Latest / Franchise Conversations with Fexingo: Buying, Running, and Scaling Franchise Businesses / Why Some Franchisees Are Franchising Their Own Locations
Transcript
- Lucas: I want to talk about something that's quietly reshaping how franchise systems grow. It's not a new brand concept or a tech tool — it's a structure. Some franchisees are now franchising their own locations. Luna: Wait — so the franchisee becomes a franchisor, but within the same brand? Lucas: Exactly. It's called sub-franchising. A successful franchisee — someone who already runs multiple profitable units — essentially licenses their operating playbook to another investor, who then opens a new unit under the same brand. The original franchisee collects a fee and a cut of royalties, while the sub-franchisee runs the day-to-day. Luna: So the brand's corporate office is okay with this? Doesn't that create a whole new layer of liability? Lucas: In most cases, yes — but only if the franchise agreement explicitly allows it. And more brands are starting to write these provisions in. I've been tracking this for a few years, and the number of sub-franchise agreements filed with the FTC has grown about 40 percent since 2022. The biggest driver? Labor costs. Luna: I can see that. If you're a franchisee with ten units, you're essentially a small business operator — hiring, training, dealing with turnover. Sub-franchising lets you offload some of that operational weight while still earning from new growth. Lucas: Right. And the economics are pretty compelling for the sub-franchisor — that's the original franchisee. They typically charge an upfront sub-franchise fee, say fifteen to thirty thousand dollars per unit, and then take a ongoing royalty override, usually one to two percent of gross sales. Meanwhile, the sub-franchisee gets a turnkey operating system and often shared back-office support. Luna: Is there a specific example you're thinking of? Lucas: One I've been following closely is a Jersey Mike's operator in Florida. He had twelve units, all performing well. In 2024, he sub-franchised to five new locations — he didn't finance them himself, didn't manage the buildout. He just provided his training manuals, his vendor relationships, and his district manager's time. He collected about a hundred and twenty-five thousand dollars in sub-franchise fees and now gets a royalty stream on those five stores. Luna: And the stores themselves — the sub-franchisees — how do they perform compared to company-operated or direct franchise units? Lucas: Early data suggests they're actually more efficient. A 2025 study from the Franchise Business Review found that sub-franchise units in quick-service restaurants had about 20 percent lower overhead in their first year, because the sub-franchisor's back-office systems were already proven. The sub-franchisees didn't have to reinvent the procurement process or the scheduling software. Luna: But there's a huge risk, right? Brand consistency. If a sub-franchisee messes up, the corporate brand gets blamed, not the sub-franchisor. Lucas: That's the central tension. The brand corporate office has to trust the sub-franchisor to enforce standards. And the sub-franchisor now has liability for the sub-franchisee's actions. Some brands require the sub-franchisor to personally guarantee the sub-franchisee's performance, which is a serious commitment. Luna: So it's not just passive income — it's a new layer of management responsibility. Lucas: Exactly. The sub-franchisor isn't just collecting checks. They're still on the hook for training, quality audits, and sometimes even rent guarantees. But for franchisees who've already built a strong system, it's a way to scale without taking on more debt or management bandwidth. Luna: It also changes the power dynamic. The corporate franchisor now has a powerful franchisee who controls multiple sub-franchisees. That franchisee has more leverage in negotiations. Lucas: That's a really sharp point. I've seen franchisee associations use sub-franchising as a bargaining chip. If a brand tries to raise royalties or change the product mix, a large sub-franchisor can say, 'My network of fifteen sub-franchisees might consider other brands.' That threat is real, and brands are starting to manage it by putting caps on how many sub-franchise units any one person can oversee. Luna: What about legal structure? The sub-franchise agreement — is it governed by the same FTC rules as a standard franchise? Lucas: It is, and that's where it gets tricky. The sub-franchisor has to provide a Franchise Disclosure Document to the sub-franchisee, just like the brand does. That means the sub-franchisor needs their own audited financials, their own disclosure history, their own legal counsel. It's not something a mom and pop operator can just jump into. Luna: So really, this is for sophisticated, well-capitalized franchisees. Lucas: Yeah. I'd say you need at least five high-performing units and a net worth north of two million dollars to even consider it. But for those who meet that bar, the returns can be