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Business Banking

Franchise

Principles
of Franchising
A step by step guide to the world of franchising

Copyright notice
Copyright 2015. This publication has copyright under the Berne Convention. In terms of the
copyright Act, No. 98 of 1978, no part of this publication may be reproduced or transmitted in any
form or by any means, electronic or mechanical, including photocopying, scanning, recording or by
any information storage and retrieval system for purposes of resale without permission in writing
granted by Absa Franchising.
Publisher
Absa Franchising
P O Box 7735, Johannesburg 2000
Publication details
ISBN 978-0-620-56297-3
First edition, first impression 2015
Disclaimer
The content of Principles of Franchising is intended for general information only and is not intended
to serve as financial or other advice. Absa Bank Limited does not guarantee, express or imply the
availability or the accuracy of information, nor is it responsible for any decisions taken, based on this
information. Absa Bank Limited excludes to the extent lawfully permitted all liability whatsoever
for any loss or damage howsoever arising, which may result from, or be attributable to, directly or
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Bank Limited may amend the Principles of Franchising without obligation to notify any person.
All intellectual property rights, including, but not limited to, copyright and trademarks in the
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consent of Absa Bank Limited.

Page ii / Principles of Franchising

Message by Absa franchising


As an important part of our commitment to the growth and prosperity of
the South African economy, Absa recognises the vital role played by the
entrepreneur in creating new wealth and opportunities.
Franchising is a viable alternative for
the entrepreneur looking to start a new
business and wishing to avoid some of
the dangers facing a new enterprise by
adopting a proven formula.
The franchising team operates across a
number of business categories, namely
grocery retail, restaurants, quick-service
restaurants, entertainment and leisure,
automotive and fuel, just to name a few.

We believe in partnering with our


franchise customers to achieve
their growth objectives through the
understanding of the environment in
which they operate. Sound knowledge
of our customers industries enables
Absa to offer best-of-breed products
and global solutions needed to meet
franchisor and franchisee business
needs, leaving them to focus on their
core business. Absas infrastructure is
geared to service franchises of all sizes
from small to corporate. Our extensive
network of industry specialists and
relationship executives team up to
provide the customer with the best
the bank has to offer. With more than
15 years of experience in the franchise
industry, Absa has established a credible
record among many of South Africas top
franchise companies.
We believe in developing partnerships
with our franchise customers by
ensuring that we have the footprint and
products to provide a solution for their
expansion across South Africa and into
the continent.
Absa offers franchise customers a range
of market-leading operational, lending
and investment products. Our solutions
are aimed at optimising banking
value, reducing operational risks and
enhancing cost efficiencies. Among our
Principles of Franchising / Page iii

market-leading operational products


are cash management and payment
solutions, merchant services, electronic
banking, business insurance and
advice, commercial asset finance and
commercial international banking.
We are proud to make this booklet
available to you and believe that
its content will be equally useful to
potential and established franchisors
and franchisees. Given the broad nature
of the topic, it will probably not answer
all your questions. We therefore invite
you to discuss your specific franchise
plans with Absa Franchising. The contact
details are as follows:
Absa Franchising
Telephone: +27 (0)11 350 8000
E-mail: franchise@absa.co.za
Website: Absa.co.za

Page iv / Principles of Franchising

About the author


Kurt Illetschkos involvement with
franchising dates back to 1975.
He had hands-on exposure as a
franchisee, franchisor and franchise
consultant and was instrumental
in establishing the Franchise
Association of South Africa (FASA).
In recognition of his services to
franchising, Kurt was elected a Life
Member of FASA in 2003.
Kurt has written books on franchising
for several publishers in South Africa
and the UK. He is also a regular
contributor to various business
magazines and websites. Through
his company, ManualMakers CC,
he produces operations manuals
and other written materials aimed
primarily at the franchise sector.

Preface
Franchising has been proven to be superior to almost any
other business model.
The combination of an experienced
franchisor expanding through a
network of highly motivated owneroperators is simply unbeatable.
When franchise failures do occur it
can generally be traced back to poor
evaluation and faulty decision-making.
This booklet aims to address this by
equipping the parties to the franchise
arrangement with the tools they need
to make an informed decision before
any damage has been done.
The text has been arranged as follows:
General information on franchising
(chapters 1-4); information of specific
relevance to prospective franchisees
(chapter 5); information of specific
relevance to prospective franchisors
(chapter 6).
Chapter 7 is aimed at experienced
operators, both franchisors and
franchisees. It makes suggestions on
how the benefits of franchising can be
leveraged for mutual benefit. The main
text ends with a bibliography followed
by a resources section and an index.
Important topics are placed in boxes
and highlighted with one of six different
icons; their meanings are explained on
page vi.

Supplementary expert articles


Franchising is a complex subject and
space in this introductory book is limited.
For this reason, reference is made to
expert articles. These articles elaborate
further on selected topics.
To access them go to the Absa website:
www. absa.co.za/franchising

List of topics
A summary of the topics we have
covered at the time of going to print will
be found on page ix, together with a
reference to the relevant page numbers
in this booklet.

Periodic updates
In an effort to provide you with the most
up to date information at any given time,
we plan to update the existing material
as and when this becomes necessary.
We also plan to add further expert
articles to the website from time to time
as developments warrant this. It makes
sense, therefore, to visit www.absa.
co.za/franchising periodically to check
for new topics.

Support via email


To contact Absa Franchising via email
write to franchise@absa.co.za.

Principles of Franchising / Page v

Contents
Message by Absa Franchising
iii
About the author
iv
Preface v
Supplementary expert articles
v
Icons used throughout the text
vii
List of expert articles accessible on the Absa website
viii
1.
1.1
1.2
1.3
1.4
1.5
1.6

Introduction to franchising
How franchising has evolved
How franchising works
Advantages and disadvantages of franchising
Look-alikes and impostors
Franchising in South Africa
Franchise failures

1
1
3
5
9
10
12

2. The stakeholders legitimate expectations


2.1 The prospective franchisees expectations
2.2 What franchisors expect from franchisees

13
13
14

3.
3.1
3.2
3.3

The financial aspects of franchising


A franchisees initial financial obligations
A franchisees ongoing financial obligations
Raising finance

15
15
16
19

4.
4.1
4.2
4.3
4.4

Legal and related issues


Laws that specifically affect franchising
Franchise documentation
Who owns what in a franchise?
Dispute resolution

23
23
24
27
28

5.
5.1
5.2
5.3
5.4

Becoming a franchisee
Evaluate yourself
Investigate before investing
The need for professional assistance
What happens next?

29
29
30
33
34

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6.
6.1
6.2
6.3
6.4

Franchising your business


Preliminary steps
Creating the franchise package
Marketing the franchise
Setting a timeline

35
35
39
41
43

7. Leveraging the benefits of franchising to best effect


7.1 General
7.2 The franchisors main responsibility
7.3 International expansion beckons
7.4 Succession planning and exit strategy

44
44
45
45
48

End notes

49

Appendix
Resources 50
Support organisations
50
Service providers to the franchise sector
50
List of useful websites
52
Dictionary of franchise terms
53
Index
56

Icons
Icons used throughout this text and their meanings.
The following set of icon will be used throughout the entire book, they are for your
reference and will provide you with further readings, interesting facts and notes to
keep in mind.

Bright
Ideas

Caution
Advised

Important
Definitions

Refer to
Website

Practical
Example

Stop and
Think

Principles of Franchising / Page vii

List of expert articles


on the website
Address: http://www.absa.co.za/Franchising
Directory and file name
Franchisee
Competition Act franchise notice
CPA regulations - extract
Detailed definition
Disc doc requirements FASA
FASA - intro
Franchise agreement
History of franchising
Legitimate variants
Letter to franchisee
Letter to franchisor
Microfranchising
Operations manual
content
Secrecy undertaking
Franchisee
Application form
Demanding performance
Exit strategy franchisee
Franchisee selection
McDonalds
Franchisees role
Getting ready to trade
Initial investigation
Questions to ask
franchisees
Questions to ask
franchisor
Will I be happy?

Full title of the document

The application of certain provisions of the competition Act


Regulations to the consumer protection act affecting
franchising
Detailed definition of business format franchising
FASA disclosure document requirements
Why FASA matters
Issues that are commonly addressed in franchise agreements
History of franchising
Legitimate variants of business format franchising
Letter written by a franchisor to a prospective franchisee
Letter written by a prospective franchisee to a franchisor
Example of a microfranchising project
Table of contents of an operations manual for franchisees
Suggested wording for a secrecy undertaking

Loan application form Absa 4036EX (for franchisees)


Demanding performance from the franchisor
Developing an optimal exit strategy for franchisees
Franchisee selection and initial training at McDonalds
The franchisees role in building the brand
Getting the business ready to trade
Initial investigation of franchise opportunities
Questions a prospect should ask established franchisees
Questions a prospect should ask prospective franchisors
Will I be happy as a franchisee?

Page viii / Principles of Franchising

Franchisor
Africa expansion
Certificate
Consultant selection
Franchise application
form CPA (2)
Franchise plan
Franchisee profile
Franchisee recruitment
Franchisors role
Site profile
Viability of franchising

The siren call of Africa


Certificate to commence trading - new locations
Tips to ensure that the consultant you appoint adds value
Application for finance - franchisor
Mapping out a strategy for national network expansion
The profile of the ideal franchisee
Recommended steps in the recruitment of franchisees
The franchisors role in building the brand
Site profile and site evaluation
Viability of franchising my business

Principles of Franchising / Page ix

1. Introduction to franchising
Franchising has taken the world by storm. Most people believe that
franchising is a relatively new business model but this is a misnomer.

This chapter explains how the


concept has evolved from modest
beginnings into a force to be reckoned
with, provides a brief summary of its
advantages and disadvantages and
concludes with an overview of local
franchising.

1.1 How franchising has evolved


A form of franchising can be traced back
to 200 BC when a Chinese trader used
franchise arrangements to expand his
market reach. During the middle ages,
various franchise formats were used
but it was only during the 1860s that
the US-based Singer Sewing Machine
Corporation developed a franchise
model that compares with todays
franchises. Franchising has grown in

Page 1 / Principles of Franchising

leaps and bounds since then and has


developed its own terminology.
The move towards business format
franchising received a strong boost
during the late 1940s, again in the USA
where several seemingly unrelated
developments combined to drive the
growth of franchising.

A global explosion of
franchise concepts
followed and the sector
hasnt looked back
since.

These were the initial triggers:

Strike 1: Lifestyle changes


The emergence of two-income families
caused lifestyle changes. Eating out was
no longer seen as a special occasion but
as a time-saving convenience. The fastfood sector boomed to such an extent
that its operators couldnt keep up with
the demand.

Strike 2: The need for expansion


finance
Growing demand triggered the
development of a string of quick-service
restaurants. Unshackled by traditional
ideas, the founders of these new
restaurant concepts turned the sector
upside down. Production-line methods
replaced culinary artistry and service was
cheerful and fast rather than ceremonial
but cumbersome and slow. Although
these restaurants were flourishing,
traditional funders were reluctant to
finance expansion. Emboldened by their
early successes and unwilling to spend
years proving the merits of what they
knew were winning concepts, these
new-age entrepreneurs were looking for
alternative ways to source capital.

Strike 3: Desire for risk reduction


After the end of World War 2, the threat
of another world war breaking out
seemed remote. The US army embarked
on a demobilisation drive, which resulted
in a large number of servicemen and
women flooding the economy. Most
were ambitious young individuals who
were eager to make up time lost serving
their country. They were keen to start
businesses but wary of making mistakes.

They liked the idea of investing in a


franchise but although several product
franchises were operational, they did not
offer sufficient ongoing support.

Readers wishing to learn about


franchisings history will find the article:
The history of franchising located on
the Absa website of interest.
The appendix to this book contains a
Dictionary of franchising terms.

