What Is a Franchisee?

A franchisee is a small business owner who operates a franchise. The franchisee has purchased the right to use an existing business's trademarks, associated brands, and other proprietary knowledge to market and sell the same brand, and uphold the same standards as the first business. Franchisees become owners and independent operators of third-party retail outlets called franchises.

Franchises are an extremely common way of doing business. In fact, it is hard to drive more than a few blocks in most cities without seeing a franchise business. Examples of well-known franchise business models include McDonald's (NYSE: MCD), Subway, United Parcel Service (NYSE: UPS), and H. & R. Block (NYSE: HRB). In the United States, there are franchise business opportunities available across a wide variety of industries.

There are benefits and drawbacks to investing in an already-successful business; as with any investment, research your options thoroughly before you decide to purchase a franchise.

Understanding Franchisees

When a business wants to garner more market share or increase its geographical presence at a low cost, one solution could be to create a franchise for its product and brand name. The franchisor is the original or existing business that sells the right to use its name and idea. The franchisee is the individual who buys into the original company by purchasing the right to sell the franchisor’s goods or services under the existing business model and trademark.

Why Become a Franchisee?

Operating a franchise could be an ideal venture for entrepreneurs with little experience because 1) the costs of opening a franchise are low compared to starting a company from the ground up, so franchisees require very little capital to start; and 2) franchisees get a lot of help, as franchisors supervise their new franchisees closely.

Franchisee and Franchisor Relationship

The relationship between a franchisee and franchisor is inherently one of advisee and advisor. The franchisor provides continual guidance and support concerning general business strategies such as hiring and training staff, setting up shop, advertising its products or services, sourcing its supply, and so on. To start, the franchisor assigns the franchisee an exclusive location where no other franchises within the same underlying business currently operate in order to prevent competition and help ensure success.

In return for the franchisor's advisory role, use of intellectual property, and experience the franchisee generally pays a startup fee plus an ongoing percentage of gross revenues to the franchisor.

Responsibilities of Franchisee

A franchisee must follow the proven business model that is already in place, as it helps to provide a consistent state of operations within all companies under the same brand name. The franchisee is responsible for growing the franchise via the usual means of advertising and marketing within its exclusive area of operation.

However, all marketing campaigns must comply with and be approved by the original establishment before releasing them to the public. As the manager of the franchise, the franchisee is expected to protect the brand name of the franchisor by offering only approved products and services that are linked to the brand name of the original company.

Key Takeaways

  • A franchisee is a small-business owner who operates a franchise.
  • The franchisee pays a fee to the franchisor for the right to use the business's already-established success, trademarks, and proprietary knowledge.
  • The franchisee receives continuous guidance and support from the franchisor.
  • The franchisee markets and sells the same brand, and upholds the same standards as the original business.

Example: McDonald's Has 34,410 Franchisees

A company that has a global presence because of its franchises is the fast-food behemoth, McDonald’s. McDonald’s was founded in 1940 by the McDonald brothers in San Bernardino, California. However, Ray Kroc opened the first official franchise for the McDonald’s System, Inc.—a predecessor of today's McDonald’s Corp.—in 1955 in Des Plaines, Illinois (a suburb of Chicago).

At fiscal year-end 2018, there were 37,000 McDonald's restaurants in 119 countries around the world, 92.7% of which were franchised. So, the company has approximately 34,410 franchisees. The company’s long-term goal is for 95% of McDonald’s restaurants to be owned by franchisees.

McDonald’s either owns the land and buildings used by the franchisees or secures long-term leases for the franchised sites. As part of the contractual agreement between the company and franchisees, a franchisee provides a portion of the capital required by making an initial investment in the equipment, seating, décor, and signs in the location that the company will provide. For would-be franchisees, McDonald's requires an initial downpayment of 40% (of the total cost) for a new restaurant or 25% (of the total cost) for an existing restaurant; and at least 25% of the downpayment must be in cash. 

The legendary success of the McDonald's franchise story is partly a result of the company's commitment to maintaining consistent standards in its menu that resonate across its various chains. A Big Mac in Los Angeles should and does have the same quality as one in London. Franchisees manage their own pricing decisions and staffing matters while benefiting from the brand equity and global experience of McDonald’s.