Gurmeet S Jakhu Partner Hamilton Pratt Solicitors Birmingham

Gurmeet S Jakhu, Partner Hamilton Pratt Solicitors Birmingham, United Kingdom Topic 1: An Introduction to Franchising and its importance for Entrepreneurs and Small and Medium – Sized Enterprises (SMEs) 1

CONTENTS 1. An Introduction into Franchising 2. What constitutes a SME 3. Franchising as a means of Entrepreneurial Activity 4. The Importance of the Franchising in (headline figures): • USA • Europe & the Rest of the World 5. Case Study: the UK Market 2

1. An Introduction into Franchising • What is a franchise? • What are common franchise terms • What are the alternatives to franchising • What are the advantages and disadvantages of owning a franchise? • What are the legal issues in franchising? 3

(a) What is a franchise? A contract between two legally independent parties which gives (U. S definition) • a person or group of people (franchisee) the right to market a product or service using the trademark or trade name (branding) of another business (franchisor); • The Fr’ee the right to market a product or service using the operating methods of the Fr’sor (use of the System -‘know-how’); • an obligation on Fr’ee to pay the Fr’sor fees for these rights (made up of an initial fee and ongoing royalty/ management service charge: (payment of royalty is based on levels of franchisee’s turnover and not profit, hence incentive to achieve market penetration rather than profit); • the Fr’sor the obligation to provide rights and support to Fr’ees; 4

What is a franchise? (contd) • In the European Union (EFF Code) “Franchising is a system of marketing goods and/or services and/or technology, which is based upon a close and ongoing collaboration between legally and financially separate and independent undertakings, the Franchisor and its Individual Franchisees…. . • This definition has been adopted by the BFA (British Franchise Associations). 5

Common features: • System of mkting goods &/or services • A close and ongoing collaboration • Fr’sor grants rights & imposes oblig on Fr’ee • A financial consideration • Commercial and technical assistance; • Written franchise agreement. 6

FRANCHISE FRANCHISOR Owns (or has the right to use the) trademark or trade name FRANCHISEE Uses trademark or trade name Uses the System Exercises continuing control Expands business with franchisor's support Provides support: (sometimes) financing advertising &marketing Training Receives fees Pays fees 7

Types of Franchises Two main types: 1. Product distribution franchises –licences TM & logo, Fr’ee not provided with entire system for running business. Product distribution Eg: soft drink distributors, car dealers and gas/petrol stations 2. Business format – replicate business format. Most common form of franchise –Fr’ee uses/replicates the complete method to conduct the business. Business format Eg: fast food, retail, restaurants, business services and lodging 8

Types of Franchise Arrangements Two types of franchising arrangements: 1. Single – unit (direct unit) franchise 2. Multi-unit franchise: » Area development » Master franchise (sub-franchising) 9

(b) Common Franchise Terms • • • Business format franchise Franchise agreement Franchisee Franchising Franchisor Product distribution franchise Royalty Trademark Disclosure statement UFOC (USA) 10

(c) Alternatives to Franchising 1. Distributorships » » » » » Distributor purchases products in his own name Has no connection with Supplier/wholesaler Familiar with local markets May do business with more than one supplier/producer; May not receive contractual support, training from the supplier/producer cf: Fr’ee Free operate business, save relating to stock levels, turnover and advertising. More extensive control in franchising – Fr’ee pays an initial fee and continuing fees Distributor – one off purchase for good. Profit element to supplier is difference in manufacture/purchase costs and that which he sells at Adv: lower initial investment costs; 11

Alternatives to Franchising 2. Agency • • 3. Agents do not purchase in their own name Contracts made either directly by supplier and customer or by agent on behalf of the supplier Few restrictions on agent - relate to the agent’s powers to incur liabilities Some Franchises contain an agency-principal relationship – eg: parcels delivery franchises customers contracts with Fr’sor but delivery collection by Fr’ees. Licensing » » IP rights licensed to a manufacturer to enable manufacture to produce/sell Pay for rights to use particular trademark Supervise the use of the license - limited Most FA contain a licence to use TM & Brand – however FA more heavily regulated 12

