sme

1. 1
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)

2. 2
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

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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?

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(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;

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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).

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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.

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

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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

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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)

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

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(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;

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Alternatives to Franchising
2. Agency
• 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.
3. 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

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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

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(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

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(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

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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

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UFOC
• US Federal Trade Commission (FTC) published amendments effective from
July 1st 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.

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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).

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

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What constitutes a Small or Medium Enterprise (contd.)
• SME’s are the lifeblood of most economies.
• 90% of enterprises are SME and account for 50-
60% 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

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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

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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)

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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);

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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 ‘know-
how’ gained by the import of, mainly US, franchise
systems outweighs disadvantages resulting from the
displacement of existing local business and capital
outflows ( repatriated profits).

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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.

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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.

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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;

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Is the Business Franchisable?
–Technical business – in the majority of cases
short period of induction training provided.
McDonalds 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

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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

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Europe and RoW Analysis (also see handout)
Franchise brands No of brands Turnover Employment
COUNTRY Total Total franchised
company-
owned currency Total franchised
company-
owned Total
Austria (2004) 390 6,900 EURO 4.5 90,000
Belgium (2004) 100 3,500 USD 2.8 30,000
Czech Rep.(2005) 90 300
Denmark (2005) 128 USD 0.07 22,316
Finland (2005) 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

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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
TOTAL EUROPE (20) 8860

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RoW
See separate handout

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Europe & RoW
• 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,
37.7euro’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.

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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

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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.

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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 £50k; 53% between
£50k - £249k; 22% over £500k 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;

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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.

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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.

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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)

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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%
Business &
Commercial Services
158 157 -1%

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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!

42. 42
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