In this blogpost, Madhuri V Kashyap, Student of the Diploma in Entrepreneurship Administration and Business Laws by NUJS, writes about, criteria one needs to know before deciding the structure of business, what is meant by franchising, advantages of franchising a business and what is a master franchising agreement.
Globalization in the business sphere has increased more than ever, and with the advances in science and technology, it has never been easier to conduct cross-border transactions. India is a young, developing country and is hot for new businesses to come in and “set up shop”, as the saying goes. By 2025, India is touted to be the fifth largest consumer market in the world. The Indian middle class alone, at 300 million is comparable in size to the European Union markets. The current Government has a friendly and accommodating stance towards start-up businesses and those seeking to invest in India. India also has the added advantage of an enormous pool of skilled and unskilled labour available at very cost-effective rates to global businesses, as compared to what they might have to shell out in developed countries.
The first set of criteria to be looked at before providing structuring advice to a business that wants to expand in India would be the following
- The proposed type of business operations to be carried out in India
- The scale of the business, whether it would be a small scale, medium-sized or large-scale operation
- Estimation of the amount of time required
- Estimating the costs of expanding, and conducting business operations on a day-to-day basis
- Profit margins and profit, the dividend-sharing ratio of the business for the foreseeable future.
- Is the business grounded enough in its home country to survive going global
- Does the company have dedicated manpower and resources to cover overseas Sales and Marketing, as well as senior staffers for handling other operations
- How much control over management and decision making of the company’s operations do the clients wish to cede or retain, as the case may be
- Determining the size of the market for the product and adaptability of the business/product to suit the local needs of consumers.
In the present scenario, we have an entrepreneur from the Middle East seeking to expand business operations in India. Keeping in mind the aforementioned factors, there would be two ways that would be optimal for the Middle Eastern entrepreneur to expand his business.
Solution – Franchising the business
What is meant by Franchising?
Franchising is a licensing arrangement that enables a business entity to expand its operations, by providing other entrepreneurs the right to use the existent business’s products and/or services, its business model and any intellectual property in another location, for an initial and on-going licensing fee for a definitive period of time. There are usually two parties involved, known as the Franchisor and Franchisee.
“Globalisation and market liberalisation have fuelled brand awareness among the Indian masses making the importation of foreign brands to Indian shores an attractive business opportunity for local businessmen.” Many international brands like Britannia, Pizza Hut, Coca-Cola have entered the Indian business spheres by means of a franchising arrangement. Other international brands that have received a tremendous response in India include Papa John’s, Domino’s Pizza, Barista, TGI Friday’s, Taco Bell, L’Oreal, Maybelline and such other brands generally in the realm of the FMCG sector. This arrangement is particularly useful because Franchising offers plenty of advantages to international players in terms of ease of regulatory and tax compliances. As such, franchising is in its developing stages, so there are no legal sanctions per se those deal with franchising specifically. However, clauses in the Franchising License agreement are governed by the statutory stipulations contained in the Indian Contract Act, Competition Act, Foreign Exchange Management Act, Trademarks Act, Income Tax Act, The Consumer Protection Act and, the Arbitration and Conciliation Act.
Advantages of Franchising a business
- A business can be franchised at relatively lower costs of expansion and operation as opposed to setting up a private limited company. “The inherent risks usually associated with expansion are thereby reduced. The franchisor is able to exploit and market its business more effectively by increasing the number of its outlets far more rapidly than could otherwise be the case.”
- When an independent franchisee is in charge of the operations of the franchise, the degree of motivation and perseverance is higher, because he is the manager and owner of his franchise, thereby creating a personal stake in the profit margin.
- Franchises create a wider base for brand recognition, locally as well as globally.
- The Franchisor’s personal involvement is reduced to the extent that the day to day responsibilities are taken care of, by the Franchisee while the Franchisor is free to concentrate on other aspects of his business.
- The Franchisor’s expansion costs are reduced because the Franchisee brings his own working capital, resources as well as initial and on-going franchising fees to the transaction.
