Chapter 1:

An Introduction To
Franchising
What is a franchise? What are common franchise
terms? What are the alternatives to franchising?
What are the advantages and disadvantages of owning a
franchise? What are the legal issues in franchising?

THE BUSINESS OF FRANCHISING

Franchising is perhaps one of the most widely misunderstood phenomena in American
business. Judging from coverage in the popular media, for every story of wild success –
every McDonald’s or Holiday Inn – there seems to be a story of a crashing failure, or even
outright thievery, all carried on under the banner of “franchising.”
Franchising is frequently, but erroneously, described as an “industry.” It has been
characterized both as the enemy of the American entrepreneur and as the “last, best hope”
of American small business to compete against integrated chain retailers.
Can franchising be all of these things? Is it any of them? The answer is “yes.” It has
been virtually all of these diverse things, in different times and at different places, and in
different manifestations. What franchising really represents is a powerful business tool to
distribute goods and services, and to expand a business. It can be a potent investment device
for franchisees.
This book provides an overview of franchising as a business tool and the limited public
regulation of franchising. It seeks to give the reader a starting point for understanding
franchising and evaluating franchise opportunities.

WHAT IS A FRANCHISE?
A franchise is the agreement or license between two legally independent parties which gives:

● a person or group of people (franchisee) the right to market a product or

service using the trademark or trade name of another business (franchisor)
 ● the franchisee the right to market a product
or service using the operating methods of the

franchisor

● the franchisee the obligation to pay the

franchisor fees for these rights

● the franchisor the obligation to provide

rights and support to franchisees

Franchising is where  a  person(franchisor)  who  has  developed  a  certain  way  of 

doing a business gives another(franchisee) the right  to  use  that  business  model  in exchange
for a fee. The business has built a certain reputation and has brand recognition.
In essence, a successful business is being replicated and run by entrepreneurs who are
called franchisees under the supervision, control and assisted  by  the  owner of the business

model, the franchisor.

IP ISSUES IN FRANCHISING
 ● Along with the right to use  the  business  model  the  franchisor  will  license  to the
franchisee the intellectual property  rights  and  know-how  associated  with that business
as well as provide initial and ongoing training and support.
● The intellectual property rights that are licensed in a franchising arrangement almost
always include trademarks, copyright and often include trade secrets, industrial designs
and patents - depending on the nature of the business.

One could say  that  franchising  is  a  special  type  of  licensing  arrangement  in  that it
involves  the  right  to  use  a  business  model  which  necessarily  includes  the right to use the 
intellectual  property  rights  integral  to  that  business  along  with support, training and
mentoring.

WANT ARE THE COMMON FRANCHISE TERMS? 

Business format franchise – this type of franchise includes not only a product, service
and trademark, but also the complete method to conduct the business itself, such as the
marketing plan and operations manuals.
Disclosure statement – also known as the UFOC, or Uniform Franchise Offering
Circular, the disclosure document provides information about the franchisor and franchise
system.
Franchise – a license that describes the relationship between the franchisor and
franchisee including use of trademarks, fees, support and control. 
Franchise agreement – the legal, written contract between the franchisor and franchisee
which tells each party what each is supposed to do. 
Franchisee – the person or company that gets the right from the franchisor to do business
under the franchisor’s trademark or trade name. 
Franchising – a method of business expansion characterized by a trademark license,
payment of fees, and significant assistance and/or control. 
Franchisor – the person or company that grants the franchisee the right to do business
under their trademark or trade name. 
Product distribution franchise – a franchise where the franchisee simply sells the
franchisor’s products without using the franchisor’s method of conducting business. 
Royalty – the regular payment made by the franchisee to the franchisor, usually based on
a percentage of the franchisee’s gross sales. 
Trademark – the franchisor’s identifying marks, brand name and logo that are licensed
to the franchisee. 
UFOC – the Uniform Franchise Offering Circular, UFOC, is one format for the
disclosure document which provides information about the franchisor and franchise system to the
prospective franchisee

