last updated 20/07/2023
Clear as mud? Franchise terms you need to know
last updated 20/07/2023
July 2022 – Franchising has its own jargon which can be pretty confusing to the newcomer. Here’s a guide to help you understand what it all means.
Franchisor, franchisee, master franchisee … they all sound similar, but mean very different things. And it’s something that is made even more complicated when well-meaning people use different phrases like ‘franchise owner’ or ‘franchise partner’. Who owns what? Is it a legal partnership? Are you really 'buying' a business? Let’s clear away the fog.
Take it from the top
To start at the beginning, the basic principle behind franchising is that someone develops a successful business model, brand and operating system which they then make available to others, enabling them to replicate the business in new areas.
The franchisor is the owner of the business name, the trademark and goodwill, and the developer of the business system which is used to operate multiple outlets or units of the franchise around the country – or even the world. McDonald’s Corporation owns the McDonald’s brand, franchise and operating system; the individual restaurants are run by franchisees. See an explanation of how franchising works.
Franchisee or franchise owner – what’s the difference?
The franchisee is the individual or company who is granted the right to use the franchisor’s name and product/service to run their own business. They own their business, which might be XYZ Limited, but they don’t own the franchise – they are only granted the right for a specific period. See Franchise Term below.
Some franchisors prefer to call their franchisees ‘franchise owners’ or ‘franchise partners’, believing that it better respects the franchisee’s control of their business, or reflects the relationship between franchisor and franchisee.
Both these terms can be misleading, though. The term ‘franchisee’ is an accurate reflection of a fixed-period commercial relationship, as with ‘lessor’ and ‘lessee’, or ‘mortgagor’ and ‘mortgagee’. There’s a legal relationship between the two which is set out in the Franchise Agreement (see below). Most of the power in this relationship is with the franchisor, who needs to protect the brand for the benefit of all the franchisees. It is certainly not a partnership in the legal sense.
For reasons of clarity, we always use the term ‘franchisee’ on this website.
And what’s a master franchisee?
A Master Franchisee is a person or company granted the right to recruit, train and/or support individual franchisees within a set national or regional territory as part of a ‘three-tier’ franchise system. The franchisor retains ownership and overall control; the master franchisee carries out some of the roles of the franchisor within their territory; the franchisee is assisted by the master franchisee.
There are also roles (often called Area Developers) in which only some of the duties of the franchisor are granted to this middle tier. If you are dealing with an area developer, it’s important to know what they will do for you, and what will be provided by the franchisor.
What about all those fees?
Franchise Fee. This is the upfront one-off payment made by the franchisee for the above rights. The cost will vary according to the value of the opportunity, awareness and value of the business name and system, initial training provided, and so on.
Royalty (sometimes called ‘ongoing fee’ or ‘management service fee’). This is paid by the franchisee for support and ongoing services from the franchisor or master franchisee as well as the franchisor’s profit. It is sometimes a regular flat amount, but is also often a percentage of turnover (note: turnover, not profit). Percentages vary between brands and industries, depending on what services are included in the fee.
Marketing Levy or Advertising Fee. This is often required as a contribution to a consolidated marketing fund to be spent for the benefit of all franchisees. It is often (but not always) expressed as a percentage of turnover. Many companies will account for this spend to their franchisees. It may be supplemented by supplier contributions to promotions, and is sometimes split into national/group advertising and local promotion.
How long will it last?
One major difference between a franchise and an independent business is that franchises are usually granted for a fixed term, often with rights of renewal. Instead of buying a franchise, it might be easier to think of setting up or buying a business, then 'leasing' a proven model for that business to operate. The reason for multiple renewable terms is to allow the model to be evolved as the market or technology changes.
A common approach to the Franchise Term might be a 5-year initial term with two further terms of 5 years, giving a possible 15 years in total. If both parties are happy with the arrangement, it is likely to be renewed. Most franchisees in New Zealand renew at least once, and many stay with the franchise for 20 years or more! See the cover story in our latest magazine.
Then there’s the paperwork
The Franchise Agreement is the legal document which sets out the precise terms and conditions under which a franchise is granted. It will usually be a lengthy document (some 40-60 pages) and does not make for light bed-time reading. Always, always get it looked at by a franchise-experienced lawyer before signing it.
The Disclosure Document is a document provided to an intending franchisee which contains information about the way in which the franchise operates, and sets out details of financial and legal obligations. This is a briefer explanation of the key points of the franchise. It is not a legal requirement to issue a disclosure document, but good franchisors will provide one – and it’s mandatory for members of the Franchise Association.
Manual Set. The manuals (which are often online, in reality) contain the ‘blue-print’ for the business which lays out the correct procedures and standards to which the franchisee must adhere. They are highly-detailed, highly-confidential, frequently updated and remain the property of the franchisor.
Get the advice you need
That’s a quick run through some of the terms you’ll come across when looking at franchising. We hope it will help you understand the info on this website.
As always, when looking at buying a new or existing franchised business, make sure you take good professional advice from a franchise-experienced accountant and a lawyer with specialist knowledge. All this jargon may be new to you, but they’ll know what it means – and be able to spot anything unusual, too. Get them on your side!
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