Alternatives to Franchising 4. Acquisition/Setting up a Subsidiary Straight acquisition of an existing business or establish a wholly owned subsidiary - provides maximum control 5. Joint Venture • • • 2 or more companies/firms agree establish a common enterprise in which they intend to participate jointly; Frequently international in nature Advantageous 13

(d)Advantages and Disadvantages of Owning a Franchise Advantages: • Independence • Customer awareness • Business success • Quality and consistency • Pre-Opening Support & Ongoing Support Disadvantages • Not complete independence • Ongoing royalties • Balance restrictions and support provided with their ability to manage their business • Term (duration of FA) is limited and terms of termination 14

(e)Legal Issues of Franchising Two main franchising legal documents 1. Disclosure Document, which in the US is in the format known as the UFOC (not used in the UK) 2. Franchise agreement – in the US both Federal Rules and State Laws apply to franchising 15

UFOC – Uniform Franchise Offer Circular • Provides information about franchisor, the franchise system and the agreements. • Includes other agreements the franchisee will be required to sign, along with the franchisor’s financial statements. • Enables, prospect can make an informed decision about investing in a particular franchise. • The UFOC also includes information about: The franchisor’s key staff; Management’s experience in franchise management; Franchisor’s bankruptcy and litigation history; Initial and ongoing fees involved in opening and running the franchise; Other franchisees in the system with contact information. • Cooling-off period for franchisee (a number of days) before allowed to sign 16

UFOC • US Federal Trade Commission (FTC) published amendments effective from July 1 st 2007 and mandatory (with respect to new disclosures, standards and prohibitions) after July 2008 • One effect to reduce costs of exploring US market especially for overeas Fr’sors • Now the rules offer exemptions for franchising investments of more than one million dollars which means that in most American states, the FTC will no longer apply to many forms of franchise market testing. • No longer necessary to present UFOC to a prospect before first personal meeting. • In the past even before boarding a flight in the US, franchisors from the UK needed to complete a UFOC, Franchise Agreement and all financial statements prepared according to US County rules. This could easily cost £ 15, 000. 00 in legal and accounting fees and only give franchisors chance to talk about a prospective deal. 17

2. What constitutes a Small or Medium Enterprise • Term ‘SME’ - not clear or uniform within individual countries • Using the European Community definition (table on next slide) • To qualify as SME need to satisfy criteria for the number of employees and one of the two financial criteria, i. e. either the turnover total or the balance sheet total. • In addition, it must be independent (ie; not owned by another enterprise) • The thresholds for the turnover and the balance sheet total will be adjusted regularly, to take account of changing economic circumstances in Europe (normally every four years). 18

Using the European Community definition: Newly adopted EU definition of SMEs Criteria Max. number of employees Micro Small-sized Medium-sized enterprises <10 <50 <250 Max. turnover in million ECUs - 7 40 Max. balance sheet total in million ECUs - 5 27 19

What constitutes a Small or Medium Enterprise (contd. ) • SME’s are the lifeblood of most economies. • 90% of enterprises are SME and account for 5060% of employment at a national level (Lukenhorst (2004)*) • SME’s support economic growth and livelihoods in developing countries because they (inter alia)*: • • More labour intensive production processes Provide opportunities Nurture entrepreneurship Are embedded within the communities 20

What constitutes a Small or Medium Enterprise (contd. ) • Fr’sor a ‘larger’ business than the Fr’ee, but not often meet description of large. • In US & Europe most Fr’sors SMEs • SMEs are various sizes & sophistication 21

Small or Medium Enterprise & IP (contd) • Recent Government policy focused on developing a vibrant & dynamic SMEs sector, requires constant creativity and innovation to adapt to changing market conditions. • Ability to use IP systems; • SME’s must be aware of efficient use of IP systems; • SMEs division of WIPO survey shows activity for facilitating more effective use of IP by SMEs fall into these main categories*: • • A. Awareness – raising and training on IP B. Technological information services C. Customised advisory services on IP D. Assistance for IP exploitation and technology transfer (*see “Best Practices” section of WIPO www. wipo. int/sme/en/best/practices) 22

