Setting up a franchise: which company will be the franchisor?

If you are developing an existing business into a franchise network, you need to decide early on which company will enter into contracts with future franchisees. Your existing business can take on this role; a separate company is not compulsory. However, the decision determines which entity must provide services, receives fees and needs to hold the necessary rights. Clarify this structure before offering franchise agreements.

1. Compare using the existing business with a separate franchise company

Start by taking stock, rather than choosing a new company name. Which entity currently runs the business? Who employs the experienced staff? Who owns the equipment, brand and training materials? Often, these resources do not all belong to the same person or company.

There are two main options for setting up the franchise:

• The existing business becomes the franchisor. The pilot operation, expertise and franchisee support remain within one entity. This can make internal coordination easier. However, the same business also takes on the obligations arising from both its own outlets and the franchise agreements.
• A separate franchise company becomes the franchisor. It signs the franchise agreements and organises services for the network. To do so, it needs its own resources or robust agreements with the existing operating company.

An additional company is therefore not automatically the better solution. It brings its own administration, accounting and contractual arrangements. However, it may make sense if different ownership arrangements are planned, or if you want to separate outlet operations from the development of the franchise network.

For each option, draw up a simple overview covering contracting parties, staff, rights, income, costs and liability risks. Then have the company law and tax implications reviewed. The key question is not simply how to set up the structure, but whether it will work in practice.

2. Understand legal forms and general obligations

Germany has no dedicated franchise law and no government franchise register. Neither the franchise network nor the franchise agreement requires franchise-specific registration or authorisation. This does not, however, exempt businesses from general incorporation, registration or trade licensing requirements.

Contractual relationships are governed in particular by the German Civil Code (BGB) and, where applicable, the German Commercial Code (HGB). Competition and trade mark law also apply, among other rules. Standard-form franchise agreements are additionally subject to scrutiny under the rules on standard terms and conditions in sections 305–310 BGB. Pre-contractual disclosure duties arise under general civil law principles, particularly the obligations created by pre-contractual dealings and the principle of good faith.

A GmbH (a German private limited company) or UG (a limited-liability entrepreneurial company) is also subject to the German Limited Liability Companies Act (GmbHG). A GmbH requires share capital of €25,000; a UG can, in principle, be formed with less. However, statutory minimum capital is no substitute for financial planning. A company must be able to fund training, support and other promised services, even if only a few franchisees are initially paying fees.

When forming a new company, particular attention must be paid to notarised incorporation and entry in the commercial register, as well as any applicable trade registration and transparency register obligations. Limited liability does not provide blanket personal protection: guarantees and potential directors’ liability must be assessed separately.

The German Franchise Association’s Code of Ethics must be distinguished from these statutory rules. It binds the association’s members and includes requirements relating to testing the concept, holding the right to use trade marks and other brand identifiers, and supporting franchisees. It is not a government authorisation process.

3. Allocate rights and services to the right company

A new franchise company cannot automatically use all the resources of the existing business simply because both have the same shareholder. They remain legally separate entities. Their operational relationship therefore needs to be expressly defined.

Check three points before signing the first franchise agreement:

1. Usage rights: Is the future franchisor entitled to use the brand, materials and other protected content itself, and to grant franchisees the necessary usage rights? Permission to use them itself does not necessarily include the right to let others do so.
2. Service delivery: Who will provide training, answer operational questions and update working materials? If staff from the existing business are involved, the collaboration needs a clear basis.
3. Availability: What happens if the relationship between the operating company and the franchise company ends, or ownership changes? Services promised to franchisees must not depend on informal favours that can be withdrawn at any time.

Record internal services, payments and responsibilities in writing. Also check whether existing contracts with software suppliers, agencies or other service providers permit the planned use by additional companies.

As a general rule, the company that has undertaken the contractual obligations remains responsible to franchisees. Simply pointing out that another group company performs the task is no substitute for reliable service arrangements.

4. Review the structure before approaching prospective franchisees

Finally, check that all documents consistently identify the relevant legal entity. The company name, legal form, registered office and authorised representatives should be consistent across the draft agreement, pre-contractual information and other business documents. Payment arrangements must also clearly match the agreed billing arrangements.

Pay particular attention to how experience is presented. If the existing business tested the concept but the franchise company has only just been formed, make that distinction clear. Do not describe the operating history as belonging to a company that did not exist at the time.

Also document which company provides disclosures to prospective franchisees and which will subsequently enter into the agreement. If the structure is changed later, replacing the contracting party is not merely a name correction: it requires a separate legal assessment.

Practical takeaway: Before launching the franchise, set out on one page who signs contracts, makes rights available, delivers services and receives fees. Only begin approaching prospective franchisees once this allocation is legally and commercially sound.