The emergence of modern-day


franchising
The fast-food pioneers were quick
to realise that by offering aspiring
entrepreneurs a complete business
package, they could speed up the
launching of their brands. As mentioned
previously, a large number of exservicemen and women were looking
for sound business opportunities.
Franchising offered them the security
blanket they craved.
Because these ex-soldiers were used to
following instructions, franchising turned
out to be a match made in heaven for
them. To this day, ex-soldiers continue
to make excellent franchisees. In 2011,
the IFA introduced a formal scheme
designed to help US war veterans
become franchisees. Initially, the
programme was perceived to be a social
responsibility exercise. Take-up was slow
but it soon became clear that ex-soldiers

Principles of Franchising / Page 2

do indeed make excellent franchisees. By


now, the programme is highly successful
with some of the early participants
having graduated to multiple unit
ownership.

Consumers embrace franchising


Franchising is a marketing tool and
its sustained success depended on
acceptance by consumers. Consumers
welcomed franchising because for the
first time ever, they could patronise their
favourite brands at various locations,
initially throughout the USA, later around
the globe.

1.2 How franchising works


Five decades of efforts to educate
the general public about franchising
notwithstanding, misconceptions
continue to exist.
The likely reason is that several other
business models appear to function
like a franchise but essential elements
are lacking. On occasion, unscrupulous
promoters take advantage of the
confusion and encourage the gullible to
invest in doubtful franchise schemes.
See Look-alikes and impostors on page
9.

Legitimate variants of business


format franchising
The business format franchise model is
extremely flexible. Provided that certain
basics are observed, it can be modified
to suit specific requirements without
losing any of its inherent advantages.

Page 3 / Principles of Franchising

FASAs definition of franchising reads


as follows:
The business format franchise
relationship is characterised by a
continuing business relationship
between the franchisor and the
franchisee that extends beyond the
implications of the product or service
and trademark.
Franchising encompasses the
entire business process including
marketing and advertising strategies,
operating standards and procedures,
accounting practices, quality control and
operational standards. Above all, close
communications between franchisor
and franchisee will be maintained on an
ongoing basis.1

Two articles offer additional insights


into the characteristics of the franchise
concept:
Detailed definition of the term
Business Format Franchising
Legitimate variants of Business
Format Franchising.
Access these articles in the directory:
General.

Principles of Franchising / Page 4

1.3 Advantages and disadvantages of franchising


Although franchising offers many advantages, it should not come as a
surprise that it has some disadvantages as well. This chapter examines
the pros and cons as seen from both sides of the fence.
Seen from the franchisees point of view:

Advantages
Access to initial guidance and support,
an established trademark, a proven
operating system and valuable trade
contacts. Instead of having to start
a business from scratch, with all the
attendant uncertainties, a franchisee
receives a business in a box, ready to be
operated at full throttle from day one.
At least some members of the target
market will know the brand and will
look forward to doing business with it
at the new location. This reduces the
period to reaching break-even.
Ongoing support ensures, among
other things, that the franchisee
keeps abreast of developments in
the market, enjoys consulting and
mentoring services and has access

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to group promotions and purchasing


arrangements.
Peer support. This is another
important aspect. Life as an
entrepreneur can be lonely. Access
to like-minded individuals who share
the same ups and downs can be
invaluable.
Resale value. Many small businesses,
especially those of the one-manand-a-van kind, are closely linked to
the person who owns them. Should
such person wish to move on or the
person dies, the business has little
value. A franchise, on the other hand,
is a branded business with a definite
resale value. The franchisor may
even have a prospective buyer on its
database.

Disadvantages
Yes, there are a few, but when compared
to the impressive list of advantages
most people are likely to agree that
they tend to pale into insignificance.
However, investing in a franchise is a
serious undertaking and it is important
to be aware of possible negatives before
becoming involved.
Initial and ongoing fees are payable.
Subject to careful selection, this need
not be a cost at all. In many instances,
savings arising from group deals
exceed franchise fees.
Because franchisors have their
corporate image to protect, they will
not permit the cutting of corners
during the set-up process. This means
that set-up costs may be higher but
this should be offset because breakeven should be reached sooner.
Underfinanced, weak or unprofessional
franchisors could stifle the
development of the brand and with it
the development of the franchisees
business. This calls for a repeat of the
statement, Evaluate before investing.

Some individuals resent the fact that


they are forced to operate within a
clearly prescribed framework. There is
no way around that. Id advise them
to think carefully before investing in a
franchise.

Should the requirement to follow the


franchisors tried and tested systems
create problems then investing in a
franchise may not be the best choice.
Dont rush into a decision, though.
As competition for good prospects
heated up, many networks adapted their
franchisee profiles to accommodate
entrepreneurial types.
These franchisors grant their franchisees
controlled independence allowing
them a certain degree of freedom
provided that they dont stray too far
from the basic concept.

Principles of Franchising / Page 6

Seen from the franchisors point of view:

Advantages

Enhanced operational efficiencies.


Companies that converted branches
For a profitable business that is ready for
to franchises report an almost instant
expansion, choosing franchising as the
increase in operational efficiencies.
preferred method of expansion offers
The reason for this is that an owner
several significant benefits, with the
is usually more diligent in controlling
following standing out:
costs and minimising waste than a
Reduced capital requirements. To set up
salaried manager.
the infrastructure required to market and
Reduced pressure on head office
support a franchise is expensive. Fees
resources. This goes hand in hand
for lawyers and other documentation,
with the previous paragraph. Because
market and site selection research costs,
a franchisee owns the unit and is
and other professional fees also add up
responsible for its management,
to a pretty penny but once all this is in
the need for crisis management by
place, the growth of the network will
head office personnel should be the
effectively be funded by its franchisees.
exception rather than the rule.
Accelerated expansion. Because
Better forward-planning. Because
franchisees fund new units, expansion
franchisees take responsibility for
can be faster than would otherwise be
setting budgets and achieving
possible. And because the franchisee is
them, network-wide forwarda separate legal entity, set-up costs and
planning becomes more accurate
attendant loans are not reflected on the
and the income stream accruing
franchisors balance sheet. This makes
from franchising is generally pretty
it possible to raise capital for brandpredictable.
building.
Economies of scale. Because of the rapid Disadvantages
pace of expansion that goes hand in
Reduced per-unit profitability. Per unit
hand with franchising, the franchisor
income in the form of management
can expect preferential service and
services fees is less than the profits
advantageous terms from suppliers.
generated by well-managed branches.
Page 7 / Principles of Franchising

This has to be weighed up against


the advantages of quicker market
penetration, bulk buying benefits,
reduced risk and lower operating
costs.
High initial costs. Although franchisees
are responsible for unit establishment
costs, a new franchisor encounters
substantial initial costs. If all goes well,
these costs can be amortised over a
period of 3 to 5 years; it follows that
patience is required.
Cost of ongoing franchisee support. As
well see in chapter 3, franchisees pay
an ongoing management services fee.
However, this fee is usually linked to
franchisees sales and this is where the
problem lies, for the following reasons:
- A comprehensive franchisee support
infrastructure must be in place from
day one, failing which the franchise
programme may never take off.
- The network has only a small
number of franchisees to begin
with. To exacerbate matters, all
these franchisees are new and
require extensive support. And
because all franchisees build their
businesses from scratch, sales
may initially be low, leading to low
management services fee income
for the franchisor. It is easy to spot
the imbalance but as the network
grows and franchisees sales pick
up the situation should stabilise.
If managed correctly, operating a
network of franchisees can be highly
profitable.

The need for a large market.


Franchising is a numbers game.
Sectors where expansion potential is
limited are not suited to franchising
unless realistic potential exists to
establish about 1520 units over a
relatively short period, franchising may
not make commercial sense.
Limitations on the freedom to act.
In a legal sense, the franchisor will
have contractually secured the right
to determine strategy but because
franchisees are investors and directly
affected by the franchisors decisions, it
is good franchise practice to seek their
input. This could limit the franchisors
ability to react quickly to opportunities
as they present themselves.
The danger of poor franchisee
selection. If a branch manager
underperforms, disciplinary steps
can be implemented to correct the
situation. With a franchisee, its not
so simple and underperforming
franchisees could damage the brand.
A well-drafted franchise agreement is
a powerful instrument in the hands
of the franchisor but in the interest
of franchisee relations, termination
should rarely if ever be considered as a
first step against an underperforming
franchisee.

Principles of Franchising / Page 8

Mixed expansion is possible.


Franchising a business does not need
to be an either/or decision; a mixed
approach can be highly effective.
Under this scenario, the company
operates branches in close proximity to
head office and appoints franchisees in
remote areas.

1.4 Lookalikes and impostors


Franchising is by no means the only
vehicle for business expansion or the
only route to business ownership.
Although anecdotal evidence suggests
that it is the most successful business
model currently known, it is not right for
everyone.

Page 9 / Principles of Franchising

Other business models have a place


in the mix provided that they are not
disguised as franchises. Indeed, subject
to personal preferences, some other
business model may meet an individuals
needs better than a franchise. To make
this decision, you need to be aware of
the differences.

The article:
Entry Level Business Formats will
assist.
Access this article in the directory:
General.

1.5 Franchising in South Africa


Franchising is well established
in South Africa. While in other
emerging economies foreign
franchise concepts tend to dominate,
this is not the case in South Africa.
Some major foreign brands are well
entrenched but the majority of brands
are home-grown. This may be a remnant
dating back to the sanctions era when
many of the foreign brands withdrew
(or stayed away) in response to pressure
applied by human rights activists in their
home countries.

Developments in franchising
The first local brand on record that
expanded through franchising is Steers.
Their first restaurant started trading in
1962 and franchising commenced in
1965. The brand eventually morphed
into Famous Brands, a multi-brand
franchisor listed on the JSE. Several
other multi-brand franchisors exist, with
fast-growing Taste Holdings being an
outstanding example.
Much has happened since 1965.
According to research last conducted
in 2010, 551 brands operate a total of
29 204 units, the bulk under franchise.
(Most franchisors retain at least one
company-owned unit which serves as
development laboratory and training
centre.) In 2010, the sector generated
287,15 billion rand in sales. This is equal
to just under 12% of South Africas

GDP and the sector provides direct


employment to over 497 000
people.2
These figures are impressive but as
matters stand, there is no reason
to celebrate just yet. Franchisings
potential is significantly greater than
its performance to date suggests
and ways need to be found to
tap into it. This is in the national
interest because franchising has
the potential to make a meaningful
contribution towards solving one
of South Africas most pressing
problems, namely job creation. The
fundamentals are in place and the
text box that follows summarises the
status of franchising in South Africa.

The status of franchising in


South Africa
Franchising is:
Well developed
Proven to work
Well regulated
Supported by Absa Franchising.
Franchising also constitutes an ideal
vehicle for the implementation of
sustainable BBBEE initiatives.
Lets look at these points in detail.

Well developed: South Africas


franchise sector has accumulated
a body of knowledge that is on par
with that available to the worlds
leading franchise nations.

Principles of Franchising / Page 10

solutions that meet current unique


Proven to work: The vast majority
challenges while at the same time
of franchised companies remained
providing for a better future.
successful even during periods of
recession. 2012 was a tough year
An ideal vehicle for BBBEE initiatives:
for most businesses, with many
In addition to the other advantages
independents forced to close down.
franchising holds, micro franchising3
Against this background, it is remarkable
and tandem franchising are
that the 2012 Business Times Top
supremely suited as vehicles for
100 Companies Survey listed three
the implementation of sustainable
franchised brands among the Top 25
BBBEE initiatives. These concepts
performers.
are defined in Legitimate Variants
of Business Format Franchising
Well regulated: Unethical franchisors
and Microfranchising: Presentation
do pop up from time to time but since
before the Portfolio Committee on
its formation in 1979, the Franchise
Economic Development, Parliament
Association of South Africa (FASA)
of the Republic of South Africa. Both
has been working hard to protect
documents are on the website under
the public from falling victim to halfGeneral.
baked schemes by actively promoting
ethical franchising. From the outset,
its members were obliged to adhere
to a Code of Ethics, which to this day
continues to be among the most
stringent to be found anywhere in the
world. FASAs efforts were hampered
because it has no jurisdiction over nonmembers. The Competition Act and the
more recently introduced Consumer
Protection Act (CPA) protect franchisees
interests and are enforceable through
the court system.
Supported by Absa Franchising: We
have put together a dynamic team that
is focused on the franchise industry.
Our aim is to understand your specific
industry and where its heading. We use
that knowledge to improve relationships
with our customers and deliver the most
competitive financial products. To this
end, we believe in actively working with
our customers to develop individual
Page 11 / Principles of Franchising

What is holding franchising back?


