Types of Franchise Businesses

What Is a Franchise?

A business franchise is an established company that has brand recognition and a proven business model. Entrepreneurs who want to set up an independent business may apply for a license to get access to the franchise brand, support, and operational systems. Franchisors must give potential franchisees a franchise disclosure document (FDD) before an agreement is signed. The franchisee must pay an initial franchise fee and ongoing royalties to the franchisor.

We make business formation EASY. Learn about our DIY business formation services here.

What Is the Difference Between a Franchise and a Small Business?

A franchise is often a small business but rather than creating an independent business startup, the small business owner pays a franchise royalty and licensing fee. The franchise owner now has access to an established brand in exchange for that fee.

The franchisor is the entity that owns the brand, trademarks, and business model, such as McDonald’s Corporation. The franchisee is the individual or business that pays a licensing and royalty fee (a franchising fee) to operate a location under that brand.

If you sign a franchise agreement with McDonald’s (franchisor), you become a franchisee. You can operate using the McDonald’s brand and system.

Small business owners with limited years of experience owning a business might find a franchise setup an attractive investment. Perks the franchisor can offer include:

• Business plan

• Existing customer base

• Brand recognition

• Future franchising offers or new locations

• Success rate and track record

• Training programs

To become a franchisee, the business owner must pay an initial investment, which includes upfront startup costs. The franchisor must provide a Franchise Disclosure Document (FDD) that outlines their fees, history of litigation, and financial performance at least 14 calendar days before a franchisee signs the contract or makes payment.

What Is Licensed by the Franchisee?

One way franchise opportunities can be distinguished from one another relates to what aspects of the franchisor’s business interact with the franchisee’s business. Franchisors can license their business model, the rights to distribution and production. If you are considering buying a franchise, it is wise to familiarize yourself with the different kinds of franchising agreements. The following types of franchise businesses are among the most common:

• Business Format Franchise – The franchisee receives a business model developed by the franchisor as well as employee training, site selection, equipment, and other assistance with establishing and operating the franchise. The most common type of franchises include most chain stores and fast-food restaurants, such as McDonald’s.

• Business Opportunity Venture – The franchisee distributes products or services on behalf of the franchisor to customers developed by the franchisor in return for a percentage of sales on commission. Business opportunity ventures include vending machine companies or instructional seminars.

• Manufacturer Franchise – The franchisor grants the franchisee the right to manufacture the franchisor’s product under license and then sell the product using the franchisor’s trademark and company name. Soft drink companies, such as Coca-Cola, and gasoline companies, such as ExxonMobil, are often manufacturer franchises.

• Product or Trade Name Franchise – The franchisee purchases the franchisor’s products, which the franchisee distributes and sells. The franchisor maintains a significant amount of control over the distribution and sale of the products. The franchisee may be required to buy minimum inventory amounts. Brand name stores are often product franchises.

Franchises and Sub-Franchises

Very large franchises may include different roles within the franchisor/franchisee relationship. This typically occurs when a franchise is seeking to open or develop markets. A new kind of franchise arises when a franchisee has the franchisor’s authorization to distribute, administrate, or sell sub-franchise rights. Examples include:

• Master Franchise – This occurs when a franchisee is granted a license to act as the franchisor. In return for a substantial fee to the original franchisor, the franchisee is granted the right to license franchises, provide franchising services, and collect royalties from their sub-franchisees.

• Area Developer Franchise – Area developer franchisees are often authorized to divide the geographic area into districts and to open and operate multiple units themselves within a territory. Unlike a master franchise, an area developer franchise is typically more limited in scope.

Get Experienced Advice About Franchise Business Options

The foregoing overview of the types of franchise businesses only scratches the surface of the wide array of business arrangements that are possible. Too many options can be as difficult to handle as too few, however, and you may need experienced advice sorting out the kinds of business opportunities that are best for your situation.

Consider consulting with an experienced franchising attorney to seek assistance making a wise choice.