Disclosure Document include?

The document should outline the salientfeatures of the franchise, its characteristics, details and a feasibilitystudy. 

First, it will list the contact details ofthe franchisor, the names and details of the shareholders and senior employeesof the franchisor, as well as the company’s background, history and structure.Next follows a description of services and products, together with the factorsinfluencing success; the details of the franchisor’s initial and ongoingsupport and training; an outline of the contents of the procedural manual;total investment required (including a breakdown of the franchise royalties,administration fees and working capital) and a short feasibility study. Detailsof other franchisees should be included. Any past and present financialdifficulties of the franchisor and franchisee must be noted, along with thefull details, requisites, equipment, layout and proposed sites for an averagefranchise outlet. Finally, the Disclosure Document will include a summary ofthe Franchise Agreement.

The purpose of the document is to ensurethat the potential franchisee has sufficient accurate information to help themassess the franchise operation, and make an informed decision about whether toenter the Franchise Agreement or not.

Whenshould I expect to see the Disclosure Document?

As soon as you request it. The DisclosureDocument is often used as a selling tool by the franchisor, so they willusually be willing to let you peruse it if they believe you have a real interestin buying into the system.

Willthe franchisee have to sign a confidentiality agreement before the DisclosureDocument is handed over?

Probably not – although you would berequired to sign the Franchise Agreement or a Confidentiality Agreement beforeyou receive additional information. It’s not usual practice to signconfidentiality clauses this early because the information contained in aDisclosure Document is often not especially sensitive.

Whatare the typical terms and conditions of an agreement? What should acomprehensive Franchise Agreement include?

The agreement will first identify anddescribe the parties (franchisor and franchisee) involved. It will thenidentify and record the intellectual property rights available to thefranchisee through the franchise arrangement, along with definitions offranchised business, intellectual property and so forth.

Next, it will detail the grant of thefranchise: whether it is an exclusive, sole or ordinary franchise. Informationabout payment is also included (the franchise fee, royalties, advertising,administration fees and working capital).

The Franchisors’ Obligations (initial andongoing) are outlined, as well as the obligations of the franchisee (alsoinitial and ongoing).

Further information contained in theagreement relates to use of trademarks; the operating manual; conditions aboutchange of ownership, death and incapacity of the franchisee and termination;conditions of restraint; disclosure, suretyship, confidentiality, a possibleprovisional period, as well as general clauses.

Arethere particular clauses that prospective franchisees should be mindful of orlook to include?

Pay special attention to the grant clause,as this will determine whether you are the sole franchisee operating in acertain territory (exclusive grant); whether the franchisor may also operate anoutlet in the same territory (sole grant); or whether there are no restrictionson the number of franchisees who may operate in that area (ordinary grant). Thenumber of operators naturally impacts on your ability to turn a profit.

Make sure you have a thorough understandingof the franchisor’s obligations. Bear in mind that although the FranchiseAgreement may appear to be onerously biased in favour of the franchisor, it isin the interests of all involved in the franchise system to ensure that thereis consistency in branding, service, product and the like. There must be abalance, however, and this is where the franchisor’s obligation to develop thefranchisee and provide guidance is key.

Do Ineed a lawyer to look at the agreement? What would they be checking?

It is advisable to ask a lawyer whospecialises in franchising – and has experience in this area – to review theFranchise Agreement. They must ensure that there is balance, especially interms of the franchisor’s obligations; that the royalty fees are reasonable;that the business model is commercially viable and that all aspects of theagreement support the success of the franchisee rather than limiting it. Thisis vital, as an agreement may look simple, but any areas that are not correctlyunderstood may have severe repercussions.

Doagreements have a cooling off period?

The cooling off period is usually 14 days.This is a FASA recommendation, according to FASA’s Code of Ethics andguidelines for Best Practice, but it is not legislated.

Isthere legislation that governs franchising in South Africa?

The Competition Act makes it unlawful for afranchisor to fix prices for a franchisee’s products and services. TheCompetition Commission also has concerns regarding exclusive suppliers andterritories. The latter may however not be prevented if there is vigorousintra-brand competition.

The Consumer Protection Bill is currentlyin its third draft form, and is due to go to Parliament shortly. The Bill willaffect all franchises – current and future – in South Africa. The intention is forthe Bill to function as a Consumers’ Bill of Rights, and it introduces asubstantial number of new considerations in terms of fairness and equity. TheBill will probably enforce full disclosure upfront, and make it possible tocancel an agreement if such disclosure was not offered or if it misrepresentswhat is sold. That’s important, because one of the biggest problems facingfranchisees at present is that their purchase of a franchise does not matchtheir expectations, either because a franchisor has puffed up the businesssystem’s success, or because they have not known the right questions to askconfirming that success. The Bill will assist in avoiding such pitfalls, byensuring that fuller relevant information is disclosed upfront.

Whatis the role of FASA in South Africa?

FASA aims to promote ethical franchising inSouth Africaand ensure that international best practice is upheld. The association is avoice for the industry, provides a support and networking function forfranchisees, hosts a reference library, and offers a mediation service insettling complaints. FASA further hosts the International Franchise Expo, whichmatches franchisors with potential franchisees, and the FASA Awards forExcellence. The body, which is now in its 30th year, has done much to advancethe development, professionalism and ethics of the franchising industry in South Africa.

