What Is a Franchisor?

A franchisor sells the right to open stores and sell products or services using its brand, expertise, and intellectual property. It is the original or existing business that sells the right to use its name and idea. The small business owner who purchases these rights is called a franchisee and the branch business, itself, is called a franchise.

Key Takeaways

  • A franchisor sells the right to open stores and sell products or services using its brand, expertise, and intellectual property. 
  • Becoming a franchisor is especially viable for already successful companies.
  • All franchisors assume the risk that a franchise could fail.
  • A corporation often will use franchising as a way to expand its global presence because it enables them as franchisors to benefit from the local knowledge of their franchisees.
  • At a minimum, a franchisor should plan to spend on business development, a flagship store, legal document preparation, marketing, and packaging plans, and recruiting and training franchisees.
  • Store types available for franchisees include freestanding stores, shopping center storefronts, gas/convenience restaurants, and special distribution opportunities (SDO).
  • Franchises are regulated by state and federal laws that require a Franchise Disclosure Document (FDD) and other regulatory documents entailing an attorney's services.
  • Generally speaking, a franchise agreement usually won't protect franchisees if their franchisor declares bankruptcy.

How Franchisors Work

The franchisor company generally receives an initial start-up fee, an annual fee, and a percentage of the branch’s profits. It may also charge for other services. Well-known corporate franchisors include Hertz (HTZ), Marriott International (MAR), McDonald's (MCD), and Subway (privately held).

Becoming a franchisor is generally a good business alternative, especially for large, already successful companies, though there are both advantages and disadvantages.

A chain store is one of a series of stores owned by one company; if Starbucks (NASDAQ: SBUX), for example, were to franchise some of its stores, then those would be owned by outside investors—not by the original company—and Starbucks would become a franchisor.

Advantages of Franchising

Expansion Opportunities

A corporation often will use franchising as a way to expand its global presence because it enables them as franchisors to benefit from the local knowledge of their franchisees.

The franchisor company grants the franchisee the responsibility of expanding in an area or country and grants them the right to sub-franchise. In exchange, the franchisee assumes the financial burden of building a unit and pays the franchisor royalties for access to its time-tested business model, market power, and brand name.

Heightened Market Share

In addition to extending its geographical reach, franchising is a good way for a company to increase its market share while minimizing capital expenditures (CapEx).

Franchises can be more profitable than corporate-owned chains, because as business owners franchisees are motivated to maximize their outlets' profitability and are responsible for their own overhead, such as staff. Less overhead can make franchises more profitable than corporations, even when their outlets are less profitable than they would be if they were run as chain stores.

Scalability

Depending on a franchisor's needs, resources, and production goals, the company can customize its franchise agreement to focus on large-volume national growth or low-volume regional growth.

Additional Sources of Revenue

A franchisor receives additional income in the form of ongoing royalties paid by its franchisees. Royalties typically include a startup fee, a monthly fee that includes a percentage of the franchisee's gross sales, and may contain other payments depending on the franchise agreement.

Royalties paid to franchisors vary by industry, location, company size, and financial strength. That said, royalties paid to franchisors usually fall in the range of between 4.6% and 12.5%.


Disadvantages of Franchisors

Some may think—partly because of the steep cash outlay—that franchisees assume more risk than franchisors. But there are potential disadvantages for franchisors, too.

Capital Investment

Establishing a franchise requires a large investment of both time and money. At a minimum, a franchisor should plan to spend on business development, a flagship store, legal document preparation, marketing, and packaging plans, and recruiting and training franchisees.

Franchise Failure

Even with scrupulous vetting on the part of the franchisor, a franchisee could turn out to be a poor choice—irresponsible, difficult to work with, or incapable of running a business for whatever reason. Or the franchise could become unprofitable for other reasons. Even with a proven business plan, there is no guarantee that a franchise will succeed.

Less Control

At the outset, franchisees will, of course, agree to follow their franchisors' training, deportment, and other instructions. But after the honeymoon is over, that might not be the reality. Franchisees are human beings with their own ideas and temperaments, so disagreements can always occur: a franchisee could become stubborn or difficult, or might not be able to effect changes as easily as the franchisor had hoped.

Costly Legal and Regulatory Fees

In the event that a franchisee refuses to cooperate, or proves to be a poor choice in other ways, legal action may be necessary; this can be both expensive as well as damaging to a franchisor's reputation among other franchisees.

Moreover, franchises are regulated by state and federal laws that require a Franchise Disclosure Document (FDD) and other regulatory documents entailing an attorney's services.

Role of a Franchisor

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.

The franchisor's advisory role is not free, however; it is part of the entire package that the franchisee purchases. Even when the relationship is solidified, and the two have been working together successfully, the franchisor still acts as a mentor. A franchisor's parental role is an ongoing commitment. In fact, franchisors generally police their franchises constantly—albeit some more than others—to ensure that they are maintaining the parent company's standards, product quality, and brand values.

Various Store Types Available for Franchisees

  • Freestanding store: A restaurant, either newly constructed or an existing structure that does not share any common walls with a third party
  • Shopping center storefront: A restaurant that shares a common wall, or walls, with third parties
  • Gas/convenience restaurants: A restaurant that is a sub- or-shared tenancy within a gas/ convenience host environment
  • Special distribution opportunity (SDO): Cart or kiosk locations that are referred to as special distribution opportunities and may be located within another host establishment, such as a stadium or another retail facility

What Happens When a Franchisor Goes Bankrupt?