The above suggests that franchising in
South Africa is in an excellent space right
now, and indeed it is, so why doesnt it
live up to its potential? Yes, there is some
growth but its not enough. Franchisings
share of GDP hovers around 12%.
Compare this with the figures of 20 to
30% attained in Australia and some
EU countries and over 50% in the USA,
and it becomes clear that there is much
room for growth. This means that
opportunity beckons.
When examining the performance of
franchising in the USA, market share
isnt the only metric worth looking at.
The sector also provides 8 100 000 jobs,
up from 7 990 000 in 2007. Granted,
the USA is a bigger country than ours
so absolute numbers arent comparable
but the percentage increase in jobs
created during a period of near-recession
when other sectors were shedding them
demonstrates franchisings resilience.

In the South African


context, one of the main
reasons for franchisings
attractiveness is that it
offers new entrepreneurs
opportunities to benefit
from skills transfer and to
operate under a known
brand using tried and
tested systems. Ongoing
support is another plus
factor.

The main reason for franchisings relative


under performance in South Africa
appears to be a lack of understanding of
the concept, followed closely by a lack
of trust. Unlocking the concepts full
potential will require a change in mind
set by all stakeholders.

1.6 Franchise failures


Without reference to franchise failures,
this section would be incomplete. When
compared with the overall size of South
Africas franchise sector and the many
success stories that exist, the few
failures on record pale into insignificance.
One could even argue that they are not
franchise failures at all but the result of
poor research, evaluation, planning and
implementation.
To put this differently: Lets assume that
you have a nice piece of exotic hardwood
and a set of the finest woodworking
tools in your possession. Give these
items to a master craftsman and he will
produce a piece of furniture of great
beauty. In the hands of a layperson, the
result will be less than satisfactory.
To sum up: Franchising is comparable
to a set of tools which, if used correctly,
will contribute towards business success.
If used haphazardly or fraudulently, the
outcome will be an unmitigated disaster.
Working diligently through the balance
of this booklet will equip you to make the
right choice.

Principles of Franchising / Page 12

2. The stakeholders
legitimate expectations
It stands to reason that both the franchisor (grantor) and the franchisee
(grantee) of a franchise will enter into the arrangement with certain
expectations. Unless these expectations are aligned, the resulting relationship
may be doomed because friction is bound to lead to disputes.

Some of the requirements set out


below are supported by legislation,
others are not. Before signing a
franchise agreement, prospective
franchisees should examine this
document with care and seek input
from a professional.
(Chapter 4 deals with franchise
agreements and related issues in
some detail.)

2.1 The prospective franchisees


expectations
Individuals ready to invest in a franchise
have a series of expectations. They
put their trust in the franchisor and
its brand; they are even willing to pay
for the privilege. Their future is at
stake and nothing less than full and
comprehensive disclosure will enable
them and their professional advisers to
make an informed decision.
Once part of the network, they will
expect to be treated fairly, and with

Page 13 / Principles of Franchising

the respect business owners deserve.


This section is of interest to prospective
franchisors and prospective franchisees
alike because each party needs to know
what the other partys expectations are.
Prospective franchisors who are either
unable or unwilling to deliver on
franchisees legitimate expectations
will be well advised to select another
expansion model. The same applies
to prospective franchisees. Both
parties need to draw up a list of their
expectations, keeping in mind that
items deviating from the norm need
to be discussed before the franchise
agreement is signed. This simple step
should prevent disagreements from
arising at a later stage.

A prospective franchisees wish list


When an individual decides to
become a franchisee, he has certain
legitimate expectations. Lets assume
that a prospective franchisee and the
franchisor of his choice had a series
of meetings and are ready to take the
relationship to the next level. At this
point, the prospective franchisee could
write a letter to the franchisor along

the lines of the example placed on the


website see the website icon at the
bottom of this page.
In reality, it is highly unlikely that such a
letter will ever be written. The example
merely intends to draw both parties
minds to a franchisees legitimate
expectations. Prospective franchisees
should draw up their own list of issues
that are important to them and discuss
these with the franchisor of their choice
during a face-to-face meeting. It is
important to do this prior to signing the
franchise agreement.

2.2 What franchisors expect from


franchisees
Franchising is a two-way relationship.
Just like franchisees have certain
expectations, so do franchisors. A letter
written by a franchisor to a prospective
franchisee illustrates this.

Please refer to the website, directory General, for the following texts:
Letter to prospective franchisor (by franchisee)
Letter to prospective franchisee (by franchisor)

Principles of Franchising / Page 14

3. The financial aspects


of franchising
The explosive growth of franchising has generated a lot of publicity,
leading some of its protagonists to talk about it with an almost
evangelical fervour. This is not helpful because at its core, franchising
is a method of doing business and must make commercial sense. This
chapter explains the various financial issues that will typically arise in a
franchise relationship and concludes with some tips for raising capital.

3.1 A franchisees initial financial


obligations
Prospective franchisees can expect to
come across the following financial
obligations:

Upfront fee
The establishment of a franchise requires
a substantial investment by the franchisor
who will try to recoup this investment
from franchisees on a pro-rata basis. The
resulting fee is known as the upfront fee
(UFF) or initial fee. The amount levied
varies from one industry sector to the
next and even between brands.

Franchisors calculate the upfront fee


by taking some or all of the following
costs into account:
Development of the franchise
package including the cost of
obtaining expert advice.
Franchisee recruitment and initial
training.
Assisting franchisees with site
selection, lease negotiations and
the setting-up of the business.
Assistance with the launch of the
business, often culminating in a
Grand Opening.

Capital investment

As a rule, the UFF is a once-off fee


that is payable at the time the franchise
agreement is signed. Some franchisors
also charge a renewal fee when the
agreement is renewed.
If so, it must be stated in the disclosure
document and recorded in the franchise
agreement.
Page 15 / Principles of Franchising

In most instances, franchisees are


responsible for all costs arising from
the setting-up of the new business
and getting it ready for trade.
Depending on circumstances, this
will include the cost of buildings,
building renovations or modifications
as required; the purchase of
furniture, fittings and equipment; the
acquisition of initial stock.

Working capital
To set up a new business and get it
ready for trading takes time. Even once
the business is up and running, it will
take time before the money coming in
fully covers the money going out. In
the interim, a host of ongoing expenses
needs to be paid. This requires working
capital.
The actual amount will obviously depend
on the type and size of the business.
As explained in chapter 4, it is a legal
requirement that the networks disclosure
document contains detailed projections.

Provision for sundry expenses


This important aspect of planning
cash requirements for the business is
often overlooked. Franchisees need to
provide for their living expenses during
the period until the business generates
sufficient income for them to draw a
market-related salary. Fees payable to
professional advisers (lawyer, accountant,
etc.) in exchange for initial advice must
also be provided for. Lastly, it is always a
good idea to keep some money aside for
unexpected expenses.

3.2 A franchisees ongoing


financial obligations
Ongoing franchise fees are levied in
exchange for services provided by
the franchisor. They fall into several
categories:

Management services fee


The management services fee
(MSF) is most often calculated as a
percentage of the franchisees sales.
Percentage figures range from 2%
to 8% and more, depending on the
nature of the business, attainable
sales levels and profit margins and
the extent of the support services the
franchisor provides.
Some franchisors levy a fixed monthly
fee instead of a percentage of the
franchisees sales. Experts tend to
frown upon this practice because it
removes the all-important element
of risk-sharing from the equation.
(An unscrupulous or short-sighted
franchisor could be tempted to reduce
the amount of support provided to
franchisees because in the short term
it would not affect fee income.)

Principles of Franchising / Page 16

Advertising fee (ADF)


Franchisors undertake national
advertising campaigns and other
product-focused brand-building
initiatives. These are usually funded
through contributions by all members of
the network including company-owned
units.

ADF contributions can


either be calculated as
a percentage of sales
(usually between 2-5%)
or as a fixed monthly
contribution. Setting the
ADF as a fixed amount
is acceptable because it
makes the funds future
income more predictable
and this facilitates
planning.
The Consumer Protection Act (CPA)
provides that franchisors must keep
advertising contributions in a separate
bank account. Monies in the ADF fund
must not be used for purposes other
than product marketing and brand
building.
Franchisees are entitled to receive
regular reports on spending; chapter 4
has more on this topic.

Local advertising expenditure


In addition to conducting national
advertising campaigns, most franchisors
will expect their franchisees to spend
Page 17 / Principles of Franchising

The MSF will contain an element of


profit for the franchisor. This is how it
should be because it will encourage the
franchisor to provide ongoing assistance
to the franchisee.
However, Ray Kroc of McDonalds fame
cautioned that, A franchisor company
should not live off the sweat of its
franchisees but should earn its keep
by helping its franchisees to become
more successful.4
an agreed amount on local advertising.
Details will be given in the disclosure
document and the franchise agreement
and the franchisor is likely to monitor the
franchisees spending.

Other franchise-related fees


Purists may argue that the following
costs are not franchise fees at all and
therefore do not belong under this
heading. They have a point but we
list them in the interest of providing a
comprehensive picture.
Administration fee: Charging an
administration fee is justified if the
franchisor takes on operational
tasks that would ordinarily be the
responsibility of the franchisee; an
example is keeping account books.
Purchasing fee: Should the franchisor
operate a purchasing scheme but
does not levy a mark-up or receive
confidential rebates, then charging

a service fee would be justified. In a


best-case scenario, franchisees stand
to benefit because they qualify for bulk
prices negotiated by the franchisor
on the strength of the networks
combined purchasing power. The
opposite could also happen, were it
not for the fact that the Competition
Act and the CPA offer protection.
Operating costs: It goes without
saying that every franchisee is
responsible for all operating costs the
business incurs. This includes costs
arising from the purchase of inputs,
rentals, salaries, taxes and statutory
payments and all other operating
expenses.

On the face of it, the Competition


Act protects franchisees against
exploitation by franchisors but it
would be unwise to rely on this alone
because the Competition Board is
unlikely to intervene unless it receives a
complaint. Affected franchisees need
to stay alert and, should circumstances
demand, raise the alarm.

Is it worth it?

right opportunity is chosen and correctly


operated, franchisees not only stand
a better chance of staying in business,
they are also likely to make more money
than independent operators working in
isolation. It must be noted, however, that
there are no guarantees.
In exchange for payment of the upfront
fee, a new franchisee leapfrogs the
learning curve because the trial and
error stage of setting up the business
will have been negotiated by the
franchisor who can be relied upon to
pass on the resulting experiences. On
an ongoing basis, support provided by
the franchisor including access to group
purchasing and marketing schemes
will enhance sales and margins. As a
result, profits are likely to build up faster
in a franchise than in a comparable
independent business.5

The steps a franchisee can take


if support by the franchisor is not
forthcoming are set out in the
document headed Demanding
performance from the franchisor.
It is located in the directory named
Franchisee.

Having gone through the list of initial


and ongoing fees and other costs
arising from the operation of a franchise,
prospective franchisees could be
forgiven for questioning the value of
the investment. They need not worry.
Experience has shown that provided the
Principles of Franchising / Page 18

3.3 Raising finance


Absa Franchising appreciates the
advantages franchising offers and
is keen to fund sound franchise
schemes.
However, it is necessary to distinguish
between the funding needs of a
prospective franchisee and a prospective
franchisor.
Prospective franchisees often complain
that funding is not available, but this is
not quite accurate. In most instances,
capital is available but the banks need
to balance their willingness to grant
loans with their obligation to safeguard
the interests of their depositors and
shareholders. Subject to certain criteria,
prospective franchisees of a reputable
franchisor stand a good chance of
raising capital; the franchisors brand will
certainly be taken into account.
Should the owner of an established
business wish to expand through
franchising, the loan request is likely to
be assessed like any other application for
expansion funding. (An application form
is on the website, directory Franchisor/

Page 19 / Principles of Franchising

Franchise Application Form). The bank


will examine the history of the business,
its profitability, future market potential
and, above all, the companys corporate
culture as this will affect the companys
approach to franchising. Chapter 6 has
more about what makes a business
franchiseable.

