EXPANDING A BUSINESS BY FRANCHISING © DLA Piper US LLP This article is reprinted by permission of DLA Piper US LLP CHGO1\30907950.1 3/2/07 TABLE OF CONTENTS I. INTRODUCTION ...............................................................................................................1 A. The Origins of Franchising ......................................................................................1 B. Modern Franchising.................................................................................................6 C. Types of Franchise Relationships ..........................................................................11 1. Introduction................................................................................................11 2. Product Franchises and Selective Distribution ..........................................16 3. Business Format Franchises.......................................................................17 4. Manufacturing Licenses.............................................................................18 5. The Conversion Franchise .........................................................................19 6. Quasi Franchise Relationships...................................................................20 7. Single Outlet and Area Franchises.............................................................21 a. Single and Multiple Outlet Franchising.........................................21 b. Area Development Franchising .....................................................22 c. Subfranchising ...............................................................................24 d. Area Representation.......................................................................26 8. Area Franchising Considerations...............................................................27 D. The Economic and Financial Relationships of Franchisors and Franchisees........29 1. General Economic and Financial Characterisits of Franchising................29 2. The Franchisor as a Supplier of Intangibles and Services .........................30 3. The Franchisor as Supplier of Tangible Products......................................31 4. The Franchisor as a Source of Capital ......................................................32 5. The Franchisor as Landlor .........................................................................32 E. In What Ways Can Franchising Be a Superior Expansion Method.......................32 1. Benefits related to capital furnished by franchisees ..................................33 a. Rapid expansion of the franchise network.....................................33 b. Franchisees share risk of expansion of the franchise network.......35 c. A franchising company can realize a higher return on its capital..35 d. Franchise networks can realize economies achieved by company-owner outlets through joint procurement.......................36 e. Reacquisition of franchised business.............................................36 2. Benefits related to the motivated management of franchised outlets ........33 a. Franchisees are motivated owner-managers ..................................36 b. Franchisees are idea/information resources to a franchisor...........37 c. A franchising company has a simpler and more efficient management structure....................................................................38 d. Franchising offers opportunities for employees to acquire franchises .......................................................................................38 3. Personal Satisfaction..................................................................................39 4. Franchising from perspective of the Franchisee ........................................39 F. Significant Elements of a Business Format Franchise...........................................32 1. Trademarks and Trade Dress .....................................................................41 2. Business Format and Operating System ....................................................44 3. Site Selection and Business Facility Development....................................46 4. Advertising and Marketing........................................................................47 5. Training......................................................................................................47 6. Continuing Assistance and Guidance ........................................................48 CHGO1\30975746.1 4/20/07 7. System Standards.......................................................................................49 8. Term Renewal and Transfer.......................................................................51 9. Other Significant Terms and Conditions ...................................................53 10. Fees ............................................................................................................53 G. A Comparison of Alternative Distribution Structures with Franchising ...............55 1. The Vertically Integrated Chain.................................................................56 2. Joint Ventures............................................................................................62 3. Independent Dealerships............................................................................64 4. Cooperatives ..............................................................................................64 5. The Internet................................................................................................66 II. SIGNIFICANT ELEMENTS OF THE FRANCHISE RELATIONSHIP...........................9 A. Introduction..............................................................................................................9 B. The Decision to Expand by Franchising................................................................71 1. The Decision to Expand.............................................................................71 2. Expansion Methods....................................................................................71 3. Sound Concept...........................................................................................73 4. Ready to Franchise.....................................................................................74 a. Prototypes ......................................................................................74 b. Financial Criteria...........................................................................76 c. Business Plan.................................................................................76 d. Sufficient Capital...........................................................................78 e. Capable Management.....................................................................79 C. Grow The Franchise Network with the Right People, In the Right Places and At a Manageable Rate............................................................................................80 1. Selecting High Potential Franchisees.........................................................80 a. Core Values and Other Characteristics..........................................82 b. Recruit High Potential Franchisees................................................84 c. Evaluating Prospective Franchisees...............................................85 d. Do Not Mislead Prospective Franchisees ......................................86 e. Grant Franchises - Don't Sell Them...............................................86 2. Developing Leads to Prospective Franchisees...........................................87 a. The Internet....................................................................................87 b. Printed and Other Sales Materials..................................................90 c. Existing Franchisees ......................................................................92 d. Referral Networks..........................................................................93 e. Public Relations.............................................................................95 f. Evaluating Lead Sources................................................................95 g. Be Responsive................................................................................96 h. Support of Franchisees...................................................................98 i. Expand At a Manageable Rate.......................................................99 D. Building and Maintaining Cooperative Franchise Relationships ........................101 1. A Brief Analysis of the Franchise Relationship ......................................101 2. Current Franchisor Thinking....................................................................102 3. The Critical Role of Franchisor Management .........................................104 4. The Profile of Current Franchisees..........................................................105 5. The Importance of Trust ..........................................................................106 ii CHGO1\30975746.1 4/20/07 6. Ending Wrong Relationships ...................................................................107 E. Effectively Documented Franchise Relationship.................................................108 1. Franchise Documents...............................................................................108 2. Uniform Franchise Offering Circulars and Franchise Sales Materials ..................................................................................................108 3. Operations Manuals.................................................................................109