Franchise Terminology for Prospective Franchise Owners

In regard to franchising, there are a number of words and terms that are common but may not be understood by those who are looking at franchising for the first time. Below, we have compiled a listing of these terms as well as their associated explanations.

Acknowledgment of Receipt: The last page of an offering circular, signed to indicate you received the documents on a certain date.

Common Area Charges: Most commercial leases are triple net, the rent includes a number of expenses including proportional share of property taxes, building insurance and possibly utilities, water, sewer and garbage collection. In some locations such as shopping centers and strip malls there is an additional occupancy charge over and above the base rent relating to the public areas such as security, cleaning, air conditioning and heating, elevator maintenance, snow removal and so on. 

Disclosure Document: A document given to the Franchisee by the Franchisor, which includes all company information. Legislature has been passed in both Alberta and Ontario, making it mandatory for a company to provide a disclosure document. This document is the equivalent of the UFOC offered in the United States.

Dispute Resolution: Most franchise agreements written today include a provision for alternative dispute resolution methods because of the expense and delay involved in using the courts. Like some marriages, not all franchise relationships are compatible and disagreements do occur on occasion. The two most common methods of handling disputes are by arbitration and mediation.

Exclusive Territory: Where the franchised business is to be operated from a single location the franchisee may receive exclusivity solely to that site or to a market area usually a set distance surrounding the location. In a mobile service business the franchisee may be awarded a geographical territory large enough to ensure growth potential. A franchise system can be impaired by having too many franchisees in one market where there may not be enough business to support them, but on the other hand a cluster of units where they are not directly competing can take advantage of the synergy that is created by dominating the market, keeping out the competition and benefiting from joint marketing promotions.

Franchisee: A person who purchases through an initial investment and ongoing fees and royalties, the right to use the trademarks, and proven operating systems of a company, following the specific guidelines set up by that company.

Franchisor: A company, which grants a license to individuals to operate under the trademark and operating systems of the company.

Franchising: A method of doing business by which a company the Franchisor grants to a person the Franchisee the right to use the trade marks, proven operating system, the company's know-how, techniques and procedures in order to advertise and offer, sell or distribute the goods or services which the Franchisor is known for and who has developed a market awareness and customer acceptance.

Franchise Agreement: This is a legal contract and reflects the franchise program. There are a number of components in the agreement starting with an outline of the concept and the business being awarded to the franchisee, the terms, fees, the rights being granted including the license to use the trade mark, logo and other proprietary rights. The second part covers the responsibilities of the franchisor and next the obligations of the franchisee. As the franchisor is risking its name and reputation on the performance of each operator a large portion of the agreement covers a whole range of what if-s. What if the franchisee decides not to follow the proven system, does not pay its bills, wishes to retire and sell or is unable to operate the business due to a medical problem. Usually the agreement is non-negotiable except for items such as location or a unique situation pertaining to a specific market.

Franchise Fee: A one time initial or up-front fee paid by the Franchisee to the Franchisor for the right to operate a franchised business. These monies provide compensation to the company for the time, effort and costs in structuring the franchise concept, attracting and approving franchisees, training and assisting the successful applicants in establishing their franchised business.

FTC Rule 436: The law passed in 1979 that regulates the franchise industry. It set forth "disclosure" requirements and prohibited franchisors from making earnings claims.

Head Lease: Locations where the franchisor has leased the premises and then sublets to the franchisee. There are a number of reasons for this practice. Landlords prefer to have the company financially committed in exchange for leasing prime locations, possibly providing tenant inducements of some free rent or financial assistance towards the tenant improvements such as lighting, floor covering and washrooms. Many times the franchisor finds an ideal site and leases the space before a suitable franchise applicant has been found. A turnkey situation is where the premises are completely ready to open for business by the time the franchisee completes their training. If the head lease is not held and the franchisee negotiates the lease, the franchisor usually reserves the right to approve any lease, sub-lease or other tenant-landlord relationship, which is established.

Multiple Unit Franchising: The franchisor awards the right to a franchisee to operate more than one unit within a defined area based on an agreed upon development schedule. If the franchisor decides to expand into a new geographical area which may be a city or province and does have the resources or staff to handle this growth themselves, a Master Franchise, Sub-franchise or an Area Development agreement is structured with a party who will use their resources to develop the franchise network by granting unit franchises to others or establish their own outlets, provide the training and local ongoing support.

Non-competition Clause: Prevents the franchisee from entering a similar line of business not only during the term of the agreement and renewal terms, but also for a period of time after the agreement ends unless prior approval has been received from the franchisor.

Percentage Rent: A Lease may have a percentage rent fee clause, which means once a target sales figure has been reached, you will pay the landlord the greater of: the amount determined by calculating a percentage of your gross sales i.e.: 6%
the regular monthly rent amount.

Royalties: An ongoing fee paid to the company by the franchisee on a regular basis, usually calculated as a percentage of sales, but some types of franchises particularly in a service business may establish a set monthly fee. This fee compensates the franchisor for providing ongoing support, research & development, head office expenses and is the primary source of profit for the company. Therefore the franchisor has a reason to work with each franchisee to make their business as successful as possible as each party benefits.

Term: The agreement has an initial term, usually 5 years with the option to renew for additional terms by the franchisee upon certain conditions, such as having met all financial commitments, having operated the business within the framework of the franchise concept and has agreed to any upgrading of assets to meet then current standards. There may be a renewal fee at that time.

Trademark: A name, symbol, or other device identifying a product, officially registered and legally restricted to the use of the owner or manufacturer.

UFOC (Uniform Franchise Offering Circular): Provides background information in over 20 categories as well as a copy of the proposed franchise agreement. Also know as, the "Circular", "Offering Circular" and "Disclosure Document".

Working Capital: A major cause of business failure is not having enough cash in the bank, trade credit, borrowing capacity or cash flow to meet start-up expenses and see the business through any unusual dips and changes in its daily activity. Initially funds are needed to pay first and last months rent, utility deposits, licenses and any number of incidental costs. As it takes time to build up a new business the first months are usually loss months, which need to be financed.