CATEGORIES OF FRANCHISE
 1. Product or Distribution Franchise -
A product manufactured by the franchisor (or on his
behalf by another) is sold  to  a  franchisee  who  in
turn sells it to  the  consumer  under  the  trademark 
of the franchisor. Such a franchise  is  usually 
restricted to a particular geographical area and the
franchisee pays fees referred to  as  royalties  to  the 
franchisor for the right to do business under his
trademark
Product distribution franchises simply sell the franchisor’s products and are
supplier-dealer relationships. In product distribution franchising, the franchisor licenses
its trademark and logo to the franchisees but typically does not provide them with an
entire system for running their business. The industries where you most often find this
type of franchising are soft drink distributors, automobile dealers and gas stations.

Some familiar product distribution franchise

include: 
Pepsi
Exxon
Ford Motor Company

Although product distribution franchising represents the largest percentage of total retail
sales, most franchises available today are business format opportunities.

1. Manufacturing, Production or Processing Franchise

- The franchisor sells to the franchisee an essential
ingredient or provides some specific know-how,
which along with ongoing quality controls by the
franchisor, enabling the franchisee to
manufacture/product/ process the final product and
sell to the consumer.
Coca cola operates in many markets in this manner
supplying franchisees with the essential ingredient
 of Coca cola protected by a trade secret enabling
them to produce the final product.

1. Business format franchising – The owner

of a business (franchisor) licenses to another
(franchisee) the right to use the particular business
model including the intellectual property associated
with it, particularly the trademark. Business format
franchising is the most widely used form of
franchising.
Business format franchises, on the other hand, not only use a franchisor’s product, service
and trade-mark, but also the complete method to conduct the business itself, such as the
marketing plan and operations manuals. Business format franchises are the most common type of
franchise.

Four essential elements of business format franchising.

● The franchisor allows the franchisee to use under license its proprietary IP, principally its
trademarks but also its designs, patents, copyright and its confidential business
information.
The most important is usually the trademark on which the brand has been built and
it is that brand recognition that makes the franchised business attractive
● The franchisor controls the way the business is run and managed by the franchisee. 
● The franchisor provides training, mentoring and assistance to the franchisee. 
● The franchisee makes both initial and periodic payments to the franchisor

Some popular business format franchises

include:
 Restaurants Health & Beauty Maintenance/Cleaning Real Estate
KFC Merle Norman Jani-King International Century 21
McDonald’ Costmetic The ServiceMaster RE/MAX
s Pizza Studios Company International
Hut Taco Supercuts Merry Maids Coldwell Banker
Bell Jenny Craig Residential Affiliates
International Automotive Service
Retail Cost Cutters Meineke Discount Convenienc
Blockbuster Family Hair Mufflers e 7-Eleven
Video Radio Care AAMCO Transmissions FamilyMart
Shack Midas International
The Athlete’s Business Precision Auto Care
Foot GNC Services
Franchising Mail Education/Training
Boxes Dale Carnegie Training
Lodging Etc. H Barbizon School of
Choice Hotels &R Modeling
Bass Hotels/Holiday Block Berlitz International
Inn Marriott Hotels ACE America Cash Sylvan Learning Systems
Express
Kwik Kopy

METHOD OF EXPANSION
In addition to being a method of distribution, franchising is also used as a method of
expanding an existing business. In this sense, we are simply looking at franchising from a
different perspective: namely, that of a business seeking ways to expand the scale of activity in
which it is engaged.

Franchising used as a method of expansion is an alternative means of capital formation.

