Franchising can be a great way to start your own business. But what makes the franchise model different from other business models? Let’s find out.
The popularity of franchising has grown massively in the UK in the last 20 years, according to the British Franchise Association (bfa). With over 48,600 franchises units, employing over 710,000 people, the future of franchising looks bright. The appeal of the franchise model can be attributed to the fact that both the franchisor and the franchisee benefit from the model’s success. This gives both parties the incentive to work together and make the business flourish. Here we take a look at how the franchise model differs from other business models that could be better suited to you.
What's the difference between franchising and other business models?
1. The franchise model
A franchise arrangement legally states that the owner of a business (the franchisor) permits a third party (the franchisee) to operate a business and distribute goods and/or services using their business’s name and systems in return for a fee. This franchise fee will take the form of an upfront payment or an ongoing payment based on the profit made - or a mix of the two.
When you buy a franchise unit, you’ll benefit from a proven business model and well-developed strategies that will help you make a profit from the get-go. In the UK, franchises must be able to demonstrate a defined method for trading and be considered a ‘business format franchise’, according to the British Franchise Association (BFA). A business owner who would like to become a franchisor must put their model to the test for at least a year, evaluating each activity, result, and challenge to ensure that it is ‘franchisable’. Franchisees can then benefit from the winning formula and profitability of the franchise.
There are costs involved with any new business venture, which can be problematic and stressful for entrepreneurs trying to get their company off the ground. This is where franchising can help.
Firstly, the franchisor might offer to pay the initial franchise fee on your behalf, which is then paid back in instalments over time. Secondly, because you’re buying a business with a proven franchise model rather than starting a totally new business, funding can be easier to obtain as you’re seen by lenders as less of a risk. Also, specialist franchise advisors are provided by many banks, offering franchisees the opportunity to seek expert advice on their financing options.
You will need to be prepared to pay a franchise fee, set-up costs, insurance and ongoing royalty fees. See our complete guide to franchise costs in the UK.
Depending on the size and type of your franchise business, you will probably need to pay one of the following: income tax, VAT, corporation tax, business rates and National Insurance (NI). The taxes you pay will depend on the franchise structure you choose and how you get paid.
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When you become a franchisee you sign a legally binding franchise agreement with a franchisor. Therefore, there are rules and procedures you will need to adhere to throughout your franchising journey and if you wanted to exit the franchise agreement, for example.
Franchisees must adhere to certain rules and regulations as set out by the franchisor in the franchise agreement. These can be restrictive for an entrepreneur who wants to run their business in their own way – if you want to develop your own business ideas and systems, setting up your own business from scratch might be a better option for you.
2. Sole trader
As a sole trader rather than a franchisee, you are the exclusive owner of your business. Therefore, you are entitled to keep all of the profits after tax is paid. You are however liable for all of the losses too.
When you’re a sole trader, raising finances isn’t too different from borrowing money for your own personal use. Your personal credit history will therefore be the focal point.
Many of your business expenses, including phone bills and business travels, will be tax-deductible.
You won’t normally get any of the tax benefits of running a profitable business or employing people. All business profits will be taxed as income.
You will need to prepare your annual accounts to include on your tax return that is submitted to HM Revenue & Customs (HMRC) each year. There isn’t much paperwork other than the annual tax return.
If someone sues your business or you face bankruptcy, your personal assets are at stake.
You will be working on your own and for yourself, but you can also employ staff if required.
However, if you crave stability, brand recognition and an established set of practices, franchising could offer you the benefits of starting a new business without the anxiety that independent start-ups can bring.
This is essentially an extension of being a sole trader. Multiple sole traders work together, register as self-employed and form a business partnership with shared liability between them.
As there are multiple partners, raising capital might be easier. All partners care about achieving the business goals so will help to raise finances. A partnership can therefore be a better idea when you need more capital to start off.
Partners need to submit their individual self-assessments to the HMRC. All of the shared profits will be taxed as income.
The liability is unlimited. This means that any business debt will be shared between all of the partners.
The business operations are shared between the partners. So, if you need to be absent for a period of time, one of the other partners can take over without too much disturbance. This isn’t the case with the sole trader business model.
4. Limited Liability Company (Ltd)
This is a private company where you are legally responsible for debts to the extent of the amount of capital that you invested. You need to become incorporated by registering with Companies House.
Your personal finances are protected because a limited company is deemed to be a separate entity to you as the director.
A registered company can leave you in a better position than a sole trader from a tax perspective. You will be taxed the same as your employees if you pay yourself a salary. Or, you might prefer to take dividends as your payment.
There is higher regulation as you are a full-fledged company with the Companies House. However, your business will benefit from more credibility.
5. Limited Liability Partnership (LLP)
LLPs are basically an extension of the partnership model. Again, it in involves forming a partnership between multiple business partners, but the liability is limited. You won’t be fully liable for the actions of other partners.
LLPs are a good choice when you need to raise multiple loans and if you intend on having multiple partners.
The tax burden falls on the individual partners. Each partner needs to register with HMRC as self-employed.
As there is limited liability, partners share the liability that is proportionate to the investment they made and the involvement they have. This can reduce your exposure to debt and other legal issues that may arise further down the line.
Because of LLPs’ ability to limit exposure to legal and financial liabilities, they work particularly well with high-risk consumer-facing sectors.
>> Read more:
Choosing the right business model for you
Now we’ve broken down the franchise model and some major business models in detail, you should have a better idea of what your current situation, future goals and financial capabilities are most suited to. If you have been reassured that the franchise model is for you, start your search in our UK franchise directory.
Becky Martin, Point Franchise ©