Careful preparation is essential


This section is aimed at prospective
franchisees. To enhance the success
chances of a loan application, applicants
need to prepare themselves well. A loan
request is unlikely to be successful if the
applicant has not written down the details
of the project that must be funded.

When approaching a bank for a loan,


it will be useful to demonstrate
familiarity with the different funding
options that are generally available to
SMEs.
The most common ones are listed on
the following page.

The bank will also expect unambiguous


answers to the following five questions:
1. How much money do you require?
2. What will the money be spent on?
3. How do you propose to repay the
money?
4. What qualifies you to make the
business successful?
5. What surety can you offer?

Equity funding

When responding to question 1, the


loan amount must make sense. Borrow
too much and you will waste money on
interest charges. Borrow too little and the
business may run out of funds early on.
To secure additional funds at that point
will be extremely difficult.

This is the amount of money you (and


your business partners if applicable) plan
to contribute from own unencumbered
sources. It is also where many
prospective franchisees come unstuck.
They expect the bank to lend them the
full investment amount but this is not
realistic, for the following reasons:
The loan has to be repaid with interest.
If you borrow the full investment
amount, the resulting monthly
repayments may strangle the new
businesss cashflow and this could
derail the business.

Unless you have accumulated a


reasonable amount of capital, the bank
has no way of assessing your ability to
handle cash responsibly.

The networks disclosure document will


provide the answers to questions 2 and 3.
In response to question 4, explain to the
bank that as a franchisee of the specific
In the absence of any meaningful
brand, you are confident that the business
equity in the business, your
will be successful. If you struggle to
commitment to the venture would be
respond satisfactorily to question 5, keep
doubtful. With little to lose, nothing
in mind that, on the assumption that
would prevent you from simply walking
everything else pans out, unconventional
away should the business develop at a
forms of funding could come into play.
slower pace than expected.
Principles of Franchising / Page 20

Soft loans

Sundry funding sources

Soft loans originate from family or


friends who want to help you realise
your dream of starting or expanding
your business. A soft loan may seem
attractive because it will typically have
no fixed repayment date and interest
payments are negotiable, but there are
some pitfalls.

Other funding formats exist but are not


always readily available. You could, for
example, take on a business partner
who injects capital. There is also the
possibility of entering into a joint venture
arrangement with the franchisor who
takes a stake in the business.

Firstly, you need to make it clear to


the lenders that they have no right
to meddle in your business affairs.
Secondly, they should be made aware
that their loans will be unsecured,
meaning that should the business fail,
their rights would be subordinated to
those of other creditors and they could
lose the full amount.

Though soft loans are


informal by nature, it is best
to have an attorney draw up
a formal loan agreement.
This will ensure that
everyone knows where they
stand and thus prevent
misunderstandings from
arising.

Page 21 / Principles of Franchising

This funding format is often used in


BEE deals. An example is Tandem
franchising, explained previously. Crowd
funding many small investments raised
through the internet is another avenue.
Venture capitalists are generally not too
keen to invest in SMEs but the situation
may change if the deal involves a multiunit franchisee.
Before granting a loan, the bank needs
to be convinced that the prospective
borrower will be able to repay the loan in
full, with interest and within the agreed
period. The bank will also expect the
borrower to sign a surety document in
his personal capacity. Lastly, banks are
obliged to take the provisions of the
National Credit Act into account. A listing
of the most common forms of loans
granted to SMEs follows.

An overdraft balance is expected to


fluctuate. Although a formal overdraft
agreement will be in place, the bank
can call up the overdraft at any time
without having to give reasons.
Therefore, an overdraft should not be
used to fund capital purchases.
Overdraft: An overdraft is intended
to support cashflow during
temporary dry spells, for example
at the end of the month when
overheads and suppliers bills need
to be paid but debtors payments are
still outstanding. It can be extremely
useful because interest is payable
only for the actual number of days
the loan is used.
Term loan: Term loans are usually
granted for periods of between 3
to 5 years. Subject to the terms of
the loan agreement, the money can
be used to fund the purchase of
equipment, shopfittings and other
capital items as well as to bolster
working capital.
Provided that repayments are made
as agreed, a term loan will usually
not be called up prematurely. The
downside is that you have to keep
the loan for the full period, even
if you have surplus cash on hand.
(Early repayment can be negotiated
but this may attract a penalty.)

Asset finance: The purchase of


production equipment and motor
vehicles can be funded through some
form of asset finance, for example
a rental agreement or a financial
lease agreement. An instalment sale
agreement is another possibility.
What happens is that the bank buys
the asset and makes it available for
use by the business. As soon as the
cost of the item including interest
charges is paid off, ownership passes
to the business, either at no cost at
all or against payment of an originally
agreed residual amount.

Preparing a winning
loan application
Banks are frequently
frustrated by the
poor quality of the
loan applications they
receive. Putting in the
necessary effort will
enhance the applicants
chances of success
tremendously; guidelines
for the preparation
of a professional loan
application are given in
chapter 5.

Principles of Franchising / Page 22

4. Legal and related issues


Chances are that scrutinising legal documents does not appeal to you at
all. Being an entrepreneur at heart, you would much rather get on with
building the business, wouldnt you? This is understandable but you need
to remember that becoming involved in franchising, be it as franchisor or
franchisee, is a serious undertaking that has long-term consequences. A basic
grasp of the legal issues surrounding franchising is advisable and this chapter
provides a rudimentary introduction.

4.1 Laws that specifically affect


franchising
Although South Africa does not have
specific franchise legislation, several
pieces of existing legislation impact on
the conduct of franchise operations. A
list of the most relevant Acts follows,
but this does not mean that you have to
study them in detail.
Consumer Protection Act, Act No. 68
of 2008
Competition Act, Act No. 89 of 1998
Companies Act, Act No. 71 of 2008
Trade Marks Act, Act No. 194 of 1993
Copyright Act, Act no. 98 of 1978
National Credit Act, Act No. 34 of 2005
Following their promulgation, some
of the Acts listed above have been
supplemented by Regulations and/
or amendments. This makes them a
moving target but the dtis website is a
good place to look for the most current
status regarding business-related
legislation see Resources.

Page 23 / Principles of Franchising

The website, directory General, contains


the following supplementary documents
and articles:
An extract from the Consumer
Protection Act headed: CPA
Regulations. It deals with franchising
and lists minimum requirements
for the compilation of disclosure
documents and franchise agreements.
An article published by the
Competition Commission:
Competition Commission Franchising
Notice. It summarises the
Commissions approach to franchising.
A paper published by Maria DAmico
Attorneys Inc. with contributions by
Maria DAmico and Pieter Swanepoel
deals with the impact of the new
Companies Act. This is of extreme
relevance to franchised establishments
and careful reading is recommended.
However, it can never be a substitute
for obtaining competent legal advice
before taking action.

4.2 Franchise documentation


Legal and quasi-legal issues relating
to franchise arrangements are
set out in a series of documents
described below. For ease of
reference, they are arranged in the
sequence prospective franchisees
can expect to come across them.
The disclosure document
Franchise failures, albeit rare, do occur.
Among the reasons is that in the past, a
small number of self-styled franchisors
have been economical with the truth,
causing unsuspecting individuals to
make ill-advised investments. This has
resulted in heartbreak and financial
losses.
To reduce the chances of this happening
again, FASA members are compelled
since 1994 to provide qualified
prospects with disclosure documents.
However, this requirement was binding
on members only, leaving prospects
exposed to exploitation by nonmembers.
The situation changed for the better in
2011 when the Consumer Protection Act
(CPA) came into effect. Every franchisor
is now obliged to provide qualified
prospects with a disclosure document at
least 14 days prior to the date on which
the franchise agreement will be signed.

The disclosure document contains all


the information prospects and their
professional advisers will reasonably
need to make an informed decision
regarding the opportunity. It describes
the nature of the business and the
franchisors trading history, gives full
details of the required investment and
includes trading projections based on
the performance of existing outlets.
The disclosure document also contains a
list of existing franchisees complete with
contact details as well as an auditors
certificate confirming that the franchise
company is a going concern.
Because much of this information is
highly confidential, franchisors will
insist that the prospect signs a Secrecy
Undertaking.

Refer to the website, directory General


for the following material:
Suggested wording for a Secrecy
Undertaking to be signed by qualified
prospects.
The current disclosure document
requirements applicable to members
of the Franchise Association of South
Africa (FASA).

Principles of Franchising / Page 24

The franchise agreement


The Consumer Protection Act contains
a detailed definition of a franchise
agreement which, for ease of reference,
has been reproduced below. It reads as
follows:6
Franchise agreement means an
agreement between two parties,
being the franchisor and franchisee,
respectively a.) in which, for consideration paid, or
to be paid, by the franchisee to the
franchisor, the franchisor grants
the franchisee the right to carry
on business within all or a specific
part of the Republic under a system
or marketing plan substantially
determined or controlled by the
franchisor or an associate of the
franchisor;
b.) under which the operation of
the business of the franchisee
will be substantially or materially
associated with advertising schemes
or programmes or one or more
trade marks, commercial symbols
or logos or any similar marketing,
branding, labelling or devices, or
any combination of such schemes,
programmes or devices, that are
conducted, owned, used or licensed
by the franchisor or an associate of
the franchisor;
c.) that governs the business
relationship between the franchisor
and the franchisee, including the
relationship between them with
respect to the goods or services to
Page 25 / Principles of Franchising

be supplied to the franchisee by or at


the direction of the franchisor or an
associate of the franchisor.
The Act also prescribes that the
following statement must be printed
on the first page of every franchise
agreement:
A franchisee may cancel a franchise
agreement without cost or penalty
within 10 business days after signing
such agreement, by giving written notice
to the franchisor.
It is important to remember that this
cooling-off period of 10 business days
applies in addition to, not instead of,
the cooling-off period of 14 days that
must lapse between the date on which
a prospect received the disclosure
document and the earliest date on which
the franchise agreement may be signed.
Although the CPA imposes an obligation
on the drafters of legal agreements
to use plain language, the franchise
agreement remains a complex
document, often consisting of 100 or
more pages. This is unavoidable because
franchise agreements need to regulate
all facets of a long-term and highly
complex relationship.

The directory General on the website


contains an article: Issues that are
commonly addressed in franchise
agreements. It makes for very
interesting reading.

The operations manual


Without well-documented processes,
systems and procedures, uniformity in
the performance of departments and
far-flung branches of a business would
be impossible to maintain. For this
reason, any business that employs a
sizeable number of staff and/or operates
from more than one location should
have an operations manual. In the
franchise environment, this has become
an imperative because the success of a
franchise depends to a large extent on
consistency.
The operations manual for franchisees
must interface with the franchise
agreement. While the agreement
addresses the various rights and
obligations of the franchisor and the
franchisee respectively in broad brush
strokes, the operations manual gives
details and outlines the tactics to be
used to ensure compliance. It should
address all eventualities the franchisee
is expected to deal with. Among other
things, it provides a brief history of the
business and specifies the networks
corporate identity (CI) requirements.
Most importantly, it gives detailed
operating instructions pertaining to
every aspect of operating and managing
the business including its administration.

agreement far too unwieldy and there


is another aspect that also needs to be
considered.
Operational guidelines need to keep up
with rapid changes in the market. The
operations manual can be updated by
the franchisor at will while changes to
the franchise agreement would require
negotiations leading to agreement by
the parties.

For an example of a typical table of


contents for an operations manual refer
to the website, directory General.

Subject to a well-written operations


manual being in place, the franchise
agreement can limit itself to describing
the areas the franchisor wishes to
control. In any event, dealing with
operational issues in the franchise
agreement in any detail would make the
Principles of Franchising / Page 26

4.3 Who owns what in a


franchise?
This issue tends to cause much
uncertainty among prospective
franchisees but it is actually very clear.
In most instances, the franchisor owns
all intellectual property including the
trademarks and operations manual while
the franchisee owns the infrastructure
(buildings, shopfittings, equipment,
vehicles and stock).

