The most common type of franchise model requires franchisees to pay for the rights to use intellectual property and to cover the establishment costs of a new franchise outlet. The greatest advantage of franchising is that it provides entrepreneurs with two fundamental elements for rapid business growth – capital and people. As a result of this, a brand is able to capture the market quicker than traditional business models – whereby owners would normally be limited in the amount of funding to open new locations.
With capital raising being one of the main rationales for choosing franchising, we now turn to consider the benefits of alternative franchise financing models.
Cost as a Barrier to Entry
One of the main reasons for providing funding assistance to franchisees, is to alleviate the financial constraints on the franchisee. This is often the case in circumstances, where the upfront costs are so significant – that they limit the number of potential franchisees. This is common in businesses which require significant upfront investments such as medical clinics or motor dealerships.
There are a few models which can help to mitigate these issues:
1. The Joint Venture model
In a joint venture model, the franchisor and franchisee each invest a percentage of funds, goods or fit out equal to their designated share as joint shareholders of the business i.e. 50:50.
Naturally, the franchisee will administer the day to day activities of the business while the franchisor will act as a silent partner. However, the roles and responsibilities could vary depending on the type of agreement entered into. In the alternative, given that a franchisor possesses a pecuniary interest in the profits of the business, they may also wish to take on more of a managerial role within the new outlet.
2. Joint Venture with equity buy-out model
Similar to the joint venture model, the franchisor and franchisee both invest into the business together. The nuance is that this model allows the franchisee to buy out the franchisor’s share over time, eventually owning 100 percent of the business. The advantage here is that the franchisor is not heavily involved in managing the day to day functions of the new outlets and the franchisee is incentivised to increase the profits of the business to buy out their partner sooner.
3. Joint Venture guarantee model
In this model, the franchisor provides all the funds required to establish the new outlet and partners with the franchisee to operate the business in a shareholding partnership. Such models may or may not have a buy-out option.
The defining characteristic here is that the franchisor provides the guarantee for loan funding and the joint-venture is responsible for the loan repayment.
To Sum up
It is imperative to be weary of the franchise financing model you select, as each type of model provides certain rights and benefits. Each option can provide both greater risk and reward to franchisors beyond the traditional business model. For business owners looking to maintain greater control of the operations of their franchisees, this can be done just as easily with a well drafted franchisee agreement and operations manual.