Franchising . . .

refers to a form of licensing that businesses use to expand and generate revenue. It is generally characterized by the license from a franchisor to a franchisee of a trademark and system of doing business. In return for the license, the franchisee pays the franchisor an up-front fee, which is often substantial, and agrees to pay the franchisor a percentage of sales or some other royalty in the future.

For the right kind of business, franchising can reduce the need for venture capital by enabling the franchisor to obtain capital from its franchisees. In most franchising arrangements, the cost of expanding to a new unit is borne by the franchisee. The franchisor advises the franchisee in the best methods of establishing his unit of the business and charges him a fee to cover the cost of providing that advice and to make a profit. After the business begins operating, the franchisee pays the franchisor a percentage of sales or other agreed-upon royalty.

Franchising does not usually replace the need for outside equity. Capital is almost always needed to develop the franchise system and protect the trademark. In many cases, franchising is pursued only after the company has owned and operated a few successful units of its business itself. This operation takes time and usually requires considerable capital to fund. Traditional venture capital sources are receptive to funding businesses that plan to grow through franchising.

Establishing a franchise program requires the preparation of an extensive franchise disclosure document, which provides information about the franchisor and the franchise program. Careful compliance with both federal and state franchise and business opportunity laws is a must. Failure to comply with all of the requirements can result in significant liability to a company and its managers. See: Licensing, Trademarks.