Many business owners who consider expansion are unsure of the options and avenues available to them. While replicating your business through the franchising route is arguably one of the most cost-effective options, there are other alternatives. In this article, we will explore four ways you can expand your business in a non-franchise way.
But First, Franchising
In order to understand what is to be considered when weighing the alternatives to the franchise expansion route, it makes sense to first know what precisely a franchise is.
In the U.S., the Federal Trade Commission and state regulatory agencies have developed a formal set of disclosure requirements and franchise-specific requirements and prohibitions that franchisors must follow in their relationships with their franchisees. To determine whether or not a business meets the definition of a franchise, under the Franchise Rule, the Federal Trade Commission applies three definitive criteria:
The right to the use of a trademark to distribute goods and services (which bear the franchisor’s trademark, service mark, trade name, or another commercial symbol);
The provision of significant control or assistance (by means of site requirements, required business practices, training programs, franchise operations manuals, etc.); and
The payment of fees (initial franchise fees, royalties, service fees, and the like).
The details and complexities of the FTC Rule 436 are too numerous to list here in their entirety; however, if you are planning on forming a business relationship that involves all three of these above criteria, you are, in fact, creating a franchise relationship – regardless of what you choose to call said business relationship. And you will be subject to compliance with franchise regulations.
Now, knowing that, let’s examine four alternatives to franchising a business and their relative advantages and disadvantages.
1. Company-Owned Operations
The most obvious expansion method for many companies is the development of additional company-owned outlets using internal or personally borrowed funds or capital raised through private investors.
This strategy offers several advantages over traditional franchising. For example, company-owned growth allows you to keep 100 percent of each unit’s profits rather than sharing them with franchisees. It also offers you increased control over unit management. And since you own the assets, you get increased flexibility and the ability to react faster to market changes.
Corporate expansion also represents a more predictable method of growth because you don’t need to learn the new business of franchising. And at the same time, these locations allow you to build tangible assets in the business, which can have a very positive impact on the company’s valuation when you choose to retire or exit the business.
There are some disadvantages, though. Risk is the biggest one. While you get to keep 100 percent of the profits, you are also responsible for 100 percent of the losses. And the more money you invest in corporate operations, the more you have at risk. Increased control also comes with increased responsibility. Sexual harassment, EEOC violations, ADA violations, workers’ compensation, and other worker or customer liability issues will all be directed at you.
And, of course, there is the question of whether the capital you have access to will be adequate to meet your goals. Moreover, in today’s age of the Great Resignation, finding and keeping management is challenging – whereas franchisees are likely to be both longer-term and much more highly motivated by their investment.
2. Business Opportunities
Some companies expand with a business opportunity or license program – sometimes something they dreamed up and sometimes the creation of their attorneys. But simply calling something a license or a business opportunity does not make it so. To avoid falling under the definition of a franchise, you will need to remove one of the definitional elements of franchising (trademark, support or control, and a fee). In the case of a license, you would remove the trademark element of the franchise definition – requiring your licensee to operate under their own brand.
The advantage to the business opportunity route is that in many cases, the licensor does not have to comply with the FTC’s franchise disclosure regulations, which saves money and makes the sales process less complex. That said, a business opportunity may still have to comply with franchise disclosure laws in some states and will need to comply with the patchwork quilt of business opportunity laws that exist in a number of states. So, while the business opportunity licensor may avoid some legal costs if a company plans to roll out the offering on a local level, a national rollout may ultimately require them to pay more in the way of legal fees and make it only marginally easier to sell.
At the same time, avoiding a common brand identity often puts you as the licensor at a long-term disadvantage. The use of a common brand and identity can benefit both the franchisor and franchisees. Even a one-unit chain looking to expand through franchising will be likely to double their advertising exposure with the sale of their first franchise, whereas the licensor who sells 100 business opportunities will get little, if any, in the way of brand recognition – because their operators will do business under their own names. And because each business opportunity will operate under their own brand, it is much more difficult to control how the licensee operates, as you do not have the same legal nexus as a franchisor would.
3. Trademark Licenses
You can also expand your brand through the use of a trademark license. An example of such a license might be someone like Michael Jordan, who has made millions allowing brands to use his name or image in association with their products – but does not exercise the kind of control over operations that a franchisor would.
But for those of us with less prominent names, trademark licenses are exceptionally difficult to market, especially if you are branding a business instead of a product. After all, if someone is going into a business, it is the system of operation – the recipes, the advertising, the operating procedures, and the knowledge of how to succeed – that the prospective buyer is looking to obtain, not just the name.
A big caveat here is that it is extremely easy to step over the line of providing “significant operating control or significant operating assistance” – the elements that would turn your trademark license into a franchise. If you have control over site approval, design specifications, production techniques, promotional campaigns requiring franchisee participation, territory restrictions, not to mention a host of other issues, you could well end up as an inadvertent (and illegal) franchisor.
4. “No-Fee” Options
The last alternative to franchising, of course, involves removing the fee element from the equation. Since the federal definition of franchising specifies that a fee is “$500 or more in the first six months,” one way of avoiding this is simply to wait more than six months to collect any fees from your “non-franchisee.”
But while this may work in some cases, some state laws defining franchising differently can make this a treacherous path. Even if you are operating in a state that would allow fee deferral, the question you should ask is why you would want to go the fee-deferral route in the first place. When you establish a franchise, you will likely incur significant marketing and sales costs as well as additional support and training expenses, all without compensation for six months –simply to avoid the minor inconvenience of complying with franchise disclosure laws. And, of course, if your non-franchisee runs out of money, you are left holding the bag, having provided support at significant cost in the process.
Aside from fee deferral, other no-fee options are more rational and often appropriate for certain companies. These include dealerships, distributorships, agencies, independent sales representatives, and joint ventures. A joint venture, of course, involves bring in an equity partner to the business. And in the remainder of these cases, the parent company needs either to manufacture a product that will be sold at a wholesale price or needs to provide a service that will be sold by a third party.
In the end, no matter how you choose to expand your business, you have options. The choice really depends on your needs and long-term business goals. The important thing is to be sure that the business structure you choose will optimize your returns and allow you to reach your goals. No one should simply choose “to franchise” or “not to franchise.” Instead, they should determine the optimal business structure for their expansion and then determine what laws, if any, define that relationship. And who knows? Once you’ve explored these avenues, you may come to the conclusion that franchising is in the cards for you after all.
Mark Siebert is CEO of the leading franchise consulting firm iFranchise Group. Reach him at 708.957.2300 or email@example.com. His book is Franchise Your Business: The Guide to Employing the Greatest Growth Strategy Ever.