As a huge corporation having thousands of locations around the world, imagine how complicated it would be to personally vet and recruit franchisees. This is why big companies, such as McDonald’s, subfranchise their businesses and rely on master franchisees that manage multiple locations on their behalf within a determined region.
Key takeaways:
In a subfranchise, also called a master franchise, a main franchisor, and a master franchisee enter an agreement in which the latter has the right to sell and control multiple locations within a specific geographical area.
What is a subfranchise?
A subfranchise is an agreement in which a franchisor grants another entity, called the master franchisee, the right to sell and control multiple locations in a designated area. In a master franchise, the franchisor allows the use of the corporation’s intellectual property for the master franchisee to recruit other individual franchisees and collect their fees and royalties, while sharing them with the main franchisor.
The roles and responsibilities of the parties that conform to this arrangement are described in the master franchise agreement.
To expand internationally, subfranchises are used to enter large new markets to which franchisors are unfamiliar. The primary franchisor can quickly scale its brand without getting involved in the management of the units in that foreign territory.
How do master franchises work?
With a subfranchise, a master franchisee will typically agree to open at least one unit in the stated region. Master franchisees will make the pertinent adaptations to the system according to the requirements of the new market. Under the master franchise agreement, they will follow a development schedule and recruit a determined number of individual franchisees, train and support them.
Here are the key components of a subfranchise:
- Franchisor: Is the original owner. They are in control of the master franchisees and collect their fees and royalties.
Creates a replicable business model
Gives the master franchisees the right to use their intellectual property
Provides the master franchisee with the knowledge, training, and assistance required to operate the franchise, as well as manuals and a list of the necessary materials to open the unit
- Master franchisee: They are contracted by the franchisor to provide services in a specified territory. The master franchisee will recruit, control, and support the individual franchisees, collect their fees and royalties, and forward a percentage to the original franchisor.
Benefit from using the franchisor’s trademarks and intellectual property
Control the units within the established territory and ensure they abide by the franchisor’s guidelines, standards, and procedures
Sell franchises, train, and provide support to franchisees
Collect franchisees’ royalties and fees and send the stipulated percentage to the franchisor
- Master franchisee agreement
The MFA regulates the relationship between the franchisor and the master franchisee. This contract establishes the roles and responsibilities of each of the parties, - Fees and royalties: Fees refer to the investment a franchisee must contribute to be part of the system and have rights over the intellectual property of the brand. Usually, royalties, or ongoing payments, are divided 50/50 with the franchisor.
- Territory: Defines the area where the master franchisee will have exclusive rights to operate
- Training and support: Master franchisees are committed to training and assisting individual franchisees at their charge.
- Reporting and compliance: Typically, a master franchisee will be required to open a quota of units, which has to be reported to the franchisor.
Another key responsibility of the master franchisee is informing franchisors about the performance of the units within the territory. They must also ensure every location is following uniform procedures and standards.
Advantages and disadvantages of a subfranchise
Before deciding to make such a hefty investment, find out if franchising is a good idea for you and your business model. Here are the pros and cons of a subfranchise.
For franchisors
Advantages
Quick expansion: With a subfranchise, a business can quickly diversify into new markets and expand internationally.
Overcome language and culture barriers: A franchisor can omit the process of understanding a new culture by delegating that responsibility to a master franchisee. Someone who has conducted business in a specific region for a considerable time will understand the implications of the business in that region.
Reduce costs: With the support of a master franchisee, a franchisor will not go through the burden of investing in the development of infrastructure overseas and training franchisees.
Disadvantages
Compromising quality: A franchisor will be required to define strict procedures and constantly monitor the franchisees\’ efficiency to ensure they meet the brand’s quality standards, or else risk delivering a deficient service and damaging the corporation’s reputation.
Cash flow division: The franchisor will have to share a significant amount of revenue with the master franchisees
Loss of control: Individual franchisees will be commanded by the master franchisee, for a franchisor needs to ensure their vision and the master franchisee’s are aligned, and that the latter can communicate it to the individual franchisees effectively.
For franchisees
Advantages
Proven business model: The master franchisee will have access to a proven business model and support from the franchisor.
Exclusive territory: Master Franchisees are granted a determined territory in which they will not have to compete against each other in the same area
New profits: For each franchisee that you recruit, you will get a percentage of the initial fee and royalties, in addition to the revenue you generate with your own franchise.
Disadvantages
High costs: Being a master franchisee requires investing significant capital, not only to cover the initial fee but to introduce the brand into a new country or region.
Risks: Since the business will be introduced into a completely new market, the chances of its failure a higher. A master franchisee must conduct thorough market research to ensure the brand will be well accepted in this new location.
Legal disputes: A master franchising agreement is a complex contract that needs to clearly define each’s roles and responsibilities. It’s common for ordinary franchise businesses to have disputes, so additional cultural barriers can increase the risk of litigation for both parties.
Master franchise vs Area development agreement
An area development agreement is similar to a master franchise in which both franchise types are required to open branches in a defined territory. However, the main difference between a master franchise agreement (subfranchise) and an area development agreement is that master franchisees have the authority to sell the franchise business to other entities in their territory while area developers are obligated to open and operate multiple units in their territory directly.
Differences between a subfranchise and other types of franchises
Single-unit franchise (traditional franchise)
It’s the most common type of franchise. In this business model, a franchisor grants intellectual property rights to a franchisee, and the latter opens and operates one location in exchange for a fee and ongoing royalties. The franchisee needs to invest their own money to establish the business, while the franchisor will assist with training, management, and other aspects of running the business.
Multi-unit franchise
A franchisor allows a multi-unit franchisee to establish a determined number of locations at a defined period without restrictions of territory.
Area development franchise
Similar to a multi-unit franchise, an area developer has the right and obligation to open a specific number of branches in a certain amount of time, but within a determined area. With territorial exclusivity, this type of franchise agreement allows the area developers to own all the franchise units inside the area and have better control of the branches.
Area development agreements are often used locally, rather than in entire regions or a country.
Whether you\’re looking to scale your business or take a franchising opportunity, you should clearly define your business goals and carefully analyze the benefits and risks the investment entails. For both sides of the transaction, having a business attorney is key to being able to understand the legal and financial implications of your deal.
Motiva Business Law’s franchise attorneys will assess your situation, provide counsel during the franchising process, and write, review, and negotiate the required legal documents to ensure you enter that business venture with the highest benefits at the minimum risk.