Sale vs Grant
In this context, one more issue needs
to be addressed: Franchisors talk about
selling a franchise but this could be
misleading. It is widely accepted that if
a person buys something and pays for
it, that such person is free to do with
it as he/she pleases. In the context of
investing in a franchise, its not that
simple. Although franchisees own the
business, they are under contractual
obligation to operate it according to
binding guidelines. Depending on need,
CI, product range, number and level of
staff employed, the method of service
delivery and even the administrative
processes that must be applied in the
business, will be prescribed.
Page 27 / Principles of Franchising

Within this framework, the franchisee is


free to operate the business, maximise
its potential and retain the resulting
profits. If the franchise agreement comes
to an end, the outgoing franchisee
retains ownership of the infrastructure of
the business but would have to remove
and return or destroy all intellectual
property. In instances where the
agreement is terminated prematurely,
the franchisor would probably be under
no obligation to refund the upfront fee or
any other franchise fees.

4.4 Dispute resolution


The success of every franchised
network depends to a large extent on
the quality of the relationship between
the franchisor and its franchisees.
Franchisors and their franchisees know
that generally speaking, relationships
between the parties are good. The large
number of franchisees who request
extension of their franchise agreements
upon expiry of the initial franchise
agreement is ample proof of that.
However, given the size of the franchise
sector, it should not come as a surprise
that disagreements do arise from time
to time. In most instances, seeking legal
redress is cumbersome and expensive.
A better option may be for the parties
to use alternative dispute resolution
processes. This should be provided for in
the franchise agreement. Various dispute
resolution bodies exist but because of

their intimate knowledge of franchising,


FASAs dispute resolution service should
not be overlooked. See quote below.

Within franchisings
structure of a franchisor
and many franchisees,
the legal intricacies
within the business
system can sometimes
result in disputes. FASA
has a proud record in
playing a facilitating role
between franchisors
and franchisees, often
assisting in resolving
disputes before they
reach the courts.7

Principles of Franchising / Page 28

5. Becoming a franchisee
This chapter focuses on the prospective franchisee. It begins with selfevaluation and takes you through the entire evaluation process up to the
point when you sign the franchise agreement. Because the decision to invest
in a franchise is likely to have far-reaching consequences, this step should not
be rushed. It is best to remain focused and approach the task as a process,
not an event.

5.1 Evaluate yourself


The first thing you need to establish
before you go any further, is whether you
are likely to be happy as a franchisee.
Although for most aspiring entrepreneurs,
investing in a franchise will make perfect
sense, it is not the right choice for
everyone. Franchisees receive a blueprint
for business success that they need to
comply with, plus extensive initial and
ongoing support. Making the business
successful remains their responsibility.

As a franchisee, you
need to have many
of the qualities of an
entrepreneur but also
need to be a team player,
prepared to operate within
the framework of a tried
and tested system. Other
prerequisites are the
willingness to make a longterm commitment and
the determination to work
hard towards achieving
success.
Page 29 / Principles of Franchising

Starting a new business from scratch gives


true entrepreneurs an adrenaline rush like
nothing else can but the risks are high.
Verifiable figures are difficult to come by
but anecdotal evidence suggests that out
of every 100 independent start-ups, only
10 make it past the ten year mark. The
opposite applies to franchised businesses;
they have a survival rate of about 90%.
This is not at all surprising because access
to a proven system, the right to operate
under an established brand, extensive
support by the franchisor and access to
bulk deals make it somewhat easier for
franchisees to succeed.
Even franchisees who fail to make the
grade will usually experience a softer
landing. Precisely because they operate
under the networks brand, franchisors
have a vested interest to apply damage
control. A failed franchisee may not walk
away financially unscathed but in many
instances, at least part of the original
investment can be recouped.

The benefits franchising offers come


at a price, in this instance conformity.
Individuals who cannot operate within
a rigid system will not be happy as
franchisees.
The directory Franchisee on the website
contains an article: Will I be happy as a
franchisee?
Be brutally honest with yourself when
you contemplate the questions the
article poses.
The resulting answers will prompt you
to make a decision that will impact on
your own and your familys lives for a
very long time to come. If at all possible,
have someone you trust and who knows
you well review the answers you have
provided and discuss them with this
person before you move to the next step.

5.2 Investigate before investing


Having concluded that investing in a
franchise is the best option for you, the
time has come to do some research.
The first step is to identify the right
opportunity. You might have a specific
opportunity or industry sector in mind,
but it is still a good idea to investigate
the wider market and find out as
much as possible before commencing
negotiations with a specific franchisor.

The directory Franchisee on the


website contains the following
documents:
A checklist: Initial investigation
The article: Franchisee selection at
McDonalds. It is included because it
illustrates how an iconic brand goes
about recruiting new franchisees. It
also shows how patient prospects
must be.8
The internet is a good starting point
for your search. The section named
Resources at the end of this booklet lists
some relevant websites. Other options
for identifying opportunities are visits
to franchise exhibitions and scrutinising
advertisements in business-oriented
magazines and newspapers. You could
also talk to the owners of franchises that
you frequent as a customer, for example
your local fast-food outlet or tyre store.
Because the volume of opportunities
on offer can be overwhelming, it is best
not to cast your net too wide or you may
never get past the initial research stage.
This is not an encouragement to rush
the process, merely a suggestion not to
waste time on researching opportunities
that are either of no interest to you or are
out of your reach financially.

Principles of Franchising / Page 30

Making contact
Most franchisors websites have a facility
for the direct submission of franchise
enquiries. Complete their enquiry forms
then sit back and wait for the responses
to arrive in your inbox. Its a buyers market
out there; in most sectors, competition for
good prospects is fierce so you shouldnt
have to wait too long. If a company fails
to respond, it is generally best to cross it
off your list and look elsewhere because if
they treat you with disdain at the courting
stage, it doesnt bode too well for future
co-operation.
The information packs you receive
should give you additional insight into
the workings of the brands. Draw up
a shortlist and contact the first two
or three companies of interest. Their
representatives will probably answer some
of your preliminary questions and then ask
you to complete an application form. This
can be an arduous task but you need to
persevere. Intensive scrutiny of prospects
by a franchisor indicates that they are
serious about building a solid network.
After reviewing your application and
assuming that you meet the networks
franchisee profile, the franchisor
representative will set up a face-to-face
meeting. Sell yourself but also make
use of the opportunity to check out the
franchisor. Those who have nothing to
hide will appreciate that. At the same
time, be prepared for the fact that some
of the questioning you will have to endure
may appear to be intrusive. They will also
check and double-check every piece of
information you provide but as indicated
earlier, this is a good thing.
Page 31 / Principles of Franchising

Be wary of franchisors
who want to sign you
up without conducting
a thorough investigation
into your background and
your skills.
Should a franchisor representative
pressurise you into signing an agreement
under the pretext that others are
keen to invest in the territory under
negotiation, it may be better to break off
negotiations. It could indicate that the
franchisor is more interested in collecting
upfront fees than in building a solid
network of franchisees.

During early meetings with the franchisor,


you should talk openly about your
aspirations. The responses you receive
will help you to determine whether joining
this particular brand will assist you to
achieve your dreams. Even if a meeting
with a prospective franchisor brings no
concrete results, it wont be time wasted
because you will gain valuable insights
into the workings of various franchises.

The form: Questions to ask the


franchisor provides examples of
questions prospects should ask. You
will find it on the website, directory
Franchisee.
Once you have reached the stage where
the franchisor has pronounced you a
good fit and you are ready in principle
to forsake all others, this is how the
process should typically unfold:
1. Check out the industry sector:
Learn as much as possible about the
industry sector, its future potential
and the standing of the brand within
the sector.
2. Obtain the brands disclosure
document: The franchisor is under a
legal obligation to make a disclosure
document available to qualified
prospects, but will require you to
sign a Secrecy Undertaking. Think
carefully before you sign it because
should you change your mind about
the opportunity, you may be unable

to become involved in the same line


of business in the foreseeable future.
3. Work at a company-owned store:
It is in both parties interest that
you work in one of the networks
company-owned stores for a few
days. Indeed, many professional
franchisors will insist on it because it
enables both parties to check each
other out in a realistic setting.
4. Interview several of the networks
franchisees: The disclosure
document will contain a complete
list of the networks franchisees.
Make appointments with a crosssection of them and visit them. Dont
allow a franchisor representative to
accompany you as this may hinder
the free flow of information. Keep in
mind, though, that even if you visit
on your own, you are still a stranger
to the franchisees so you cant
expect them to give you the full story.
However, after speaking with several
of them you will get a good feel for
the way things really are within the
network, especially whether the
franchisor generally keeps promises.

The form named Questions to ask


established franchisees lists questions
you should ask existing franchisees
of the network under investigation. In
terms of the CPA, you have every right
to do that. You find the form on the
website, directory Franchisee.

Principles of Franchising / Page 32

5. Secure funding: Because of the


impact of variables such as the size of
the premises (which will be governed
by the size of the operation), the
exact investment amount may not
be known at this stage but the
disclosure document should contain
a reasonable estimate. This can be
used to negotiate funding in principle.
Absa Franchising has tailor-made
franchise finance packages in place;
they also maintain a database of
franchisors whose opportunities have
been investigated.

5.3 The need for professional


assistance

How Absa can help

The single most important


professional you need to consult with
is a good franchise attorney. Next in
line would be an accountant with a
good understanding of franchising.
A franchise consultants input could
be useful too, but cost considerations
may put this out of reach of most
prospective franchisees. However,
should your franchise involve a
multi-million rand deal, it would be
false economy to try and save on
consulting fees.

At Absa Bank we believe that hard


work goes hand in hand with vision
and focus. So, when you are ready to
talk to us about your business plans
and dreams, well be ready to discuss
with you the funding solutions that are
likely to optimally meet your specific
requirements. With an impressive track
record when it comes to working with
entrepreneurs, we have the practical
knowledge, financial products and
dedicated services to help you make your
business dream become reality.

Page 33 / Principles of Franchising

The importance of seeking


professional assistance cannot be
over-emphasised. Such assistance
doesnt come cheap but because of
the magnitude of the commitment
you are about to enter into, the fees
charged by professional advisers are
insignificant when compared with the
cost of potentially making the wrong
decision. This is not to say that you
need to hire a team of advisers.

Ongoing support

It is a good idea to ask a franchisor


representative to accompany you on
visits to professional advisers and
the bank. This is advisable because
the franchisor will be able to answer
questions that need a level of familiarity
with the franchise that you are unlikely
to possess at this stage.

5.4 What happens next?


Lets assume that you and the franchisor
of your choice have reached agreement
regarding the opportunity, the bank
has approved your loan in principle
and you are ready to sign the franchise
agreement. From here onwards, the
process is likely to unfold as set out in the
document: Getting ready to trade. It will
be found on the website, in the directory
marked Franchisee.

It is important to realise
that at this point, the
franchisors obligations
arising from the payment of
the upfront fee have been
fulfilled. Ongoing franchisee
support will be supplied in
exchange for the payment
of ongoing franchise fees.
These are usually payable
monthly for the duration of
the franchise relationship.

Depending on the nature of the


business, franchisees will have access
to some or all of the following benefits:
Joint purchasing and marketing
initiatives; access to a troubleshooting
hotline and technical support; regular
updates to the operations manual and
periodic support visits by a field service
consultant. Mature networks may offer
coaching services as well.

The need for participation


To derive maximum benefit from being
a member of a franchise, franchisees
need to embrace the brand and actively
participate in all its activities. This
includes, for example, participation in
the networks marketing campaigns,
attendance of regional and national
meetings and supporting all other
activities. Involvement in the networks
franchisee council or similar structure,
if operational, is also important. One
more thing: Franchising depends on
teamwork, so its not a happy playground
for lone rangers. Both parties will do well
to keep this in mind before becoming
involved.

Principles of Franchising / Page 34

6. Franchising your business


Most of the benefits of expanding a business through franchising have
been set out in chapter 1. This chapter focuses on the actual steps involved
in setting up a professional franchise operation. Only broad principles are
covered; detailed guidelines for franchising a business are available from
FASA.