- The Franchisor has a regular source of income as the Franchisee is expected to pay him a previously agreed upon share of the profits, royalties, licensing fees (both initial and on-going) for the time period, as agreed upon in the Licensing Agreement between the two parties.
- Developing networks with franchisees can be mutually beneficial to the franchisor too because this can act as a great tool for collective bargaining and enable product-based franchisors to negotiate extremely favourable prices.
What type of franchising agreement would be best in the instant case?
If the entrepreneur from the Middle East has a goods-based or distribution-based business, then it would be best to go in for the Product or Distribution Franchise agreement. Some popular examples of conglomerates that opted for this model include Exxon, Ford and other automotive enterprises.
If the business model is one where the franchisor is required to sell/lease the usage rights of specific know-how, which along with an essential ingredient or a secret formula and quality control processes is instrumental in the manufacturing of the final product then the entrepreneur would be advised to go in for the Manufacturing, Producing or Processing Franchise. Examples of companies that operate under this kind of licensing include Pepsi, Coca-Cola that provide the knowledge of their secret recipe/ingredient to their franchisees exclusively, subject to stringent sanctions in case of any breach by the franchisee, regarding disclosure of the same. This kind of franchise agreement usually has a water tight Non-Disclosure clause as leaks could potentially cause massive damages to the franchisor.
If the business model is one where the franchisor grants full rights to the franchisee to use the business model as well as intellectual property rights, then the entrepreneur may go for the Business Format Franchising Agreement. Exclusive luxury hotels like the Holiday Inn, the Hilton chain of hotels have gone in for this kind of franchising agreement.
What is a master franchising agreement
Based on the degree of control desired by the Middle Eastern entrepreneur over his franchise, he may be advised to go for a Master Franchising Agreement. That means, drawing up a Franchising Agreement in a manner to sub-franchise the powers and responsibilities of the franchisor, to the franchisee in a particular area for a certain amount of time, previously agreed upon. The only disadvantage here would be the loss of flexibility and direct control over the sub-franchisee as the franchisor and franchisee would have virtually no interaction on a regular basis. The Middle Eastern franchisor would be required to form a subsidiary in India that can act in the capacity of the franchisor locally. The subsidiary of the franchisor in India and the local franchisee form a joint venture for the purpose of expanding the Middle Eastern business into India as well. While expanding the business internationally, the entrepreneur must keep in mind that the protections afforded to the intellectual property rights are territorial, and every attempt must be made to secure their intellectual property as per lex loci.
All that the entrepreneur needs to do is register with the Ministry of Corporate Affairs, India and fill out the requisite forms given on the website for the creation of a subsidiary to act as the sub-franchisor between the franchisee and the global franchisor. “Any Foreign LLP can establish its place of business in India by filling Form 27 (Registration of particulars by Foreign Limited Liability Partnership (FLLP)). The eForm has to be digitally signed by authorized representative of the FLLP. There is no mandatory requirement to apply and obtain DPIN or DIN for Designated Partners of FLLP, but the DSC of the authorized representative is mandatory. Form 25 is required to be filed with Registrar to reserve the name of foreign LLP or foreign company for a period of three years.” Additionally, the franchisor has to provide the details of ownership documents, the audited financial statements, a list of franchise owners in other countries (if any), and any other relevant material to be filed with the Ministry of Corporate Affairs. India does not have a specific statutory requirement for the disclosure of material information to the franchisee, unlike in many other countries. However, the Middle Eastern entrepreneur would be advised to register his company’s existing intellectual property documents with the Registrar of Trade Marks using the filing form, TM-28. This would ensure that the intellectual property of the Middle Eastern franchisor would be protected under the laws of his country, as well as the Indian intellectual property laws. Thus, this would be the most cost-effective way of expansion of the Middle Eastern business into India. It is this model that has made it possible for over 115 businesses from the Middle East to actively expand their business operations to India.