3. Franchising as a means of entrepreneurial activity • Franchising developed most in USA • International expansion to cope with market saturation • Growth rate accelerated, end of 1980’s approx 400 American business format Fr’sors operated in about 37, 000 foreign outlets • If you consider the iconic US business format franchise – the fast food/restaurant industry - number of outlets ‘exported’ to other countries rose from 2, 169 establishments in 1974 to 8, 485 in 1989 (Howarth International, 1991); 23

Franchising as a means of entrepreneurial activity (contd. ) • Conditions favourable to the growth of franchising; • Achieved • Figures suggest, that 15% of US Franchised outlets are now located in lesser developed countries (International Franchise Research Centre Special Studies Series Paper No: 7 - John Stanmore). • Developing countries must decide whether ‘knowhow’ gained by the import of, mainly US, franchise systems outweighs disadvantages resulting from the displacement of existing local business and capital outflows ( repatriated profits). 24

Franchising as a means of entrepreneurial activity (contd) • The advantages of global franchising to the Fr’sors may be summarised as: • Fewer financial resources, as Fr’ees incur majority costs; • Less susceptibility to political, economic and cultural risk if ownership is local – property less likely to be expropriated since Fr’ees are local nationals; • Fr’ees are more familiar with laws, language, culture, business norms and practices of the satellite country. 25

Franchising as a means of entrepreneurial activity (contd) • Risks of employing franchising as a vehicle to international expansion, (Fr’sors viewpoint) are: • Possible difficulties in repatriating royalties; • Difficulties in protecting copyright and other IP rights; • Difficulty in policing quality standards; • Local laws may create difficulties in terminating contracts; • Unfamiliar laws, regulations, languages and business norm. 26

Is the Business Franchisable? Yes so long as it can be: • Replicated, last as long as there are franchisees and generates profit for franchisee. • Pilot testing – if not, difficult to recruit! • Most businesses are franchisable except: –Creative businesses – require particular skill whether of an artistic or creative nature which cannot be easily taught; 27

Is the Business Franchisable? –Technical business – in the majority of cases short period of induction training provided. Mc. Donalds have an extensive training over a long period is the exception to the rule. –Low Margin Businesses – there has to be sufficient margins for both to make a profit –Fashion product/services – a concept or idea which will last the original term and 2 renewals –No advantage in doing so 28

4. The Importance of the Franchising in (headline figures) • Reference to BFA, IFA and EFF reports. • EFF reports (European Franchise Federation) • In the USA, franchising accounts for: – – 10% of the private sector economy and 50% (approx) of retail sales; Directly employs 10 million people and Indirectly employs 13. 7 % of the private sector workforce 29

Europe and Ro. W Analysis (also see handout) Franchise brands No of brands Turnover Total franchised companyowned currency Austria (2004) 390 6, 900 Belgium (2004) 100 3, 500 Czech Rep. (2005) 90 300 Denmark (2005) 128 Finland (2005) COUNTRY Employment company- owned Total franchised Total EURO 4. 5 90, 000 USD 2. 8 30, 000 USD 0. 07 22, 316 177 3, 666 EURO 4. 88 46, 000 France (2006) 1037 43, 680 EURO 45 Germany (2006) 900 51, 100 EURO 37. 7 429, 000 Great Britain (2006) 800 35, 000 USD 21. 7 340, 000 Greece (2005) 430 6, 540 Hungary (2005) 300 20, 000 Italy (2005) 735 54, 893 46, 337 8, 556 EURO 18. 2 120, 340 Netherlands (2006) 498 21, 400 EURO 21. 9 30

Franchise brands No Total Of franchised Outlets Comp ow Turnover Total Franchised Comp owned Employment Poland (2005) 210 13, 500 EURO 1. 1 Portugal (2005) 489 8, 500 USD 3. 4 53, 000 Russia (2006) 195 2, 800 Slovenia (2006) 141 3, 246 1, 531 1, 715 Spain (2006) 960 63, 584 EURO na Sweden 2005) 300 9, 600 EURO 8. 42 1. 9 4. 5 67, 000 Switzerland (2005) 180 Turkey 800 USD 25 8860 TOTAL EUROPE (20) 31