6.1 Preliminary steps

Why expand through franchising?

It is best to begin with a review of the


issues that need to be considered before
you decide to expand your business by
franchising it.

When a business is ready for expansion,


setting up branches may be most
entrepreneurs first choice but it is rarely
the best option. A strong resource base
is required and this tends to slow down
the process. Furthermore, branches
rarely perform to their full potential.

Should proof be needed that franchising


tends to outperform other business
models, the recent economic downturn
provided it.

They are operated by managers who


may or may not be sufficiently motivated
because they dont share in the business
risk. By contrast, having made a sizeable
investment, franchisees can be relied
upon to manage the business optimally.
This results in customer service
excellence, quicker market penetration
and enhanced returns.

Review

The franchise sector weathered


the storm significantly better than
independent businesses did. Indeed,
most of the stronger networks continued
to grow.

Page 35 / Principles of Franchising

Is the business franchiseable?


Most of the information on what makes
a business franchiseable is given in
chapter 1. In addition, consider this:
1. Offering franchises is not an
add-on to the core business. It
is a new business venture which
should operate separately from the
core business. The new businesss
objective will be to put people into
business and make them profitable.

2. Franchisees are not branch


managers. They have made a
substantial investment and expect
to be treated with respect. They also
want a say in the future direction
of the business and expect utmost
transparency, honesty and loyalty
from their franchisor.
3. Setting up and operating a franchise
requires acceptance of a long
investment horizon. Given the
high cost of creating a professional
franchise package, plus the costs
of setting up and operating the
necessary franchisee support
infrastructure, the franchisor can
expect to incur operating losses for
two to three years after start-up.
Provided that the programme is
implemented correctly, the situation
can be expected to change for
the better as soon as a reasonable
number of franchisees become
operational.
4. To ensure, as far as this is possible,
that franchisees are successful, the
underlying product or service must
have a clearly defined USP (unique
selling proposition) that is likely to
appeal to the target market. The
target market must be sizeable and
growing.
5. Franchisees need to have a realistic
chance to earn fair returns on their
investments after paying franchise
fees and drawing market-related
salaries. This means that the target

market must be prepared to pay a


premium for added value in the form
of highly personalised service.
6. Franchising is a numbers game.
Unless there is sufficient potential for
expansion, franchising may not be a
viable option and other methods of
expansion should be explored.
7. What type of person makes an ideal
franchisee? What attributes and skills
do they require? How much money
will they have to invest? Taking all
this into consideration, will I be able
to attract the right people in sufficient
numbers?
8. Once the system has been fully
developed and tested, launch
must be swift to minimise initial
operational losses. If the concept
is site-dependent, will suitable sites
become available? If so, will I find
sufficient sites at affordable rentals?
(New franchisees cannot be expected
to sit at home waiting for a site to
become available because in the
meantime, they will be quite literally
eating into their savings.)

The directory Franchisor on the website contains the


following documents:
Viability of franchising my business
Franchisee profile
Site profile
Mapping out a strategy for national network
expansion.

Principles of Franchising / Page 36

Developing the financials


A complete set of financials must
be developed for the prospective
franchisor and the typical prospective
franchisee. This culminates in
the drafting of a franchise plan essentially a business plan that reflects
the development of the franchise
operation over the next five years in
terms of territorial coverage, income
and expenditure.

During the initial period after a new


franchise commences operations, all
members of the network will be busy
building their businesses from scratch.
This means that demand on support
services will be high while income
from ongoing fees is likely to be low.

For this exercise to be meaningful, the


following issues need to be examined:
1. Target areas for expansion: These
need to be identified based on
the findings obtained during the
operation of the pilot unit; you
would look for areas with similar
demographics. The projected
number of units to be established
under franchise over the projection
period can then be worked out.

4. Working out franchise fees: Based


on the above findings, upfront fees
and management services fee
percentages can be calculated. As
a rule, as soon as the network has
achieved critical mass, usually after
5 to 8 units are up and running,
management services fee income
should cover the cost of franchisee
support and begin to leave a profit in
the franchisors hands.

2. Franchise development costs: The


cost of developing the franchise
package must be estimated.
Details of what this entails are
given in chapter 6.

3. Franchisee recruitment and


support costs: Costs arising from
the recruitment and support of
franchisees need to be calculated;
see caution below.

Page 37 / Principles of Franchising

It is customary to amortise franchise


development costs pro rata based on
the number of units the franchisor
expects to establish over the first
three to five years after start-up.

When franchise fees are


calculated, the franchisors
legitimate expectation
to generate a profit
needs to be balanced
against the reality that
unless franchisees stand
a realistic chance of
generating adequate
returns on their
investment, franchising
the business will not be
viable.
5. Calculating the advertising/
marketing fee: The advertising/
marketing fee can be set as a
percentage of sales or a fixed
amount. It is not income in the
hands of the franchisor but must be
calculated at this point because it
affects franchisees operating costs
and therefore needs to be included in
the financial projections.

The pilot unit


Lets assume that everything works out
as expected and the decision is taken in
principle to go ahead with franchising
the business. One final step is still
outstanding: It is advisable to operate a
pilot unit for a reasonable period. This
could be an existing company-owned
outlet but it is usually better to set up a
new unit from scratch and operate it at
arms length from the core business.
Think of the pilot unit as a laboratory
for the development of the franchise
package. Everything necessary to
make future franchisees businesses
profitable including the setting-up
process will be tested, reviewed and
tweaked to perfection before the
necessary systems and procedures are
recorded. On completion of the piloting
phase, the pilot unit can be used for the
development of new products, systems
and procedures and their testing. It will
also be useful for the training of new
franchisees and their staff. Alternatively,
it could be sold as a going concern to a
franchisee.

Principles of Franchising / Page 38

6.2 Creating the franchise


package
The franchise package consists of the
necessary documentation (operations
manual, disclosure document and
franchise agreement), plus marketing
and training materials. With the
exception of the franchise agreement,
which must be drafted by a competent
attorney, most of the work could be
done in-house but this may not always
be the best option.

the right individual is retained as


a consultant, this move will add
substantial value. FASAs website
lists franchise consultants under
Affiliate members; discuss your
project with several of them and
obtain cost estimates. There is also a
relevant article on the website - see
Consultant selection in the directory
Franchisor.

In addition to providing guidance


on franchising and help with the
necessary documentation, some
consultants offer to assist with
the recruitment of franchisees.
Depending on the agreed
remuneration model, this could be
problematic.

Should the consultant be paid a


commission he/she could be under
pressure to sign up poor prospects.

The need for professional assistance


Prior to discussing the franchise
package, the necessity for using
professional advisers needs to be
addressed. Many entrepreneurs feel
that advisers charge exorbitant fees but
contribute little in terms of real value.
This is a misnomer. It is true that good
advice doesnt come cheap, but neither
does failure.
1. Branding consultant: Unless the
companys corporate image has
been professionally designed and no
tweaking is required, now is the time
to commission professional designs
and have them legally protected.
Leaving it for later could put the
franchise programme into jeopardy.
It would also be unfair on early
franchisees who would be forced to
rebrand.
2. Franchise consultant: Seeking input
from a good franchise consultant
at an early stage is recommended.
Franchising a business is a complex
undertaking and provided that

Page 39 / Principles of Franchising

The quality of a
networks franchisees
will ultimately make or
break the brand. Also,
far from being a onceoff deal, the relationship
between the franchisor
and its franchisees is
ongoing. It follows that
the franchisor must
retain the final say on
franchisee recruitment.

3. Manual writer: The involvement of


a professional manual writer will
ensure that the operations manual
not only covers every aspect of
systems, procedures and processes
franchisees need to adhere to but
the writer will also know how to
present the material in such a way
that franchisees actually want to
use the manual. Some consultants
provide this service but it is
advisable to call in the services of a
specialist.
4. Franchise attorney: To stand up to
scrutiny in the face of a potential
legal challenge, the disclosure
document and the operations
manual need to interface seamlessly
with the franchise agreement.

Retaining an attorney with franchise


experience to prepare the franchise
agreement and having such
attorney review all other franchise

documentation is essential. This is


one area that definitely does not
lend itself to a DIY approach. FASAs
website lists franchise attorneys
under Affiliate members. Discuss
your project with several of them
and obtain cost estimates before
committing yourself.
5. Accountant: Your accountants role
is to review your financial projections
and ensure that they make sense.

To save on professional fees without


taking risky shortcuts, finalise your
franchise project on paper. Next, have
the operations manual completed and
an early draft of the disclosure document
drawn up before you commission the
drafting of the franchise agreement.

Principles of Franchising / Page 40

Writing the operations manual


Information garnered during the piloting
phase forms the input for the creation
of the operations manual. This manual
needs to describe every activity the
franchisee needs to carry out to emulate
the franchisors success. Although it is
possible to write the operations manual
in-house, it may not be the best option
because the manual shouldnt limit
itself to operational guidelines only.
Every professional manual writer knows
that numerous other issues need to be
addressed.

A growing number of
experienced franchisors
create, in addition to the
ubiquitous operations
manual for franchisees, a
formal guide for franchisor
personnel, essentially a
franchisor manual. This
introduces new personnel
to the workings of the
franchise and ensures
compliance regardless of
changes in head office
staff. Seen from the
franchisees viewpoint, it
ensures consistency.
Drafting the disclosure document
The disclosure document can be drafted
in-house. Alternatively, the manual writer
or the franchise attorney can undertake
this task.
Page 41 / Principles of Franchising

The Regulations to the Consumer


Protection Act list the minimum
information the disclosure document
must contain. In addition, FASA
publishes guidelines under the heading:
Disclosure Document Requirements7
which are compliant with the Act but are
more detailed.
These two documents can be accessed
on the website under General.

Creating the franchise marketing


materials
With competition for good prospects
at an all-time high, good marketing
materials are an essential prerequisite
for attracting high-calibre individuals as
prospective franchisees. The information
can be web-based to reduce production
costs and simplify updating but
professional web design is essential.
Regardless of whether the marketing
materials are printed or published
digitally, the secret to the creation of
good franchise marketing materials is
to tell it like it is. To promise more than
you are prepared to deliver would not
only be unethical, it could also create
legal problems in terms of the Consumer
Protection Act.

6.3 Marketing the franchise


In the past, franchising used to be a
sellers market but this is no longer the

case. It is true that South Africas leading


franchise brands, especially those active
in the quick service food sector, continue
to have long waiting lists of franchisee
hopefuls but other franchisors find it
quite difficult to attract quality prospects.
This notwithstanding, there is no doubt
that subject to the right approach,
suitable prospects can be found.

Promotional media
Creating a section on your website that
promotes your franchise offering is
essential. On top of the list of media that
are known to drive traffic to franchisors
websites is another website www.fasa.
co.za Participation in franchise and small
business exhibitions (see Resources)
and the placement of advertisements in
business-oriented publications rank next
in importance. PR can also play a major
role.

The power of word of mouth


Nothing is more powerful than a
personal recommendation. It could
come from existing franchisees, supplier
representatives, customers of your
core business and fellow members of
the social club you belong to. In short,
anyone and everyone who believe in your
brand and who are prepared to pass on
information about the opportunity.

A hard-sell approach should be


avoided
Promoting the franchise opportunity is
acceptable, pressurising a prospect into
signing up is not. It is best to respond
promptly to initial enquiries but to leave
it to the enquirer to make the next move.
Once the prospect has been qualified,
the situation changes. Some people
are born procrastinators; giving them a
gentle nudge in the right direction will
be in their best interest.
The prospects ability to support the
required investment is important,
but this should not override other
considerations. Poor franchisee selection
creates all sorts of problems and can
damage your brand.

To quote franchise legend


Martin Mendelsohn, It
is not uncommon to find
that a franchisor will have
more problems originating
from among the first 10
franchisees than from all
those who join the network
subsequently. Granted,
your franchise agreement
will empower you to get rid
of bad apples but in the
interest of positive franchise
relations, termination of a
franchise agreement should
be seen as the last resort.
Principles of Franchising / Page 42

As soon as expressions of interest are


received from prospective franchisees,
the sequence of events will usually
unfold as set out in the document:
Recommended steps in the
recruitment of franchisees in the
directory Franchisor on the website.

