What is Subfranchising?
Wherever you are on your franchising journey, you’re likely familiar with the traditional agreement between a franchisor and franchisee to operate one business. However, not all franchising agreements follow this same model. Sometimes, franchisors may allow another party to exercise powers which are typically reserved for themselves. This practice, known as subfranchising, grants the rights and responsibilities of the franchisor to a subfranchisor, or “master franchisee,” within a designated territory.
Unsurprisingly, becoming a master franchisee comes at a cost, as the right to sign up subfranchisees within a given territory requires a substantial up-front investment. After this initial fee, however, subfranchising benefits can be significant. Master franchisees may:
- offer and sell franchises,
- collect fees and royalties, and
- provide training and support services to franchises in their specific region
Therefore, when a franchise is sold within this area, franchisees sign an agreement with the master franchisee rather than the franchisor.
This may sound lucrative, but it’s important to keep in mind that master franchisees must forward a percentage of the fees and royalties they collect in their area upward in the franchise system. While it’s possible that the master franchisee may be able to retain a majority of the fees, the specific percentage that must be split with the system is usually dictated in the subfranchising agreement. You’ll want to pay close attention to the terms of this agreement when deciding if a subfranchising arrangement is right for you.
As the specific terms of this agreement will be decided by the franchisor, you’ll also want to keep in mind the requirements and subfranchising limitations set forth. This usually includes a quota of units to be open and operating within your designated territory, which often may be met by both opening your own units and licensing other franchises in the region. Other common objectives may include franchise agreements executed and units under construction. If you successfully meet and operate the number of franchises agreed upon, this quota may be revised by the franchisor, opening the door to further opportunity.
Not every franchising system offers subfranchising. Some organizations may dislike the loss of power associated with this type of agreement. Although master franchisees can help to expand the reach of a franchise, they can also exert greater influence on the franchise than individual franchise units, as master franchisees have more units under them and are therefore a larger source of revenue for the system.
It’s also important to keep in mind that there is substantial financial risk involved when becoming a master franchisee. For one, the up front investment required to be able to purchase subfranchising rights within a territory can be quite large, especially when considering that a dividend of future profits must be shared with the franchise system. The master franchisee is also responsible for the leasing arrangements of franchisees in the area. Additionally, if you are unable to meet the demands of your agreement, you may face fines from your franchisor. Finally, as the franchises in the territory sign their agreements with the master franchisee, this opens up the possibility for litigation from unhappy franchisees.
While there are significant risks and responsibilities involved, the rewards of subfranchising can be lucrative in the long run. In addition to receiving a portion of the initial fee for all new franchises in the area, the ongoing royalty payments may continue to come in for over 20 years! Ultimately, you will need to evaluate the limitations and benefits of subfrancising, as well as the specific terms set forth by the franchisor, to decide whether entering into a subfranchising agreement is right for you.
Franchise Financing Options
Recently I've received a few questions from our users about what their options are when it comes to financing their franchise. So I figured it might be a good idea to put together a quick post outlining some of the options out there for financing your new franchise.
How Do You Pay for a Franchise?
Whether you’re purchasing a whopper from Burger King or joining the Burger King franchise system, the old mantra holds true: there’s no such thing as a free lunch. When you first get started running a franchise you need to pay a fee to allow you to enter into that franchise. These fees are the largest fees that you will normally pay a franchisor and typically range between $5,000 and $1,000,000 depending on the franchise. The franchisor charges this fee as a way to recoup the costs of expanding the franchise and to continue to grow. From a franchisee perspective, this is a major outlay and can take a long time to make back, but is a necessary step. Aspiring business owners must understand how much capital is available to them so they can ascertain how much they can afford. The cash you have at your disposal is known as liquidity, and there are numerous ways to increase your liquidity above the balance in your bank account. As a result, many people don’t realize how much capital they actually can use for investments, like launching a franchise branch. We’ll run through some of those methods below.
What is an Area Representative?
The reason why anyone would choose being an Area Representative is that they are paid a certain portion of the initial franchise fee of each new franchisee they solicit as compensation. Aside from the sales commission the area representative may get paid by the franchisor a portion of the royalties received for servicing franchisees. In some cases, franchisors will pay the area representatives a portion of the fee received from new franchisees in the reps’ territory even though the area representative may have had nothing to do with the screening or recommending that particular franchisee. However, all these and other contingencies- such as compensation for furnishing many of the pre-opening and on-going services to the franchisee- should be covered in the area representation agreement.
