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Why it pays to separate the franchise company from the mother company

Think of setting up a new company to better support your franchisees
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When looking for a franchise, you will likely come across some franchise companies that have two corporate names. You need not be confused or scared by this. While maintaining a separate company for company-owned outlets, some franchisers do incorporate their franchise system as a separate company. What should be more important to know is how the two entities differ from each other.

The franchise company (FC) primarily grants franchises and manages the franchise organization that provides support and on-going assistance to its franchisees, while the mother company (MC) is primarily involved in managing company-owned branches. The primary functions of the FC and the MC being considerably different, organizing them as separate entities obviously can greatly benefit both the franchise company and its various franchisees.

Simple structure
It can be reasonably assumed that before going into franchising, a company must have already operated several company-owned branches for a number of years. Therefore, a bigger organizational structure must have already evolved in the company to manage and operate these branches.

When a company starts to franchise, the organization needed to support a few franchised branches will be different from the bigger organizational structure supporting numerous company-owned branches. It is not difficult to imagine the difference between the structure needed to run, say, 45 company-owned outlets and 5 franchised stores.

Different competencies
Based on my many years of franchising experience, it is better to have a separate company--the FC--handling the franchise system. When there is only one company--the MC--the many tasks needed to support franchisees become an added and heavy burden to its employees.

In many cases, this results in unhappy franchisees because even with the MC's best efforts, company-owned branches will usually take precedence over franchised branches--a situation that can make some franchisees feel like they are second-class citizens. Even more problematic, the competencies required to support company-owned branches are considerably different from those required by franchised branches.

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In deciding whether to put up a separate franchising company, the mother company should not overlook the fact that motivation and persuasion rather than discipline are more critical to the success of its dealings with its franchisees. As business partners who own their own branches, franchisees obviously cannot be expected to accept the same form of discipline and procedures that the MC imposes on company-owned stores. The franchiser can at best only invoke the franchise agreement to get the franchisee to comply with the system, and then only as a last recourse. Indeed, the best key to the franchisee's compliance is persuasion.

Another advantage in having a separate entity and structure for the franchise system is that it will enable the franchiser to make a more purposive effort to hone the skills of its employees to better relate to and support its business partners. Imparting these skills may take some time, but the training and exposure can transform employees of franchise organizations into effective field support officers to the franchisees, who after all are the backbone of the franchise system's sustainability and growth.

Improved operational performance
When a separate franchise company is established, the operational efficiency of the franchise system is improved. This is because the operating parameters of company-owned branches are different from those of franchised stores. Company-owned stores need to carry out detailed operational analyses, from customer service all the way down to how a piece of equipment is cleaned.

Although the MC can also do this for its franchised stores, such analyses are better left for the franchisees to do themselves. Instead, the franchise company can best support its franchisees through field visits, quality assurance reports, meetings with franchisees, system-wide marketing, and assistance in local store marketing.

Streamlined  financial analysis
Franchising a business is obviously meant to expand it and generate additional revenues and profits. With this objective, having an FC will make it much easier for the franchiser to see if its financial goals are being achieved or not.

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Indeed, if there was only one company, the MC need to continually break down its sources of revenues, operating costs, and profit streams. However, if the franchiser has a separate financial statement for the MC and for the FC, the analysis for each could be done in isolation. The franchiser can then more easily spot the areas of nonperformance and address them right away.

It also has to be taken into account that action plans to remedy nonperformance will be very different for FCs and MCs. For instance, when operating costs get high, the MC can simply issue a memo to all managers and employees to abide by an action plan or risk paying the company back for unexplained costs. In contrast, when faced by the same problem, the best that the FC can do to with the franchisee is to motivate him or her to control costs, and recommend ways of achieving that goal.

Isolation of liabilities
Still another advantage of making the franchise company separate is that it allows for the liabilities of the FC to be isolated from those of the MC. This isolation of liabilities is, in fact, a very important business decision that must be made right when the MC starts franchising its business. In fact, an MC that keeps itself a single company when it goes into franchising runs the risk of total loss, for it would be assuming all the liabilities of both its company-owned branches and franchised branches. This is like putting all your eggs in one basket.

Tax-efficient approach
Finally, as the operational areas of the MC and the FC are distinct, so are their tax liabilities. The FC's basic revenue sources are franchise fees and royalties, which are subject to a final tax of 20 percent and a value-added tax (VAT). Another revenue source is the pre-operating services the FC provides to the MC; these, too, are subject to VAT and the expanded withholding tax (EWT).

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On the other hand, the MC's revenue sources are the sales of its company-owned branches, which are subject to VAT and corporate taxation. It would therefore be more efficient for a franchiser to have an FC distinct and separate from its MC.

Even with all these advantages of having a separate entity for franchising, however, the need for one often will not be felt at the onset of the franchising program. We always advise clients at GMB Franchise Developers that even before signing their first franchise agreement, it is best to put up a separate company to handle the management of the franchise organization.

We point out that although the franchise company often spends more than it earns during the initial stages of franchising, it usually becomes viable and revenue-generating after a year or two of operation. We then advise franchisers to decide based on the expected long-term results and not on the short-term ones.

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