significant. The Jersey Mike's sub-franchisor I mentioned — he's now getting a 15 percent return on his sub-franchise fees alone, not counting the royalty stream. Luna: What's the brand's perspective? Why would a corporate franchisor allow a franchisee to essentially become a mini-franchisor? Lucas: Speed and reduced capital risk. If the brand wants to open fifty new units but doesn't want to invest in real estate or training infrastructure, sub-franchising lets them tap into existing franchisee expertise. The brand still collects its royalty from the sub-franchisee — usually at the same rate — so they don't lose revenue. And the sub-franchisor handles the heavy lifting. Luna: It's like a franchise within a franchise. A tiered system. Lucas: Exactly. And some brands have formalized it. Checkers Drive-In Restaurants, for example, has a program where top franchisees can become 'area developers' with the right to sub-franchise within a defined territory. That's been around for a while, but now we're seeing it in smaller brands too — pizza chains, fitness concepts, even service brands like cleaning franchises. Luna: So where do you see this heading over the next few years? Lucas: I think we'll see more brands explicitly enabling sub-franchising in their agreements, but with tighter guardrails. Maybe requiring the sub-franchisor to have a certain number of years of experience, or limiting the number of sub-franchise units. And I expect the FTC to take a closer look — there's a question of whether sub-franchisees are getting adequate disclosure when the sub-franchisor might not be as transparent as the corporate brand. Luna: That's a good point. If you're investing three hundred thousand dollars into a sub-franchise, you want to know the sub-franchisor's track record, not just the brand's. Lucas: Right. And right now, the disclosure quality varies wildly. Some sub-franchisors have professional FDC documents; others basically copy-paste from the corporate FDC. That's a regulatory risk. Luna: It also makes me wonder — could this eventually lead to franchisees buying out weak corporate franchisors? If a sub-franchisor builds a strong network, why not just acquire the brand? Lucas: That's actually happening. We covered that in episode 18 — brands buying out their own franchisees. But the reverse is possible too. If a sub-franchisor controls forty percent of a brand's units, they could theoretically lead a buyout. I've heard of at least one case in the fast-casual space where a franchisee group is in talks to acquire the parent company. I can't name names yet, but it's real. Luna: Interesting. So sub-franchising might not just be a growth tool — it could be a precursor to ownership. Lucas: Exactly. And that changes the whole dynamic of franchising. It's no longer just franchisor and franchisee — it's a network of overlapping investor-operator relationships. Luna: You know, this kind of conversation is exactly why we keep this show ad-free. It gives us the freedom to dig into structures like sub-franchising without any sponsor pressure to keep it light. Lucas: That's a nice way to put it. And honestly, if these conversations have helped you think about your own franchise strategy, listener support is what keeps the show independent. If you've gotten value from episodes like this one, you can find us at buy me a coffee dot com slash fexingo. Luna: And it really does make a difference. A few coffees a month from listeners like you keep the research budget going and let us avoid ad breaks. Lucas: Alright, back to sub-franchising. One more angle I want to explore: the tax implications. When a sub-franchisor collects fees, that's ordinary income. But if they structure it as a management services agreement rather than a sub-franchise, the tax treatment can be different. Luna: So there's an incentive to call it something else. Lucas: Yeah, and the IRS is starting to pay attention. I've talked to franchise attorneys who say they're seeing more audits of sub-franchisors who try to classify fees as capital gains or pass-through income. If you're considering this model, you need a good tax advisor. Luna: Good advice. So what's the takeaway for a franchisee listening who's thinking, 'Should I try to become a sub-franchisor?' Lucas: First, check your franchise agreement. If it doesn't explicitly allow sub-franchising, assume it's prohibited. Second, build a track record of operational excellence — at least three to five years of consistent profitability. Third, get your legal and financial house in order before you approach any potential sub-franchisees. And fourth, talk to other sub-franchisors. There's a small but growing community of them, and they're surprisingly open about the pitfalls. Luna: And if the model keeps growing, we might see sub-franchising become a standard career path for top franchisees — somewhere between operator and investor. Lucas: Exactly. It's a new rung on the franchise ladder. And I think five years from now, we'll look back and see this as a major structural shift in how franchise systems scale.