6.4 Setting a timeline

Prospective franchisors always ask how


long it will take to prepare a business
for franchising. The realistic answer is
that it will take one-and-a-half to two
years. This tends to put them in a state
of shock.
You need to accept that franchising a
business is a massive undertaking. The
process should not be rushed and no
matter how many resources you allocate
to it, certain steps cant be tackled
unless the previous step has been
completed. The text box provides an
example of the typical duration.

Compiling the operations manual will


take a minimum of 4 to 6 months;
usually longer. The manual writer cant
begin to document processes before
the piloting phase has been completed,
adding another year. And the lawyer
cant finalise the franchise agreement
before the operations manual is
completed. This is how time adds up.

Page 43 / Principles of Franchising

7. Leveraging the benefits


of franchising to best effect
Franchising is well established but the concept is capable of delivering so
much more, especially in the South African context where job creation and
BBBEE issues are national priorities. This chapter shows how the benefits of
franchising can be optimised.

7.1 General
Unless a brand is constantly reinvented,
it will lose market share and eventually
wilt away. Brand development is the
responsibility of the franchisor but
franchisees have an important role to
play.
Firstly, they need to act as the networks
eyes and ears and alert the franchisor
to any changes. Secondly, they are
responsible for the implementation of
approved changes.

The documents named The franchisees


role in building the brand (directory
Franchisee) and The franchisors role
in building the franchise (directory
Franchisor), both on the website, provide
tips on how the parties can advance
their individual interests while at the
same time driving the growth of the
brand for mutual benefit.

Principles of Franchising / Page 44

7.2 The franchisors main


responsibility
This is arguably the most important
section in this chapter yet it is among
the shortest because the franchisors
main responsibility can be defined
in one simple sentence. It reads:
The franchisors main responsibility
is to enhance the sustainability and
profitability of the networks franchisees.
This objective is in keeping with the spirit
of franchising and little else matters. It
makes perfect business sense because
franchisees financial health translates
into sound network performance.
Sounds like Utopia? Well, it need not
be. Many successful networks have
demonstrated that it can be done.

The steps a franchisee can take if


support by the franchisor is inadequate
are set out in the document named
Demanding performance from the
franchisor. You find it on the website,
directory Franchisee.

7.3 International expansion


beckons
Given the high level of consulting
expertise available, South African
franchisors have access to global best
franchise practices; some have used
this to best effect. As soon as their local
market presence is sufficiently strong,
they take their concepts into other
countries.
Page 45 / Principles of Franchising

Many markets around the world, but


especially in the rest of Africa, hold
South African brands in high esteem.
Already, several of our leading franchisors
have taken up the challenge, with great
success. Given that Africas middle-class
is expanding exponentially, potential for
those who are brave enough to exploit it
remains virtually unlimited.

Considerations surrounding
international expansion
Franchising is an ideal vehicle for
international expansion because it
facilitates mutually advantageous cooperation between the exporter of the
concept and operators in the target
country who are familiar with local
conditions. Under the next heading,
several franchise formats suitable for
international expansion are listed.
However, before you even begin to
consider their respective advantages
and disadvantages, you should have
established a strong presence in your
home market and have spare capacity that
can be redirected towards international
expansion. Martin Mendelsohn, in his
book Franchising in Europe10, identifies 5
common mistakes inexperienced master
franchisors tend to make:
1. An insufficiently strong home-based
business
2. An unwillingness to devote
resources exclusively to international
development
3. An unwillingness or inability to devote
sufficient financial resources to the
effort

4. An unwillingness or inability to devote


sufficient manpower resources
5. An inability to recognise the amount
of time it will take to become
established and profitable in the
target country

International franchising
should never be
undertaken on a whim, or
in response to an enquiry
received from some
exotic country that may
or may not constitute a
viable target market for
the product or service
on offer. Target countries
need to be selected
based on their potential
and access to a suitable
local partner.
Formats for international expansion
Regardless of the format used, the
most common pitfalls that arise in
international expansion are cultural
differences, existing legislation that,
for example, fails to adequately protect
the master franchisors intellectual
property and restrictive exchange and/
or import controls. These issues must
be addressed before anything else is
set in motion because there is no point
in entering into an agreement with a
foreign partner if it cannot be enforced.
Several business formats can be used.

Direct franchising
Foreign franchisees are signed up
just like local franchisees, except that
legislation in the target country needs
to be taken into account. For logistical
reasons, this format is primarily viable in
neighbouring countries.
Setting up a subsidiary
A subsidiary that acts as the franchisor is
set up in the target country. It operates
one or more pilots to adapt the offering
to local needs, before recruiting,
training and supporting franchisees.
This approach requires a substantial
investment and carries the biggest
risk because the franchisor will have to
acquire an intimate understanding of the
local market but it also offers the highest
level of control and potential rewards.
Entering into a joint venture
The franchisor sets up a joint venture
in the target country. This is similar to
setting up a subsidiary but the joint
venture partner will have an intimate
knowledge of the local market. Risks and
rewards are shared.
Principles of Franchising / Page 46

Appointing a master franchisee


This is the most common method
of expanding into foreign markets.
Generally speaking, it is also the most
successful. Issues that need to be
considered before this step is undertaken
revolve primarily around legal and
cultural differences, exchange control
and, on occasion, differences in business
ethics.
So, how does a master franchise work?
The master franchisee is a legal entity
that resides in the target country and
is granted the right to operate as the
franchisor in that country. A master
franchise agreement is drawn up that
sets out the rights and obligations of the
parties and an initial master franchise
fee is paid. As a rule, the master
franchisee carries the full operational risk
in the target country.

Franchise fees in international


franchising
Working out a fair fee structure can be
problematic because franchise fees need
to be shared between the franchisor and
the master franchisee.
Over time, the master franchisee must
stand a reasonable chance, firstly, to
recover the initial master franchise fee.
Secondly, the master franchisee needs
to cover the cost of rendering ongoing
franchisee support and be left with a
reasonable profit.

Page 47 / Principles of Franchising

The master franchisor, too, needs to


earn a reasonable return on initial and
ongoing involvement. Proven potential to
achieve adequate volumes and trading
margins in the target market must be
evident before the establishment of a
master franchise should be considered.

Initial and ongoing obligations of the


master franchisor
In principle, these are the same as in
the home market. Representatives of
the master franchisee are trained at
the master franchisors home base in
all aspects of operating the franchise. A
period of operating pilots in the target
country for the account of the master
franchisee but with strong support by
the master franchisor follows.
During this period, the necessary
experience is gained to adapt the
product offering and the franchise
documentation to local requirements.
The master franchisee is now ready to
launch the franchise. At operational
level, the master franchisor will gradually
withdraw but will maintain close contact,
which should include periodic support
and monitoring visits.

Expanding into the rest


of Africa offers vast
opportunities but it is
not for the fainthearted.
Although the population
exceeds one billion
people, it would be a big
mistake to see them as
a homogenous market.
The cultural, economic
and legal consequences of
setting up business must
be explored on a percountry basis, making cooperation with individuals
who possess local
knowledge invaluable.

7.4 Succession planning and exit


strategy
No matter how much a franchisee
enjoys being part of a network, the day
will come when such franchisee wants
to leave. Exiting a business can either
be done in stages or cold turkey. For
example, the owner of the business
could nominate a family member or a
deserving employee as successor and
groom such person for the role. Or the
business could be sold outright.

The article: Developing an optimal


exit strategy for franchisees is located
on the website, directory Franchisee.
Most of the issues it deals with apply
to exiting any business but exiting a
franchise adds an extra dimension
because the franchisor must be involved
from an early stage.

Following Absas acquisition of Barclays


branches throughout the rest of Africa,
local expertise is now on tap in many
countries throughout the continent.
The article Africa expansion, to be
found on the website, Franchisor
directory, provides additional insights.

Principles of Franchising / Page 48

End notes
1

Illetschko, K: How to Franchise Your Business, 6th edition, FASA, 2012.

Gordon, B: The Franchise Factor 2010, website of Franchize Directions, 2011.

Sireau, N, Illetschko, K et al, Microfranchising, Greenleaf Publishing Ltd, UK, 2011.

Love, JF: McDonalds behind the golden arches, Bantam Books, USA, 1986.

Illetschko, K: How to Evaluate a Franchise, 5th edition, FASA, 2012.

Consumer Protection Act 2008, Act No. 68 of 2008, Government Gazette, 2011.

Osso, G et al: 2012 Franchise Directory, FASA, 2012.

Illetschko, K: SA Guide to Franchising, Butterworths, Durban, 2001.

Mendelsohn, M: The Guide to Franchising, Cassell, London, 1992.

10

Mendelsohn, M: Franchising in Europe, Cassell, London, 1992.

Page 49 / Principles of Franchising

Resources
Contact details of Absa Franchising

Service providers to the franchise sector

Telephone +27 (0)11 350 8000


E-mail franchise@absa.co.za
Web site www.absa.co.za

Franchise consultants
Franchise Assist
Feasibility studies, franchise model
determination, franchise documentation
and related requirements.
Contact: Lynn Mendona
lynn@franchiseassist.co.za

Support organisations
FASA
The Franchise Association of South
Africa (FASA) promotes ethical
franchising. The website directory
General contains a summary of this
organisations activities: Why FASA
matters.
Telephone +27 (0)11 615 0359
E-mail fasa@fasa.co.za
Website www.fasa.co.za
SEDA
SEDA (Small Enterprise Development
Agency) is a member of the dti Group.
They have staff and resources available
to assist individuals interested in
franchising with additional information.
Telephone +27 (0)12 441 1000
E-mail info@seda.org.za
Website www.seda.org.za
The following pages contain a list of
a cross section of established service
providers to the franchise sector
arranged in alphabetical order. The list
does not claim to be comprehensive
and Absa does not endorse any specific
organisation or company.

franchizedirections
Franchise consulting and training as well
as business consulting and training for
franchisors and franchisees.
Contact: Lindy Barbour
enquiries@franchize.co.za
Franchising Plus
South Africas leading franchise
consultancy with over 100 years of
combined franchise expertise.
Contact: Anita Du Toit
reception@franchisingplus.co.za
Lawyers
Adams & Adams
Franchising, licensing and distribution
agreements; patent, trademark and
copyright attorneys.
Contact: Danie Strachan
danie.strachan@adamsadams.com
Bowman Gilfillan
Intellectual property, franchise and
commercial law attorneys
Contact: Paul Hart-Davies
p.hart-davies@bowman.co.za

Principles of Franchising / Page 50

DAmico Attorneys
We provide professional advice on the
drafting of franchise agreements and
related intellectual property issues.
Contact: Maria DAmico
maria@damico.co.za

Spoor & Fisher


Patent, trademark and copyright
attorneys with offices in Johannesburg,
Pretoria and Cape Town.
Contact: Hugh Melamdowitz
h.melamdowitz@spoor.com

DM Kisch
DM Kisch provides legal services
pertaining to the setting-up and
maintenance of legal structures
franchisors require.
Contact: Kevin Dam
KevinD@dmkisch.com

Webber Wentzel
Legal assistance pertaining to franchise
arrangements including structures,
agreements, dispute resolution and
intellectual property.
Contact: Candice Meyer
candice.meyer@webberwentzel.com

Hogan Lovells South Africa


We are a leading full-service law firm
with affiliations in 47 countries across
the world.
Contact: Ian Jacobsberg
ianjacobsberg@hoganlovells.com

Providers of other relevant services


Go Communications
Public relations, marketing and events
management with focus on the
franchise sector.
Contact: Giuli Osso
giuli@gocomms.co.za

Livingstone Crichton
Specialists in the drafting of contracts,
property transactions and litigation
pertaining to the franchise sector.
Contact: Lee Astfalck
leea@livingstonechrichton.co.za
Smit & Van Wyk
Law firm dealing with intellectual
property, licensing, franchising and
related commercial aspects.
Contact: Esmari Jonker
e.jonker@svw.co.za

