Multiple Franchising

A variety of terms have been used to describe the techniques in franchising
known and described below as area development, subfranchising, area representation,
and franchise brokerage. The most common of these terms are “multiple-unit
franchising,” “multiple franchising,” “multi-tier franchising,” and “master franchising.”
Close analysis of these terms indicates that perhaps the term “multiple-unit franchising”
is the most appropriate to describe all of these techniques. All of these are available when we talk about Franchise Philippines. The term “multiple-unit franchising” recognizes the common goal of these
techniques to establish relationships which provide for the opening of more than one unit.
“Multiple franchising” does so as well, but is less precise as it does not specify the item
to be multiplied. The term “multi-tier franchising” appears to provide an inadequate
description because it fails to recognize the distinction between ordinary franchiseefranchisor
relationships, which are two-tier in nature, and area development relationships
(described below), which are also two-tier in nature. The term “master franchising”
could be used to identify the techniques but may not be the best choice because it
describes neither the common goal of the techniques to establish multiple-units, nor the
structure of the relationships which are established. Thus, the term “multiple-unit
franchising” will be used to refer to the group of techniques identified above.

A. Overview

The common goals of multiple-unit franchising are to establish many units with
speed, to leverage both money and personnel by relying upon another person’s
resources, and to obtain a local presence. These goals recognize the following potential
advantages of multiple-unit franchising:
• Opportunity for extremely rapid development.
• Use of another person’s financial and human resources.
• Shared risk with another person.
• Opportunity to consult with another person who has certain shared interests.
• Added source of ideas.
• Potential for rapid cash flow from sale of multiple-unit franchise rights.
• Increased local credibility.
• Increased knowledge of local conditions.

• Added knowledge of local competition and ability to tailor programs to meet such
competition.
Multiple-unit franchising also has its disadvantages, including the following:
• Loss of control to another – potentially large and powerful – person.
• Potentially more difficult to manage and lead the other person.
• “Giving it all away” – a significant portion of the revenue may no longer flow to
the franchisor.
• Vicarious liability for acts by the other person.
• Potential limitations on the franchisor’s ability to enforce its franchise agreement,
especially where the franchisor is not a party to the agreement.
• Complexity of the required agreements and the interrelationship of several
required agreements.
• Complexity regarding the required content of disclosure documents and the
procedures for registration.
As a matter of caution, it should be noted that, while multiple-unit franchising is a
clear trend and a source of success for many franchisors, it is not recommended for all
franchisors. The reasons for this may relate to one or more of the disadvantages listed
above, to corporate goals or philosophies, to business exigencies, or to timing. Multipleunit
franchising may be appropriate for a franchisor at one point in its life cycle, but not
at another point. For most franchisors, for instance, it is recommended at an early stage
of development, in order to encourage initial growth at a rapid rate. A mature franchisor
who has utilized multiple-unit franchising, often regrets having granted rights which the
franchisor wishes it had retained. In such cases, in fact, franchisors sometimes attempt to
repurchase previously granted rights. Franchisors often will utilize a combination of
techniques, or a multiple-unit franchise technique in some territories but not in others.

B. Area Development

Area development is a technique whereby the franchisor grants to an entity (the
“area developer”) the right, and the area developer undertakes the obligation, to establish
and operate more than one unit within a specified territory. The area developer may pay
a development fee for the right to have territory set aside for its development and,
generally, must adhere to a schedule for development. Individual franchise agreements
ordinarily will have to be entered into for each unit to be developed, and a portion of the
development fee may be credited toward the initial franchise fee payable under each franchise agreement.
Under this technique, the area developer must have the financial and managerial
capability to develop multiple units itself. Ordinarily, subfranchising, as that term is used
below, is not permitted. The area development arrangement may be structured, however,
so that the area developer has the right, for example, to have the individual units owned
and financed by limited partnerships in which the area developer is the sole general
partner.
Area development has potential for rapid growth with shared risk. The pace of
growth may not be quite as rapid as the subfranchising and area representation techniques
described below, however, and will depend upon the financial and managerial resources
of the developer. If structured properly, area development can increase a franchisor’s
revenues through both initial development fees and increased franchise fees and royalties.
On the downside, area development has the potential to create large and powerful
counterparts who may demand concessions of both an economic and business nature. A
franchisor also risks “freezing” an area by misjudging the potential number of franchises
which can be established in that area. The required agreements can be complex, and the
disclosure implications significant.

