Must Know Franchise Terms

Before you investigate opening a franchise, you’ll need to know the lingo. We put together this cheat sheet of the most common — and most important — industry terms.

Franchisee: An individual who purchases the right to operate a business under the franchisor’s name and system.

Franchisor: The parent company that allows individuals to start and run a business using its trademarks, products and processes, usually for a fee.

Franchise fee: The initial fee paid to a franchisor to become a franchisee, outlined in Item 5 of the Franchise Disclosure Document (FDD). For some franchises, this is a flat, one-size-fits-all fee; for others, it varies based on territory size, experience or other factors. Many franchisors offer franchise fee discounts for veterans, minorities or existing franchisees.

Startup cost/initial investment: The total amount required to open the franchise, outlined in Item 7 of the FDD. This includes the franchise fee, along with other startup expenses such as real estate, equipment, supplies, business licenses and working capital.

Royalty fee: Most franchisors require franchisees to pay a fee on a regular basis (weekly, monthly or yearly). Usually, it’s a percentage of sales; sometimes it’s a flat fee. Some franchisors also require a separate royalty fee to cover advertising costs.

Franchise agreement: The written contract, included in the FDD, which outlines the responsibilities of both the franchisor and the franchisee.

Term of agreement: This spells out the length of time that your franchise agreement is valid–usually anywhere from five to 20 years. At the end of your term, if you are a franchisee in good standing, most franchisors will allow you to renew your agreement for a percentage of the then-current franchise fee.

Company-owned units: These are locations that are owned and run by the parent company (the franchisor), rather than by franchisees.

Conversion: Some franchisors offer entrepreneurs the opportunity to convert their existing independent business into a franchise.

In-house financing: Financing offered by the franchisor to franchisees to help with expenses, which can include the initial franchise fee, startup costs, equipment and inventory as well as day-to-day expenses such as payroll.

Third-party financing: Financing provided by a source other than the franchisor. Many franchisors have relationships with banks or are registered with the SBA in order to expedite the loan process for their franchisees.

Absentee ownership: An option offered by some franchisors that allows a person to own a franchise without being actively involved in its day-to-day operations.

Master franchise: A master franchisee serves as a subfranchisor for a certain territory. Master franchisees can issue FDDs, sign up new franchisees, provide logistical support and receive a cut of the territory’s royalties.

Area developer: An area developer agrees to open a certain number of franchise units in a large territory within a specified time period. They may open and operate the units themselves or recruit other franchisees to open them.