Key Business and Franchise Terms Every Franchise Investor Should Know

If you are new to franchising and considering buying a franchise, it's important to become educated in basic business and franchise terminology to help you make a smart franchise investment decision. Here are key business and franchise terms every franchise investor should know.

Key franchise terms

Acknowledgement of receipt

This document states that you received the legal franchise documents on a certain date.

Advertising fee/fund

A fee or fund paid by franchisees for advertising and marketing expenditures. The fee usually is less then 3% of the franchisee's annual sales and is in addition to royalty fees.

Arbitration

An alternative to a lawsuit in which a neutral third party hears both sides to a dispute and renders a decision.

Area development rights

Optional right to develop multiple individual franchises in a specific geographic area.

Assets

Owned property that can be used for payment of debt.

Balloon payment

A final payment due at the end of a loan.

Bid letter

The initial letter sent to a borrower defining the terms of the transaction.

Business plan

A business plan is a detailed document that defines a business's development goals and plots how and where the resources needed to accomplish the objectives will be obtained and used.

Collateral

Assets used as security for a loan in the event of default.

Company owned

An outlet owned directly by the corporation.

DBA

DBA stands for "doing business as." For example, if the name of your corporation is XYZ Co., but is known to the public as ABC Co., your business would be classified as XYZ Co. d/b/a ABC Co.

Default

Failure to meet terms of an agreement.

Designated supplier

Exclusive suppliers of products and/or services used in the franchisee business.

Distributorship

A business authorized to sell the products or services of a parent company. This is usually a manufacturer/reseller relationship, not necessarily a franchise.

EBITDA

This stands for "Earnings Before Interest, Taxes, Depreciation and Amortization." It measures cash flow available to meet debt payments.

Earnings claims

Statements of sales, profit or other financial information made by the franchisor regarding their franchisees.

Exclusive territory

A specifically defined geographic area in which franchisees retain the sole right to operate.

Federal Trade Commission (FTC)

Federal agency regulating trade practices, commerce and franchises.

Franchise

A legal and commercial relationship between the owner of a trademark, service mark, trade name, or advertising symbol and an individual or group wishing to use that identification in a business.

Franchise agreement

The franchise contract.

Franchise Disclosure Document (FDD)

Provides background information in over 20 categories, as well as a copy of the proposed franchise agreement.

Franchisee

A franchise owner.

Franchise fee

The upfront fee you need to pay the franchisor to purchase a franchise concept.

Franchising

A method of conducting business in an industry that involves a franchisor (parent company) and franchisee (someone who pays for the right to sell the parent company's products and use their trademark/name).

Franchisor

The person or company that owns the right to manage/sell franchises.

FTC Franchise Rule

A federal regulation that requires franchisors to prepare an extensive disclosure document called the Franchise Disclosure Document (FDD) and to give a copy to any prospective franchise purchaser before he or she buys a franchise.

Initial investment

The upfront cash investment required to purchase and start a franchise business. Your total investment can vary depending on several factors.

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Master franchisee

A separate class of franchisees responsible for developing additional franchise locations within a designated geographic territory.

Master region

A specific geographic region purchased by a franchisee with the intent to divide and sell additional franchises.

Net cash flow

Shows how much cash is generated by the business after expenses, interest, and principal repayment on financing are paid.

Net worth

Total assets after liabilities.

Non-compete clause

Restrictions on competing with the franchised company during or upon termination of a franchise agreement.

Operations manual

Provided by the franchisor to the franchisee, contains all training, reference and business specifications required to operate the franchise business.

Pro forma

Complete projected financial picture of the franchisor including: balance sheet, profit and loss statement, assets, liabilities, net worth and/or cash flow statement.

Registration states

Many states require franchisors to file documentation before a franchise can be sold.

Renewal

The mechanism used to continue the term of the franchise agreement once it has expired.

Royalty

A percentage of gross sales or an ongoing fee that you pay to the franchisor monthly.

Spread

Difference between cost of funds and lending rate.

Total investment

This may include the initial investment plus any required inventory, advertising, or equipment purchases.

Working capital

The amount of liquid assets you are required to have and maintain to operate the franchise.