When a franchisor files for bankruptcy, the court will immediately impose a stay of all actions against the franchisor. In other words, franchisees aren't allowed to take legal action against the franchisor.

Generally speaking, a franchise agreement won't protect franchisees if their franchisor declares bankruptcy. In fact, franchisees are usually obligated to pay royalties and continue operating amid a franchisor bankruptcy.

The following steps in the process are determined by the type of bankruptcy the franchisor chooses to file for.

In a Chapter 7 bankruptcy, all of the franchisor's assets are liquidated to pay its creditors. Companies typically go this route because it's flat going out of business. In this situation, it's highly unlikely that the franchisor will be able to meet its franchise agreement obligations. Therefore, it's also unlikely that the franchisee will be able to stay in business.

In a Chapter 11 bankruptcy, a franchisor reorganizes their debt obligations and continues to operate as a going concern. Under this type of bankruptcy, the franchisor works with its creditors to create a reorganization plan while continuing to meet at least some of its franchise contract obligations. A reorganization plan sometimes takes months or years to complete.

In either case, a franchisor's bankruptcy will likely have a significant impact on its franchisees.

Real-World Example

Dunkin’ Brands Group (DNKN), which used to be called Dunkin' Donuts, began operations in 1954 and has been franchising since 1955.

With more than 130 years of franchising experience, Dunkin' is home to two of the world's most recognized franchises: Dunkin' and Baskin-Robbins. According to its most recent count, Dunkin' boasts approximately 12,870 locations in more than 45 countries.

As a franchisor, Dunkin’ licenses stores and restaurants that sell Dunkin’ coffee, donuts, bagels, muffins, compatible bakery products, sandwiches, and other food items and beverages compatible with the franchisor’s concept.

Most companies that offer franchising opportunities post how-to information for prospective franchisees on their websites. Generally, this is comprehensive, voluminous, and often written in legalese or boilerplate. In its franchisor role, Dunkin's text speaks to its would-be franchisees clearly and understandably, as the following sample shows.

Training Overview

  • Franchisees must at all times manage their network with at least two individuals, one of whom must be the franchisee or another partner, shareholder, or a designated representative. But both must successfully complete the required training program.
  • It takes a minimum of 20 days to complete the classroom/instructional phases of the Dunkin’ Core Initial Training program—not including online training, in-restaurant practice, or travel time; this is offered a minimum of 25 times a year at Dunkin’ Brands University in Braintree, Massachusetts.
  • The classroom and in-restaurant time are based on 10-hour days. Some of the franchisor’s required classes are only offered on the internet and are referred to as online training. These classes will require approximately 65 hours to complete.

Obligations and Restrictions

Franchisees must devote continuous best efforts to the development, management, and operation of their business. This means devoting sufficient time and resources to ensure full and complete compliance with their obligations to the franchisor, their customers, and to others.

Franchisees may not conduct any other business or activity at the restaurant without the franchisor’s prior written approval. They may sell only products approved by the franchisor and they must offer for sale the full menu prescribed by the franchisor.

Franchisees are not permitted to sell or distribute goods or services via the Internet or other electronic communications.

Financial Assistance

Dunkin' typically does not offer to finance. However, from time to time, it may, at its discretion, offer voluntary financing to existing franchisees for specific programs such as the purchase of specialized equipment or accelerated development in specified markets.

The franchisor has facilitated certain third-party lending arrangements that may provide financing for qualified franchisees. The amount of financing and repayment period varies by program, circumstances, and creditworthiness of the applicant.

Estimated Initial Investment

Dunkin' estimates that the cost to open one of its franchises—not including real estate costs—is approximately $95,700 at the low end and $1,597,200 at the high end.

You may find a complete breakdown of the fee schedule on the franchising page of the company's website.

Franchisor FAQs

What Franchises Make the Most Money?

Here are five of the biggest money-making franchises, and the initial investment required:

  • McDonald's ($1M-$2.2M): Iconic symbol of fast-food hamburgers, fries, chicken nuggets, breakfast sandwiches, and a wide variety of other signature food items. Operates more than 36,000 restaurants in more than 100 countries. Founded in 1954.
  • Dunkin' ($96K-$1.6M): World's leading baked goods and coffee chain, serving more than 3 million customers each day. Offers more than 50 varieties of donuts. Founded in 1950.
  • Sonic Drive-In ($1.2M-$3.5M): Currently owns and operates the largest chain of drive-in restaurants. They are primarily located in the south-central and southeastern United States. Founded in 1990.
  • 7-Eleven ($38K-$1.1M): Operators of more than 60,000 convenience stores, mainly in North America and Asia. Founded in 1927.
  • Popeyes ($383K-$2.6M): One of the world's largest quick-serve chicken restaurants, operating more than 2,700 restaurants in the United States and around the world.

What Is the Cheapest Most Profitable Franchise?

Here are five lower-cost opportunities with strong brand power, and the initial investment required:

  • Kumon Math & Reading Centers: $64K-$140K
  • ServiceMaster: $77K-$275K
  • uBreakiFix: $98K-$303K
  • Jan-Pro: $4K-$56K
  • Cruise Planners: $2K-$24K