Common Franchise Terms Explained Before you look into the benefits of opening your own franchise, it helps to know the terminology. We put together this cheat sheet of the most common -- and most important -- words you'll need to understand.

By Tracy Stapp Herold

entrepreneur daily
Shutterstock

Franchisee: An individual who purchases the right to operate a business under the franchisor's name and system.

Franchisor: The parent company that allows individuals to start and run a business using its trademarks, products and processes, usually for a fee.

Franchise fee: The initial fee paid to a franchisor to become a franchisee, outlined in Item 5 of the Franchise Disclosure Document (FDD). For some franchises, this is a flat, one-size-fits-all fee; for others, it varies based on territory size, experience or other factors. Many franchisors offer franchise-fee discounts for veterans, minorities or existing franchisees.

Franchise Disclosure Document: All franchisors are required by the U.S. Federal Trade Commission to provide this legal document to prospective franchisees. FDDs are updated annually and consist of 23 items, which explain the company history, the fees and costs, contractual obligations, unit data and more. Don't make a move without reviewing it.

Startup cost/initialinvestment: The total amount required to open the franchise, outlined in Item 7 of the FDD. This includes the franchise fee, along with other startup expenses such as real estate, equipment, supplies, business licenses and working capital.

Royalty fee: Most franchisors require franchisees to pay a fee on a regular basis (weekly, monthly or yearly). Usually, it's a percentage of sales; sometimes it's a flat fee. Some franchisors also require a separate royalty fee to cover advertising costs.

Franchise agreement: The written contract, included in the FDD, which outlines the responsibilities of both the franchisor and the franchisee.

Term of agreement: This spells out the length of time that your franchise agreement is valid--usually anywhere from five to 20 years. At the end of your term, if you are a franchisee in good standing, most franchisors will allow you to renew your agreement for a percentage of the current franchise fee.

Company-owned units: These are locations that are owned and run by the parent company (the franchisor), rather than by franchisees.

Conversion: Some franchisors offer entrepreneurs the opportunity to convert their existing independent business into a franchise.

Registration states: Fifteen states require franchisors to register their FDDs with a state agency before they are legally allowed to sell franchises within that state. Find a list at FTC.gov.

In-house financing: Financing offered by the franchisor to franchisees to help with expenses, which can include the initial franchise fee, startup costs, equipment and inventory as well as day-to-day expenses such as payroll.

Third-party financing: Financing provided by a source other than the franchisor. Many franchisors have relationships with banks or are registered with the SBA in order to expedite the loan process for their franchisees.

Absentee ownership: An option offered by some franchisors that allows a person to own a franchise without being actively involved in its day-to-day operations.

Master franchise: A master franchisee serves as a subfranchisor for a certain territory. Master franchisees can issue FDDs, sign up new franchisees, provide logistical support and receive a cut of the territory's royalties.

Area developer: An area developer agrees to open a certain number of franchise units in a large territory within a specified time period. They may open and operate the units themselves or recruit other franchisees to open them.

Tracy Stapp Herold

Entrepreneur Staff

Tracy Stapp Herold is the special projects editor at Entrepreneur magazine. She works on franchise and business opportunity stories and listings, including the annual Franchise 500.

Want to be an Entrepreneur Leadership Network contributor? Apply now to join.

Editor's Pick

Related Topics

Money & Finance

How to Know If Your Business Is Profitable This Very Second

It's important to periodically take stock of your business status, but don't wait until the end of the quarter or Tax Day to know. Too many decisions you need to make depend on your profitability. Here are things you should be doing regularly so that when you need to know where you stand, you know.

Social Media

With This LinkedIn Algorithm Change, Your Best Posts Could Reach New Readers for Years

It's one of many new features rolling out on the platform in 2024.

Travel

Save Big on Airfare with a Dollar Flight Club Subscription for Less Than $60

This discounted Dollar Flight Club subscription can turn dream trips into reality.

Living

The CEO of Catholic Prayer and Meditation App Hallow Says Founders Need to Be Part of Something Bigger Than Themselves

On this episode of "The CEO Series," learn about the soulful journey of Hallow's CEO and founder Alex Jones.

Leadership

Your Boss is Watching You. Here's Why Monitoring Workers is a Two-Edged Sword

Companies increasingly use technology to track and monitor their workers, but this doesn't always improve performance or morale. Employers can — and should — monitor their workers so everyone can benefit from the process.

Science & Technology

AI May Not Take Your Job, But Someone Using AI Likely Will — Here's Why.

Artificial intelligence is becoming ubiquitous across marketing and public relations agencies. These tools can increase productivity, but there are risks to consider.