C. Subfranchising

Subfranchising is a technique whereby a franchisor grants to another person (the
“subfranchisor”) the right, in a specific territory, to exercise powers normally reserved to
the franchisor. The subfranchisor may be an existing franchisee or, in some systems, a
person unrelated to the system. Some franchisors will require their subfranchisors to
operate at least one unit, while other franchisors will prohibit the subfranchisor from
engaging in such activities. The subfranchisor ordinarily has the right to offer and sell
franchises (sometimes subject to a schedule or quota), to sublicense the use of the
franchisor’s trademark, to collect franchise fees, and to provide certain services to
franchisees. Generally, the subfranchisor undertakes services of a regional or local
nature, while the franchisor assumes broader responsibilities such as national advertising
and annual conventions.
The subfranchisor signs a subfranchise agreement with the franchisor. The
subfranchisor also enters into franchise agreements with franchisees. The form of
franchise agreement is generally provided or approved by the franchisor, although in
some cases the subfranchisor has wide latitude as to the form of franchise agreement
which is used. The franchise agreements also may be signed by the franchisor, or the
franchisor may be a named third party beneficiary in such agreements.
A subfranchise agreement will delineate the portion of fees which will be retained
by the subfranchisor and the portion which will be paid to the franchisor. In some cases,
the subfranchisor may retain a majority of the fees. Also, in some cases, subfranchisors
are granted rights to purchase individual franchises – often at reduced fees.

Subfranchising has the potential for extremely rapid expansion. It also benefits
from most of the advantages listed above. It is in disfavor among many franchisors,
however, because it also suffers from most of the disadvantages listed above, especially
those related to loss of control (primarily due to the insertion of an additional and
independent entity between the franchisor and franchisee) and to registration and
disclosure complexities.

D. Area Representation

Recognizing some of the disadvantages of subfranchising, the concept of area
representation has developed. In an area representative arrangement, the so-called “area
rep” is given the right to solicit prospective franchisees, and to provide certain services to
existing franchisees, in a stated territory. Unlike the case in subfranchising, however, the
area rep has no right to contract with franchisees. All franchise agreements are entered
into directly between the franchisor and the franchisee. In this fashion, the franchisor
assumes all responsibilities to the franchisee, but delegates some of those responsibilities
to the area rep. For example, the area rep, in addition to soliciting for prospective
franchisees (which is, ordinarily, subject to a schedule or quota), might have
responsibilities for training franchisees, periodic inspections, local or regional
advertising, and periodic consultation.
As the franchise agreements are entered into directly between the franchisor and
the franchisee, the initial franchise fees and royalties are paid directly to the franchisor.
The franchisor might charge the area rep for the right to solicit and service within the
territory. In turn, the franchisor will pay the area rep a portion of the initial franchise fees
as compensation for soliciting prospective franchisees, and a portion of the royalties as
compensation for servicing franchisees.
The primary advantage of the area representative approach is that the franchisor
retains direct control over franchisees by contracting directly with them. While the
franchisor retains responsibility for servicing franchisees if the area rep can no longer (for
whatever reason) do so, this increased responsibility, when compared to subfranchising,
generally is viewed as a small price to pay for increased control. Another advantage of
the area representative approach is that, because the area rep is not contracting directly
with franchisees, less disclosure may be required concerning the area rep in the offering
circular furnished to prospective franchisees than would be the case with the subfranchise
approach discussed above. Also, depending upon whether the area rep pays for the
acquisition of area representative rights, the area rep may or may not be acquiring a
“franchise,” as that term is defined under the FTC Rule and state franchise laws, for
which registration is necessary and disclosure must be furnished.
Despite these advantages of the area representative approach, as compared to
subfranchising, the area representative approach is not without its costs. Some of the
disadvantages discussed above are common to the area representative approach,
including the potential to give away a significant portion of the revenue, vicarious

liability concerns, the complexity of agreements, and the complexity of
registration/disclosure issues. Thus, franchisors should not undertake the area
representative approach without adequate thought, analysis, and guidance.

E. Franchise Brokerage

Franchise brokerage is a technique in which the franchisor retains a third party
(the “franchise broker”) to solicit prospective franchisees on behalf of the franchisor. A
number of franchisors rely upon outside franchise brokers, wholly or partially, for the
sale of franchises. In addition, a subfranchisor and an area rep are likely to be franchise
brokers under both federal and state franchise laws.
Franchise brokerage can relieve a franchisor from many of the burdens of the
franchise sales process and increase the pace of franchise sales. However, franchise
brokerage also can result in loss of control over one of the most vital aspects of the
franchise relationship – the sales process. This is a point at which the franchisor’s
potential.

Source: Franchise.org