How to Structure a Franchise
- 1). Plan the franchise structure. The most practical method for structuring a franchise rests on the needs of the owner, number of locations and number of employees. No matter the tax/legal structure (e.g., S corporation, C corporation, limited liability company), the franchisees will be responsible for paying wages, unemployment insurance and federal and state taxes, and collecting withholdings for Medicare and Social Security.
- 2). Base the franchise structure on the franchise business model. The business model of a franchise is important to determining its structure. If the franchise is service based, perhaps an LLC would be the most beneficial. If the franchise is product based, an S-corp structure may be the most advantageous.
- 3). Implement the fee structure in the franchise. Franchisees pay fees to the franchisor for the right to do business under the moniker provided by the franchise. Franchise fees will be paid to the franchiser, so they directly affect whether the franchise should be structured as a proprietorship, corporation, or partnership.
The fee structure is crucial to the success of the franchise: too little and the franchisor absorbs too much cost; fees too high will put undue burden on the franchisee and locations will fail. The fee structure should be based on a reasonable percentage of the franchisee's sales and incorporate enough to contribute to the overall brand and marketing of the franchise; these will be detailed in the franchise agreement. - 4). Choose an LLC, S corporation or C corporation. An LLC provides the principal owners legal protection from the business's liabilities and has a pass-through tax structure (a system in which the business profits aren't taxed on a corporate level and are instead "passed through" directly to the owner to be reported on his personal tax filings. A C corporation requires a salary be paid to the owner, which in turn means taxing profits on a corporate level and then again on the owner's personal tax liabilities. Lastly, an S corporation also requires the owner to take a salary (which is taxed on his personal returns) and any additional profits are paid to the owners via dividends (which are exempt from employment taxes).