A business seeking to expand the scale of its operations needs growth capital. Traditional ways
of raising such capital include venture capital lenders, various forms of bank and commercial
financing, or public or private placement of securities through investment banking channels.
Franchising may be thought of as an alternative to these more traditional means of raising growth
capital. Using franchising, the business in effect appropriates to its enterprise the capital, as well
as the managerial talent and effort, of the franchisee. This is most commonly accomplished by
inducing franchisees to invest in additional retail outlets, usually in new geographic market
areas, but all in support of and customarily identified by the franchisor’s trademarks. The
franchisee, therefore, makes a significant capital contribution to the strengthening and expansion
of both the scale and the goodwill associated with the franchisor’s business enterprise and brand.
To be sure, capital formation through franchising entails some significant equity trade-
offs. This is discussed later in “Choosing Franchising as a Method of Distribution.”
Franchising as a method of expansion is especially attractive to a business seeking to
expand into foreign markets or markets that are geographically or culturally remote from the
franchisor. This would be every bit as true for a Minnesota-based company seeking to expand
into Texas or California as it would be for expansion into Canada or Europe, or for a foreign
business seeking an effective means of penetrating the U. S. market.
Finally, because of its inherent capital and managerial leverage, franchising is often
attractive as a means of expanding a business more rapidly than might otherwise be possible.
Rapid growth is a goal often cited by firms that elect to expand using franchising.
OTHER BUSINESS GOALS
Franchising sometimes is attractive to a business not as a primary business goal, but
as a means to other ends. In this mode, franchising can be a catalyst to the achievement of
other, more primary, business goals.
A company may find that for technological, regulatory, or other business reasons, it is
desirable for the manufacturer to attain a much higher level of presence or involvement in retail
operations involving its products or services than might otherwise be the case. The business,
nevertheless, cannot always afford or even desire to vertically integrate its distribution program
by owning the retail level of operation. For such companies, franchising can be an attractive
compromise. It provides many of the advantages of equity ownership of a retail operation but
avoids much of the capital cost and managerial responsibility that can be burdensome to
companies lacking unlimited capital.
One example of such a business would be a manufacturer of a high tech product who
determines that demonstration, sale, installation, and after-market customer support of its
products dictate a more “hands on” presence by the manufacturer than would be possible through
the use of unaffiliated, independent wholesalers and retailers. A second example is a company
selling products that have significant consumer safety or public regulatory implications. For
those reasons, the company might choose not to place its product in the hands of independent
and essentially uncontrolled retailers. In both cases, franchising offers an attractive middle
ground between merely selling the products to distributors or wholesalers for unconstrained,
unsupervised redistribution, or a vertically integrated, “company owned,” retailer network.

Types of franchising arrangements

a. Direct Franchise Agreement –  A  franchisor  may  enter  into  individual

franchise agreements with each territory or outlet. Here the franchisor has direct control
of his franchisees and a revenue flow that does not need to be shared        with others.
However, direct franchising may not be that suitable when the
outlets are in another country. Problems may include the
issues of repatriating revenue, tax implications as well as the
difficulties of dealing with the uniqueness of different
countries, including language, culture, laws, regulations and

business practices.
 b. Master Franchise Agreement - A  franchisor  may  enter  into  a  master  franchise
agreement whereby another entity  is  given  the  right  to  sub-franchise  the franchisor's
business concept within a given territory with a development timetable. These rights are
usually secured  by  an  initial  development  fee charged by the franchisor.

c. Development Agreement - A development agreements obliges a developer to open

multiple outlets in accordance with a development timetable. Vis-ā-vis the developer
and the outlets; rather it  involves franchising between the franchisor  and the developer.

WHAT ARE THE ALTERNATIVES TO FRANCHISING?

In addition to franchising, there are two other popular methods by which businesses
expand their market and distribution channels:
Distributors
hips
Licensing

In a distributorship, the distributor usually:

● has a contractual relationship with the supplier
● buys from the supplier in bulk and sells in smaller quantities
● is familiar with local markets and customers
● may do business with many companies, more than just the supplier/producer
● may not receive contractual support and training from the supplier/producer like a
franchisee
Some distribution arrangements are similar to franchises, and vice versa. A franchisee with a
great deal of leeway in how to run the business may look like an independent distributor. A
distributor may be subject to many controls by the supplier/producer and begin to resemble a
franchise.

Some popular distributorships include: Amway

Color Me Beautiful Cosmetics Mountain Life Spring Water Knorr Soup
Vendor
 Campbell’s Soup Vending Machines

Licensing, on the other hand, allows a licensee to pay for the rights to use a
particular trademark. Unlike franchises, in which the franchisor exerts significant control
over the franchisee’s operations, licensors are mainly interested in collecting royalties and
supervising the use of the license rather than influencing the operations of the business.
Check out www.licensing.org.