Ro. W See separate handout 32

Europe & Ro. W • Italy - 735 brands; 54, 893 outlets; 18. 2 billion (Euro’s); employing 120, 000 people • Spain – 960 brands; 63, 500 franchised outlets • Germany – 900 brands; 51, 100 outlets, 37. 7 euro’s; employing circa 429, 000 people • USA: 2, 500 brands, 800, 000 outlets; • PPRChina – 2600 brands, 195, 000 outlets • Australia – 960 brands, 70, 000 outlets, USD 62 billion. 33

5. The UK – A Case Study • Headlines (source 2007 BFA/Natwest Survey): • Over the past 10 years the number of active franchise systems has increased from 541 to 781 an overall growth of 44%; • 800 brands, 35, 000 outlets • Average business unit turnover has reached £ 323, 00, up a further 4. 9% on last years growth • The franchising industry as a whole contributes £ 10. 8 billion of revenue to the UK Economy 34

The UK – A Case Study • Employment: » 29. 03 million people are employed in the UK » Franchising accounts for 371, 6000 workers (up 6, 800 on 2005); • Over the last 10 years revenue per head within franchising has improved by 20% compared to the UK economy which has seen a 16% rise. • Vast numbers of Fr’sors now use internet to recruit new franchisors • Almost all Fr’sors charge a franchise fee at start up (93%) with initial start up costs averaging about £ 37, 400. 35

UK a Case Study (contd) • In addition 77% charge a recurring management services fees, averaging 7. 5% of sales (although this varies across the different industry sectors) • The vast majority of Fr’ees (93%) say that their business is profitable • 19% of FBUnits report annual turnover of less £ 50 k; 53% between £ 50 k - £ 249 k; 22% over £ 500 k and 6% over £ 1 million. • Reasons for continued growth in the UK Business Format Franchise Systems are attributable to: – Continued interest in the UK market from overseas Fr’sors – The combination of a strong UK economy and established franchise market makes UK an attractive region for international business; 36

UK a Case Study (contd) • In the UK there were 211 franchise systems with an international presence • Hotel and Catering are the lead sector for international operations • Europe appears to be the favoured destination for Fr’sors – 27% claim to operate units on the continent • Most Fr’sors (43%) reported that they wanted to expand internationally. • The most common method of expansion being granting a master licence (63%); but others wanted to operate directly from the UK. 37

UK a Case Study (contd) • 54% of the franchise systems required premises to operate business leaving 43% who operate remotely or from home • Where specific premises are required, 28% of Franchisors act as Landlords. 38

UK a Case Study (contd) Franchising Structure • The BFA/Natwest Survey found that Property Services was the largest of the franchised systems (see next slide) 39

UK a Case Study (contd) 2005 2006 %change Hotel & Catering 108 109 -1% Store retailing 97 101 4% Personal Services 144 153 6% Property Services 182 189 4% Transport & Vehicle 66 70 6% 157 -1% Business & 158 Commercial Services 40

In Conclusion • Franchising -a form of business expansion • SMEs play an integral role all economies – 90% of enterprises are SMEs and account for 50 -60% of employment • The Franchising Industry accounts for – 13. 7% (indirectly) of employment in the private sector in the US and – UK contributes to about £ 10. 5 billion to UK Plc • Clearly franchising is integral to all economies and is here to stay! 41

Bibliography In addition to those referenced throughout; • Intellectual Property (IP) Rights and Innovation in Small and Medium -Sized Enterprises; • Lukenhorst W. (2004) ‘Corporate Social Responsibility and Development Agenda’ Intereconomics, May. June. • Franchising Law & Practice – John Pratt of Hamilton Pratt, England • Franchising as a source of Technology-Transfer to Developing Economies Special Study Series No 7 (Professor John Stanmore, S Price, C Porter, Tony Swabe & Dr M Gold); • IFA Educational Foundation: An Introduction to Franchising. • SME and Corporate Social Responsibility: A discussion paper June 2005 (Tom Fox of IIED) • 2007 BFA/Natwest Franchise Survey 42