Every franchise model may be different, but each operates on similar principles. It’s important to understand the foundations of franchising before setting out to buy a franchise.

Franchising is a well-established practice which allows other individuals to profit from the success of the original concept. It’s doubtful that the man credited with setting up the first franchise, sewing machine distributor Isaac Singer, would have imagined his idea would achieve such a global presence nearly 100 years later.

So, what exactly is a franchise?

Franchising is a method of doing business that incorporates diverse business models across almost every conceivable industry. This can range from the traditional to the up-and-coming. It encompasses all kinds of industries from the high-profile food retail chains to studio gyms. It can range from lawn mowing to commercial cleaning; from early learning to aged care.

McDonald’s is probably the most famous business format franchise. It is a perfect example of a business that grew exponentially once Ray Krock introduced the systems and consistency that mark a solid franchise.

Can you explain the main difference between a franchise and another business?

A franchise has to have two main ingredients. The franchisor owns the rights to the brand and the operating systems while the franchisee, who buys the rights to operate under the brand and use the systems.

The franchisee usually signs up to run the business for a set period of time.

Both the franchisor and franchisee can be an individual or group of individuals.

6 vital points you need to know

1. A franchise is not a licence

While the franchisor is effectively licensing the rights to a third party, franchising is more stringent than a licence or distribution model.

2. Why businesses franchise

Franchisors are looking for franchisees to replicate the business they have established, and are likely to use the capital injection from new franchisees to help support the existing businesses and expand the network of franchisees.

3. What a franchisee buys

A franchisee is purchasing the rights to operate a business, and the details of compliance will be outlined in a franchise agreement. While the franchisee runs the business according to the rules, this is likely to be for a set term. There may then be the opportunity to renew the contract, or to exit from the business. On exiting, the franchisee has no further rights over the branded business. They will be expected to vacate any premises occupied under the franchise name.

4. How a franchisee makes money

There are two ways a franchisee can get a return on their investment. The first is to make enough money to put aside profits as the business is operating. The second way is to sell the business and get a big capital gain at the end.

Of course a good ROI is dependent on the purchase price of the business, ongoing costs and the final sale. Franchising offers no guarantees for profitability.

5. What are the fees?

The franchisor has taken the risk to trial a business concept and will put a cost on that. Franchisors charge franchisees to an initial fee for the business. Franchisees also pay ongoing royalty fees and marketing levies for the rights to operate and for head office support.

Regular fees are likely to be paid monthly. There are rules around marketing fees. These dictate the funds must be used to advertise and promote the brand. Franchisees can expect to pay for their own local area marketing.

6. The rules around franchising

Every franchise in Australia, whether it is headquartered here or is an overseas brand, comes under the jurisdiction of the Franchising Code of Conduct.

This code outlines important rights for the franchisee. It and sets out processes to deal with disputes, and renewing and ending a franchise agreement.

Do you want to read more about franchising basics? Read 5 pros and cons of franchising and 6 things to do before buying a franchise.

Check out the Franchise Handbook for more details.