Whatis the criterion for FASA membership for franchisors?

Members must meet and maintain FASA’srequirements. They must lodge with FASA a Franchise Agreement that is compliantwith the association’s ethical code and best practice guidelines, along with anOperations and Procedure Manual and a Disclosure Document.

Howwill I, the franchisee, be affected by Capital Gains Tax?

There may be a Capital Gains Tax payable ifyou sell your franchise.

WillI, the franchisee, be affected by the New Credit Act?

Yes, inasmuch as any other industry isaffected. If the franchisor has funded the franchisee, or granted a loan, theywill be regulated according to the terms of the Act.

Whatdoes the upfront fee cover?

In a turnkey franchise situation – wherethe franchisee purchases a complete store – the upfront fee includes fixtures,fittings, equipment, opening stock and the cost of setting up the store. Thecost of training is also taken into account, along with the franchisor’smanagement and legal costs and the goodwill element of the brand, which will bemore expensive in developed franchise systems. The upfront fee of an operationwhich is not a turnkey franchise will cover similar costs, but it may be brokendown differently. You may, for example, spend the same on purchasing stock andsetting up the store, but this money will be spent with suppliers and possiblynot directly with the franchisor.

Whenand how is the fee usually paid?

It’s usually paid into a trust account, ordirectly to the franchisor on signature of the Franchise Agreement (or shortlythereafter).

Whatdoes working capital cover and how much will the franchisee need?

That depends on the business itself. Veryfew franchises can cover their costs from month one, so you will needsufficient funds to cover – or at least partially cover – the business’sexpenses at least until the business breaks even. The feasibility studyincluded in the Disclosure Document is a guide to how much working capital isrequired.

Whatcan the franchisee expect to pay in terms of ongoing franchise fees?

The ongoing fees may be termed managementservice or royalty fees. This is usually calculated around 25% of thebusiness’s net profit, or a percentage (usually up to about 6% or 8%) of grossturnover. This monthly fee is for the continued use of intellectual property,as well as administrative and management services provided by the franchisor.Monies paid for marketing should go into a separate, independent fund which ismanaged by the franchisor in consultation with the franchisee. This sum isusually about 3% of turnover.

Whatshould new franchisees expect from the franchisor in terms of an operationsmanual?

It is not a legal requirement to provide anOperations and Procedure Manual, although it is a FASA requirement. Thisprovides a blueprint for the operation of the franchise.

Whatshould the new franchisee expect from the franchisor in terms of scouting forand securing a location?

This differs between systems. In somecases, the franchisor finds a location, then looks for a franchisee to operateit. On the other hand, the franchisee may approach the franchisor because hebelieves he has found an optimal location, in which case the franchisor willevaluate it. It’s important that both parties are satisfied that the locationis a good one.

Whatshould the new franchisee expect  fromthe franchisor in terms of training  andsupport?

The franchisor should provide adequate andappropriate training, which is sufficient to allow the franchisee to carry onhis business effectively and efficiently. Training usually takes place on aninitial basis, but may be ongoing as the business requires. This should beoutlined in the Disclosure Document.

Whatshould the new franchisee expect  fromthe franchisor in terms of  marketingassistance?

This is broad and varied, because itdepends on the requirements of the store. For example, if the franchise systemis brand new and is not nationally known, it makes sense to advertise locallyat first. However, if the franchise is part of an established and nationalnetwork, less investment in local marketing may be required. The franchisorusually assists with the initial marketing, public relations and a grand opening,but this again depends on the franchise system’s level of development. Thefranchisor’s obligations are also influenced by the money available in themarketing fund.

Isthere an ‘out’ of the agreement, should the franchisee wish to sell theirfranchise?

There usually is an out; however, thefranchisor must consent to your sale to a new franchisee, so that they can besure the new franchisee suits the business requirements. It’s advisable toexamine your Franchise Agreement to determine whether there are any restraints,and how long that restriction is. The franchisor may be entitled to apercentage of your sales fee, particularly if further training for the newfranchisee is needed.

Afterwhat period is a franchisee able to sell their franchise?

This is dictated by the terms of theFranchise Agreement.

Howdoes a franchisee go about selling?

The sale is conducted in conjunction withthe franchisor, as their consent must be obtained before the sale goes through.The franchisor may be able to put you in touch with prospective franchisees, oryou may advertise as you would with any other business. The franchisor oftenmakes the ultimate decision about whom the franchise is sold to.

Isthere a benefit to buying a re-sale franchise?

Yes; you’re buying a business that ishopefully already established and has ironed out any initial problems. Yourstaff will have received training, you are likely to have a regular clientele,and the business may also be generating profits. There’s no guesswork about theviability of the franchise (as when buying a new outlet), because it will havebeen in operation for some time. Be careful, though, that you don’t overpay forthe business – carefully consider the information including financial informationprovided.

Howshould one evaluate a re-sale franchise?

Evaluate the outlet using similarinformation as if you are buying a new one. The difference here is that theoutlet would have been trading for some time so having a look at its financialrecords and speaking to existing staff regarding performance of the outlet andany difficulties experienced will be very useful.