Some popular licensors include: 

Netscape Communications
 Apple Computer
Canon Inc. Woolmark
Compaq Computer

WHAT ARE THE ADVANTAGES AND DISADVANTAGES OF

OWNING A FRANCHISE?

The many advantages and disadvantages of owning a franchise should be carefully

evaluated before deciding to purchase one.

Advantages:
“Owning a franchise allows you to go into business for yourself, but not by
yourself.”

A franchise provides franchisees with a certain level of independence where they

can operate their business.

A franchise provides an established product or service which already enjoys

widespread brand- name recognition. This gives the franchisee the benefits of customer
awareness which would ordinarily take years to establish.

A franchise increases your chances of business success because you are associating
with proven products and methods.

Franchises may offer consumers the attraction of a certain level of quality and
consistency because it is mandated by the franchise agreement.

Franchises offer important pre-opening support:

● site selection
● design and construction
● financing (in some cases)
 ● training
● grand-opening program
●

Franchises offer ongoing support

● training
● national and regional advertising
● operating procedures and operational assistance
● ongoing supervision and management support
● increased spending power and access to bulk purchasing (in some
cases)

Disadvantages:
The franchisee is not completely independent. Franchisees are required to operate
their businesses according to the procedures and restrictions set forth by the franchisor in
the franchise agreement. These restrictions usually include the products or services which
can be offered, pricing and geographic territory. For some people, this is the most serious
disadvantage to becoming a franchisee.

In addition to the initial franchise fee, franchisees must pay ongoing royalties and
advertising fees.

Franchisees must be careful to balance restrictions and support provided by the

franchisor with their own ability to manage their business.

A damaged, system-wide image can result if other franchisees are performing

poorly or the franchisor runs into an unforeseen problem.

The term (duration) of a franchise agreement is usually limited and the franchisee
may have little or no say about the terms of a termination.

What are the laws regulating franchising? 

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transitionType=Default&contextData=(sc.Default)

