By Charles Dean Smith, Jr., CPA

In recent years, franchising has been gaining popularity as a cornerstone of entrepreneurial endeavors. This business model offers the opportunity to own and operate a business under already-established brand umbrellas.

When considering purchasing a franchise, it’s helpful to first become familiar with various terms and concepts.

Key Franchising Terms

From understanding the intricacies of franchise agreements to the dynamics of franchise development, prospective franchisees that equip themselves with knowledge will be more likely to make informed decisions and successfully navigate the due diligence and purchase processes.

In this article, we’ll outline common franchising terms in four categories.

Franchise Operations and Development

  • Candidate – The term used by franchisors for prospective franchisees who have contacted them about a franchise opportunity.
  • Franchise Agreement – The contract between a franchisor and franchisee to open one or more franchise business(es). Among other details, this contract includes the term of the agreement (typically 5 to 20 years).
  • Franchise Disclosure Document (FDD) – Required in the U.S. for any company offering a franchise opportunity, this document describes the business model, estimates the upstart costs, and names officers and franchise owners, among other information.
  • Franchise Fee – This one-time fee is part of the initial investment in a franchise business and allows the franchisee to use the brand’s name and likeness.
  • Franchisee – The person or corporate entity that owns a franchise business.
  • Franchisor – The company offering a franchise opportunity.
  • Franchise Development – The process of adding new franchisees to a franchise company.
  • Initial Franchise Investment – Total estimated cost to get the franchise business up and running, including: franchise fee, construction, equipment, property lease, etc. This number or range is listed as Item 7 in a franchisor’s Franchise Disclosure Document.
  • Low-Cost Franchise: A franchise with a low initial franchise investment, typically defined as less than $100K.
  • Multi-Concept Franchisee – Owns units of multiple franchise brands. Some franchise brands prohibit multi-concept franchising, while others seek franchisees who already own units of other brands.
  • Multi-Unit Franchisee – Owns multiple franchise business units. This term generally refers to owning units of the same brand, but may include multi-concept ownership.
  • Franchise Operations – The standardized processes, procedures, and strategies of the franchise to provide products and/or services to customers.
  • Renewal – The process of extending the original franchise agreement so the franchisee retains ownership for a new/lengthened term.
  • Supplier/Vendor – A business that provides a service or product to the franchise. Franchisors often establish “preferred” supplier/vendor relationships with negotiated discount pricing.

Financial Terms Franchises Should Know

  • Breakeven – The point at which a franchise generates enough revenue to cover the initial investment costs.
  • Royalties/Royalty Fees – Usually an agreed-upon percentage of gross sales paid by the franchisee to the franchisor on a regular basis. Royalty fees generally don’t exceed 10% of gross sales.
  • Lender – A bank or financial institution that provides a business loan.
  • Liquid Capital – Includes cash and assets that can be easily converted to cash. Prospective franchisees must demonstrate a minimum amount of available liquid capital.
  • Net Worth – Calculated by subtracting total liabilities from total assets, net worth represents one’s total monetary value. Many franchisors require prospective franchisees to demonstrate a minimum net worth.

Franchise Expansion and Territory Management

  • Advertising Fund – The franchisor uses this pool of funds to market the brand. Franchisees often contribute to the ad fund monthly along with other royalties.
  • Area Franchisee – One who, by signing an agreement, has acquired exclusive rights to open franchise units within a defined territory.
  • Area Representative – A franchisee who also operates as a salesperson for the franchisor in a specific territory by identifying new potential franchisees in return for a commission.
  • Conversion – Rebranding and modifying an existing business into a franchise unit of a different company.
  • Discovery Days – Typically a final step before deciding to invest in the franchise, discovery days are when one or several prospective franchisees visit the corporate office to learn more about the company.
  • Field Consultant – An employee or contract worker of the franchisor who supports franchisees at their locations.
  • Franchise Broker – A person or company hired by a franchisor to identify and cultivate potential new franchisees.
  • Franchise Expo – An event where prospective franchisees can meet franchise companies and discuss franchise opportunities. The largest U.S. expos take place annually in New York City, Anaheim, and Houston.
  • Master Franchise – A franchise agreement where the franchisor allows a franchisee to sell franchise units in a specific geographic region.
  • Territory – To prevent conflict between franchisees, some franchisors designate an area for the franchise unit.
  • Validation – Part of the due diligence process when buying a franchise, validating is speaking with existing franchise owners to confirm representations made by the franchisor.

Franchise Transition and Legal Terms

  • Churning – When ownership of a franchise turns over from one franchisee to another, from a franchisee back to the corporate entity, or the termination and closing of a franchise altogether.
  • Company-Owned Locations – Sometimes called corporate locations or units, these franchises are owned and operated by the corporate entity of the brand, rather than a franchisee.
  • Transfer – The movement of ownership of the franchise business from one party to another.
  • Turnover – A franchise agreement that has been terminated, not renewed, transferred, or the franchise business goes out of business.
  • UFOC (now FDD) the original name of what is now called the FDD.
  • Item 19 – An optional section of the Franchise Disclosure Document, this item discloses earnings claims of existing franchise owners and corporate locations. Note that this data may not represent all franchisees. Be sure to understand what the number represents.
  • Franchisee Satisfaction Index (FSI) – Using a 100-point scale, the index measures satisfaction of franchise owners within a particular brand.

Learn More

By taking time to familiarize yourself with these terms, you’ll embark on the franchising journey with more confidence.

With many years of experience serving franchises in various industries, our dedicated franchise team offers comprehensive accounting, management, and business advisory services for new, established, and aspiring franchise owners.

Contact us today.