When you first investigate franchising opportunities there are many new terms that need an explanation. Tony Melhem, FCA deputy chairman, has picked some of the most common franchising terms to explain.

Franchisor and franchisee: the franchisor is the owner of a proven business model with systems, operations manuals and strong branding that you as a franchisee are considering buying into. The franchisee is the investor who is looking to buy into a proven system and brand and the person who will operate that specific business under a licence. A master franchisee is still a franchisee, however they are responsible for a large territory and can appoint other franchisees within that territory.

A franchisor will give a prospective franchisee a disclosure document outlining the franchisor’s business experience and litigation history, franchisee payments to the franchisor, and details of existing and past franchisees, of the supply of goods and services, of marketing or other cooperative funds, of the franchise site or territory and copies of any leases, sub-leases and other documents relating to the franchise.

The purpose of the disclosure document is to ensure prospective franchisees have a sufficient amount of accurate information to make a reasonably informed decision about whether to enter into a franchise agreement. The disclosure document must be supplied to a prospective franchisee, in accordance with the Franchising Code of Conduct.

The Franchising Code of Conduct is a mandatory Code that governs franchising in Australia and is designed to guide the behaviour of franchisors and provide certain protections to franchisees. It is administered through the Australian Competition and Consumer Commission (ACCC).

To operate the franchise/business under a licence you will need a franchise agreement, the contract between you and the franchisor. This explains the rights and responsibilities of both the franchisor and franchisee and sets out the ways in which the business will be operated. It provides the franchisee with the right to use the business name, includes financial terms as well as the length of the contract and effects of terminating the contract before that time.

The franchise agreement may also cover information about the franchise territory and whether or not multiple unit franchising (the ability to operate a number of franchises within the area) is acceptable. It is vital for a franchisee to obtain qualified and experienced legal advice before signing any franchise agreement.

The franchisee agreement will make reference to the term franchise fee. The franchise fee is a one time payment made by the franchisee to the franchisor for the right to operate a business under the name of the franchise. The fee can range from $10,000 to $100,000.

Royalties are the continuing payment to the franchisor for the right to operate the business and can be a flat fee or a percentage of sales or profit.

Franchisees are also required to contribute to the marketing fund or advertising levy. These funds will cover the franchise system’s advertising and promotional activities. This is usually calculated as a percentage of the franchisee’s net sales.

Local area marketing is marketing you as the franchisee are responsible for conducting in the franchise territory or designated marketing area. Local area marketing is generally paid for by the franchisee.

The operations manual is what you will be given once you become a franchisee and it covers general business procedures such as system standards, accounting, advertising, personnel, promotion, and maintenance. It spells out why a franchisor wants a franchisee to run their business in a certain way.

Finally the last term is due diligence: what every good potential franchisee is expected to conduct. It is a thorough examination of the franchise business before purchase.

Tony Melhem, FCA deputy chairman, chairman of national franchisee forum, founder of Coco Cubano (espresso, chocolate & cocktail bars) and award winning franchisee.