There are no specific laws governing franchising in the Philippines. Franchise agreements
are regulated by the applicable provisions of the:
● Intellectual Property Code (IPC).
● Civil Code.
● Corporation Code.
 ● Relevant special laws.
IPC
Sections 87 and 88 of the IPC list prohibited and mandatory provisions of technology
transfer agreements, including franchise agreements. Failure to conform to these provisions (that
is, the inclusion of prohibited provisions or the exclusion of mandatory provisions in a franchise
agreement) will render the agreement unenforceable. Sections 87 and 88 of the IPC are intended
to prevent unfair competition and trade. The prohibited provisions are deemed prima facie to
have an adverse effect on competition and trade.
Civil Code
The Civil Code contains the general law on contracts and human relations. Franchise
agreements are considered to be ordinary contracts. Therefore, franchise agreements are subject
to the general provisions of the Civil Code governing obligations and contracts. For example,
when offering a franchise, a franchisor must observe honesty and good faith. Additionally, offers
are only deemed accepted if they are accepted unconditionally. Contracts between a franchisor
and franchisee are also subject to the rules on interpretation of contracts.
Actions for remedies for breach, damages or recovery relating to franchise agreements
are treated as regular civil actions.
Corporation Code
The Corporation Code sets out the requirements for registering a business in the
Philippines. Before it can conduct trade or business in the Philippines, a foreign corporation must
apply to the Securities and Exchange Commission (SEC) for a license to transact business in the
Philippines.
A foreign corporation that intends to conduct franchising operations in the Philippines
has the followings options:
● Enter into a franchising agreement with an existing local entity.
● Establish an entirely new corporation under Philippine laws.
● Register a branch office with the SEC.
The third option is only available to corporations from countries that provide reciprocal
treatment to Filipinos for doing business in their country.
Special laws
There are some special laws that affect franchising, such as:
● While foreign corporations are generally governed in the same manner as domestic
corporations, the Retail Trade and Liberalization Act prevents them from owning or
wholly owning a business below a certain amount of paid-up capital.
● The Foreign Investment Negative List and the Foreign Investments Act set out
restrictions and prohibitions on foreign investors in relation to the sectors they can invest
in and how much they can invest.
 ● The Philippine Competition Act prohibits:
● anti-competitive agreements; and
● one or more entities from abusing their dominant position by engaging in conduct
that would substantially prevent, restrict or lessen competition.
● The Data Privacy Act of 2012 protects individuals from unauthorized processing of
personal information by regulating the collection, recording, organization, storage,
updating or modification, retrieval, consultation, use, consolidation, blocking, erasure or
destruction of personal data.
 What is the regulatory authority responsible for enforcing franchising laws and
requirements in your jurisdiction? 
Technology transfer arrangements (TTAs) are primarily regulated by the Documentation,
Information, and Technology Transfer Bureau (DITTB), an agency under the Intellectual
Property Office of the Philippines (IPOPHL). The DITTB is responsible for reviewing all TTAs,
including franchise agreements, to determine their compliance with the requirements of the
Intellectual Property Code (IPC) before the TTA's recordal with the IPOPHL. The DITTB also
determines whether a particular TTA can be granted an exemption from any of the requirements
under the IPC.
On 21 July 2015, the Philippine Competition Act (PCA) was signed into law. The PCA
created the Philippine Competition Commission (PCC), which is tasked to promote and maintain
market competition by regulating anti-competitive conduct (that is, anti-competitive agreements,
abuses of dominant position and anti-competitive mergers and acquisitions). The PCA regulates
all entities, including franchisors and/or franchisees engaged in either:
● Trade, industry or commerce in the Philippines.
● International trade, industry or commerce having direct, substantial and reasonably
foreseeable effects in the Philippines, including those that result from acts done outside
the territory of the Philippines.
The Data Privacy Act of 2012 was signed into law on 15 August 2012, and its
Implementing Rules and Regulations (IRR) came into force on 9 September 2016. The Data
Privacy Act and the IRR created the National Privacy Commission (NPC) to administer and
implement the provisions of the Data Privacy Act. The NPC regulates acts or practices by
entities, including franchisors and/or franchisees, outside the Philippines if:
● The act, practice or processing relates to personal information about a Philippine citizen
or a resident.
● The entity has a link with the Philippines, and the entity is processing personal
information in the Philippines or even if the processing is outside the Philippines as long
as it is about Philippine citizens or residents such as, but not limited to, the following:
● a contract is entered in the Philippines;
● a juridical entity unincorporated in the Philippines but has central management
and control in the country;
 ● an entity that has a branch, agency, office or subsidiary in the Philippines and the
parent or affiliate of the Philippine entity has access to personal information and
the entity has other links in the Philippines such as carrying on business in the
Philippines and the personal information was collected or held by an entity in the
Philippines. 
Must the franchisor be registered with a professional or regulatory body before
setting up a franchise system? 
The law does not require the registration of franchisors with a professional or regulatory
body before setting up a franchise system. However, Bureau Order No. 10-24 Series of 2010
(Advisory on Due Diligence to be Undertaken by a Prospective Franchisee) advises potential
franchisees to require the franchisor to obtain a certificate of good standing from the Securities
and Exchange Commission, and a certificate stating that the franchisor is a member of any
franchisor association and has no pending cases against it.  
Do franchisees benefit from any laws designed to protect consumers or small
businesses? 
Republic Act No. 10644, known as the Go Negosyo Act, contains provisions that assist
micro, small and medium enterprises that seek to enter into technology transfer arrangements
(TTAs).
The Go Negosyo Act provides for the establishment of Negosyo centres in all provinces,
cities and municipalities in the Philippines. These Negosyo centres assist micro, small and
medium enterprises by facilitating business registration and renewal. They also help these
enterprises with entering into TTAs through their partnerships with the Philippine Franchise
Association and the Association of Filipino Franchisers.