Page 51 / Principles of Franchising

ManualMakers CC
I focus on the compilation of operations
manuals, disclosure documents and
franchise-related publications.
Contact: Kurt Illetschko
kurt@manualmakers.co.za
safranchise warehouse
We publish the most accurate and
comprehensive monthly franchise and
business opportunities listing in South
Africa.
Contact: Kobus Oosthuizen
info@safw.co.za

List of useful websites


The following websites will be of specific interest to those prospective
franchisees who are interested in opportunities in the fuel sector:
www.sapia.co.za
www.sapra.co.za
www.fuelretailers.co.za
www.energy.gov.za

The following websites provide general information on franchising:


Absa Franchising
Association de la Franchise Marocaine
Australian Franchise Council
British Franchise Association (BFA)
Egyptian Franchise Development Assoc.
European Franchise Federation (EFF)
Franchise Association of South Africa
Franchise Association of West Africa
Franchise New Zealand
Franchising Association of India
Int. Franchise Association (IFA)
ManualMakers CC
Nigerian Int. Franchise Association
The Franchise Magazine (UK)
World Franchise Council (WFC)

www.absa.co.za
www.fmf.ma
www.franchise.org.au
www.thebfa.org
www.efda.org.eg
www.eff-franchise.com
www.fasa.co.za
www.franchisewestafrica.org
www.franchise.co.nz
www.fai.co.in
www.franchise.org
www.manualmakers.co.za
www.nigerianfranchise.org
www.thefranchisemagazine.net
www.worldfranchisecouncil.org

Other franchise-related websites:


www.franchise-chat.com
www.franchisedirect.com
www.franchiseinfo.co.uk
www.franchiseeurope.com
www.franchise-group.com

Principles of Franchising / Page 52

Dictionary of franchise terms


English is the lingua franca of franchising
and English words have found their way
into many other languages. As a result,
certain business and franchise-related
English words have been assigned a
meaning that differs slightly from their
original definition.
A
Area developer individual or company
holding the right to establish a chain of
franchised outlets within a defined area.
This is often linked to a development
plan that determines how many units
must be set up within a certain period.
B
Business format franchise
comprehensive blueprint offered by the
franchisor, entitling the franchisee to
receive access to a brand as well as initial
and ongoing support.
Business plan the document used to
project the development of a business
into the future. Within the context of
franchising, the franchisor will develop a
business plan for the franchise operation
known as a franchise plan.
C
Capital expenditure (CAPEX) the
investment required to set up a business
and its infrastructure.
Confidentiality agreement also
described as secrecy agreement is
a formal legal document designed
to protect the franchisor against
misuse of confidential information by
individuals holding themselves out to be
Page 53 / Principles of Franchising

prospective franchisees with an intention


to invest.
Consumer Protection Act (CPA)
Legislation that impacts the franchise
relationship.
Conversion franchise established
businesses in the same industry sector
convert to a franchised networks brand
and operating systems.
D, E
Disclosure document contains highly
confidential information pertaining to
a franchise offer. In terms of the FASA
Code of Ethics, such a document must
be given to qualified prospects before a
franchise agreement can be signed. A
cooling-off period of 14 days needs to be
observed.
F
FASA: Franchise Association of South
Africa.
Field service consultant (FSC) an
individual employed by the franchisor
who is tasked to visit franchisees and
provide ongoing on-site support as well
as troubleshooting services.
Fractional franchise a franchised unit
that operates under the roof of another
business that may or may not be a
franchise. An example would be a car
wash located within the precinct of a
petrol station.
Franchise see business format
franchise.
Franchise agreement the legal
document that governs the relationship
between franchisor and franchisee. It is
usually a standard document and not
negotiable.

Franchise Association of South Africa


(FASA) the industry body established
since 1979 that represents the interests
of the franchise industry. Membership is
voluntary.
Franchise manager individual
employed by the franchisor to manage
the franchise operation.
Franchise plan see business plan.
Franchisee owner of a business that
operates under a formal business format
franchise arrangement. Franchisees
are obliged to conduct the business in
accordance to guidelines issued by the
franchisor.
Franchisee Representative Committee
(FRC) committee consisting of
democratically elected representatives of
the franchisees of a network to represent
franchisees interests.
Franchiser a term used occasionally
instead of franchisor, notably in the
United States. However, franchisor is
the universally accepted term and is
preferred.
Franchisor grantor of a franchise.
Owns the intellectual property package
that constitutes the franchise and is
compelled to provide initial and ongoing
support to franchisees.
FRC see Franchisee Representative
Committee.
FSC Field Service Consultant.
G, H, I
Get-up description of the appearance
of a store etc., also known as the trading
style of a network.
Initial fee lump sum payable by the
franchisee to the franchisor at the
beginning of the franchise relationship.

It pays for access to the network, use


of trademarks, access to expertise and
initial support.
Intellectual property the intangibles
owned by the franchisor including
trademarks, registered names,
patents, designs, colour schemes and
copyrighted materials.
L, M
Licence agreement legal agreement
granting rights to specified intellectual
property for a specified period. For
example, the licence to use the
franchisors name, trade- marks and
business know-how forms part of every
franchise agreement.
Management services fee ongoing
fee franchisees are compelled to pay to
the franchisor. Usually calculated as a
percentage of franchisees sales, payable
weekly or monthly in arrears. Calling it
a royalty is misleading and should be
avoided.
Marketing fee paid by franchisees into
the networks advertising or marketing
services fund).
Marketing services fund administered
by the franchisor, usually in cooperation
with franchisees. It pays for product
advertising and is funded by franchisees
and company-owned stores.
Master licence agreement formal legal
agreement used to grant a company
or an individual the right to a master
franchise covering an entire country or
continent. It would include the right to
sell franchises in this country and the
master licensee effectively becomes the
franchisor in the target country.

Principles of Franchising / Page 54

Multiple unit franchisee operates more


than one unit of the same franchise.
Frequently used to create a bigger
footprint and discourage opposition from
establishing itself in an area. See also
satellite franchise.
Mystery shopper individual hired to
visit stores pretending to be customers
and provide formal feedback.
N, O
Network wide purchase arrangements
initiated by the franchisor to secure
bulk purchase benefits for all members
of the network.
Operations and procedures manual a
comprehensive collection of instructions
issued by the franchisor for franchisees
to follow. It is a highly confidential
document known as the bible of the
network.
P, Q, R
Regional master franchisee acquires
the right to establish, within a specified
region or area, own unit(s) as well as the
right to sub-franchise to others.
Restraint of trade places restrictions on
franchisee and sometimes franchisees
key staff, should they wish to compete
with the franchisor and other members
of the network. Must be specific in terms
of time and area covered.
Royalty fee payable in return for the
use of intellectual property, be it a
musical or literary work, a trademark, a
protected name or a process. Sometimes
used in place of the term management

Page 55 / Principles of Franchising

services fee but this is wrong and can


have unintended consequences.
S, T
Satellite franchise additional unit
operated by an existing franchisee
in close proximity and designed to
offer a limited range of services to the
immediate neighbourhood.
Secrecy agreement formal
undertaking not to use confidential
information in any way other than it
was intended to be used and/or to
divulge it to unauthorised third parties.
Territorial rights a franchisees right
to an exclusive (or non-exclusive) area.
This could be a province, a town, part
of a town or merely a street address.
Such arrangements are generally
frowned upon by the Competition
Commission and may not always be
enforceable. Competent legal advice
should be sought prior to granting
such rights.
Total investment this is the sum total
of the initial fee (or upfront fee), the
required capital expenditure and the
necessary working capital needed to
set up the franchised business.
Trading style everything pertaining to
the image that the business wishes to
convey including store design, fittings,
furnishings, logo and colour schemes.
U-Z
Working capital the amount of
money an entrepreneur needs to
finance ongoing operating expenses.

Index
A
Accountants role..................................... 40
Administration fee in a franchise...........17
Advantages of franchising franchisee.................................................... 5
Advantages of franchising franchisor.................................................... 7
Advertising (marketing) fee....................17
Asset finance............................................ 22
B, C
Becoming a franchisor............................ 35
Business format franchising.................... 3
Capital investment in a franchise..........15
Controlled independence......................... 6
Cooling-off period.................................... 25
Cost of ongoing franchisee support...... 8
D
Definition of franchising........................... 3
Development costs for franchisor........ 37
Disadvantages of franchising franchisee.................................................... 6
Disadvantages of franchising franchisor.................................................... 7
Disclosure document requirements.... 24
Disclosure document.............................. 41
Dispute resolution................................... 28
E
Equity funding.......................................... 20
Exit strategy.............................................. 48
Expansion finance..................................... 2
Expansion formats.................................. 46
Expansion into Africa.............................. 48
Expectations of franchisors....................14
Expectations of prospective
franchisees.................................................13

F
Failures in franchising............................. 12
Financial aspects of franchising............15
Franchise agreement.............................. 25
Franchise attorney................................... 40
Franchise documentation...................... 24
Franchise failure....................................... 12
Franchise fee calculations...................... 37
Franchise lookalikes.................................. 9
Franchise package................................... 39
Franchise statistics...................................10
Franchisee selection.................................. 8
Franchising a business........................... 35
Franchisor manual................................... 41
Franchisor performance..........................18
Franchisors responsibilities................... 45
Funding sources...................................... 21
G, H, I
History of franchising................................ 1
Imposter...................................................... 9
Initial cost of franchising.......................... 8
Initial financial obligations franchisee...................................................15
International expansion.......................... 45
Investigate before investing................... 30
J, K, L
Laws impacting on franchising............. 23
Legal assistance...................................... 40
Legal issues in franchising..................... 23
Loan application.......................................19
Local advertising expenditure................17

Principles of Franchising / Page 56

M, N
Management services fee (MSF)..........17
Manual writers role................................. 40
Market share of franchising................... 12
Marketing a franchise............................. 41
Martin Mendelsohn, quote.................... 42
Master franchisee.................................... 47
Micro franchising......................................11
Mixed expansion strategy........................ 9
Modern-day franchising........................... 2
O
Ongoing financial obligations franchisee...................................................16
Ongoing support in a franchise............ 34
Operating costs........................................18
Operations manual................................. 26
Overdraft finance..................................... 21
Ownership issues in a franchise........... 27
P, Q
Pilot unit.................................................... 38
Professional assistance.......................... 33
Provision for sundry expenses franchisee ..................................................16
Purchasing fee .........................................17
Questions to ask franchisees................ 32
Questions to ask franchisor.................. 32

Page 57 / Principles of Franchising

R
Raising finance..........................................19
Recruitment and support costs............ 37
Renewal fee in a franchise......................15
Risk reduction............................................. 2
S
Sale versus grant in a franchise............ 27
Secrecy undertaking............................... 24
Self-evaluation, franchisee.................... 29
Soft loans.................................................. 21
Status of franchising................................10
Succession planning............................... 48
Sundry expenses in a franchise.............16
T
Tandem franchising.................................11
Target areas for expansion.................... 37
Term loan.................................................. 22
Timeline setting up a franchise............ 43
U-Z
Upfront fee.................................................15
Variants of franchising.............................. 3
Viability of franchising............................ 36
Word of mouth in franchising............... 42
Working capital.........................................16

Are you ready to take charge of your future by starting a


business but concerned about the associated risk?
A franchise may be the answer.
Franchises are often described as entrepreneurship with a safety net
and there is a good reason for this. Every legitimate franchise concept
has been tried, tested and turned into a blueprint for business success.
Options open to prospective franchisees are no longer limited to Fast
Food outlets or fuel retailing. Thanks to franchisings explosive growth,
opportunities are now offered in over 21 different business sectors.
There is truly something for everyone. In addition to prospective
franchisees, operators of successful businesses will find this book to be
an eye-opener. It shows how expansion through franchising can turn
a budding brand into a national icon in double-quick time. Absa makes
this book available to demonstrate its commitment to franchising.
The information it conveys is easy to digest and thoroughly practical.
However, Absas support for franchising doesnt end here. Our team
of experts is standing by to provide advice on franchising long before
offering customised funding solutions.

Absa Bank Limited Reg No 1986/004794/06 Authorised Financial Services Provider Registered Credit Provider Reg No NCRCP7