So You Think You Want to Be a Franchisor? Feel the Need to Franchise Your Business?
I come from the Keep It Simple school of franchise law, and prefer to make franchising as uncomplicated as possible. But it is still not something you should jump into just because you think franchising is a fast way to grow or a great way to easy money. Simple doesn’t mean easy or cheap. Doing things right means taking the time to understand completely what franchising is about, what the choices are and how different choices have different legal consequences.
Here are some questions I often get from “tirekickers,” most of whom are not ready to franchise:
1. What type of legal entity do you recommend I form as my franchise company?
I don’t believe in getting overly complicated in forming a business entity. A sole owner, or 2 or 3 “partners” typically only require a limited liability company or corporation. Unless there are plans to go public or raise capital by offering equity in the company to multiple investors, it is more often a tax driven determination as to which form of entity better suits the owners. It is all based on the circumstances and the needs of the individuals involved.
For purposes of maintaining the shield of a legal entity, LLC or corporation, be sure to have proper legal documents prepared and then operate the company and maintain the company records as instructed by your attorney. Remember that doing it right helps protect the personal assets of the owners/officers of the company.
For purposes of franchising, it is unlikely to make any difference which entity you choose. It is possible that as more states look at taxing the royalties paid by its citizen franchisees that the form of entity might matter, but I doubt it.
2. Should I franchise my business?
I do not necessarily recommend franchising. It requires planning and legal documents that make the assistance of legal professionals essential. No do it yourself kit or non-lawyer will give you the advice and protections you need while ensuring that your franchise activities comply with all the federal and state laws involved. You must investigate and decide whether the legal constraints and benefits suit your business model and goals. You must also decide whether it is an acceptable way of doing business.
3. Is the Business Opportunity I Propose to Sell to Others Really a Franchise?
The FTC Franchise Rule is the overriding definition of a franchise on a national level. 16 CFR § 436.1 (h) of the Franchise Rule defines a franchise as the offer or sale of any business opportunity that meets 3 fairly simple elements.
Consider this – Does the business opportunity you propose to grant/sell to others meet these three elements as specified in the Federal Trade Commission’s Franchise Rule (see, https://www.law.cornell.edu/cfr/text/16/436.1):
Franchise means any continuing commercial relationship or arrangement, whatever it may be called, in which the terms of the offer or contract specify, or the franchise seller promises or represents, orally or in writing, that:
(1) The franchisee will obtain the right to operate a business that is identified or associated with the franchisor’s trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor’s trademark;
(2) The franchisor will exert or has authority to exert a significant degree of control over the franchisee’s method of operation, or provide significant assistance in the franchisee’s method of operation; and
(3) As a condition of obtaining or commencing operation of the franchise, the franchisee makes a required payment or commits to make a required payment to the franchisor or its affiliate.
If the relationship you envision falls within this definition, then what you propose is almost certainly a franchise by legal definition. Then the questions becomes, do you want to revise your business model to avoid being a franchise? This requires careful evaluation of what options you may have. Keep in mind that the definition of a franchise is just the start to your evaluation and there many considerations that vary from business to business.
4. What types of franchisors are there? What would be best for my company?
Franchising and franchise systems can be structured in an enormous variety of ways. Without understanding with more certainty the business and how the principals/owners/founders want to operate their franchise system, it is an impossible question to answer accurately. Some franchise advisers/consultants suggest multiple layers of franchise rights with goal of expanding nationally very quickly. However, those layers usually create unnecessarily complicated relationships. If there are any flaws in the business, the contract or the way the franchise system is structured, then “layered” franchises (such single unit/multiple unit/ area or master franchise area units) will magnify and enhance all of the legal liabilities and financial problems that result.
Picture the daily operation of your franchise company. What do you think you need to do to be prepared? If unsure, start looking for experienced professionals with experience in many types of franchising and business to get a clear picture of what your options may be.
5. Ok, I definitely want to franchise my business . How do I do that?
You must comply with the requirements of the Federal Trade Commission Franchise Rule with respect to all offers or sales of franchises anywhere in the United States. While some state statutes have their own requirements in addition to the FTC Rule delivery requirements), every franchisor must start by preparing certain legal documents according to the FTC Rule. Obviously, you need to have a contract drafted, the Franchise Agreement. The franchise agreement will define the rights and obligations of the franchisor and the franchisee. It basically creates a legal definition of your franchise system. You must also have a legal prospectus called a franchise disclosure document prepared to comply with the FTC Rule.
All franchisors must provide a franchise disclosure document (“FDD”) to all “prospective franchisee” no later than 14 calendar days before the prospective franchisee can sign any franchise or other agreement, such as a development agreement or option agreement, which imposes a binding, legal obligation on the prospective franchisee, or (b) the payment of any consideration for a franchise by the prospective franchisee. The FTC Rule also requires a franchisor to provide the prospective franchisee with any agreement to be executed (with all blanks filled in) at least seven business days prior to execution.
The legal documents cannot be created accurately or completely just from a template. You need legal advice and assistance from an experienced franchise attorney.
Got the message? You can’t do it yourself and you need to have a lawyer experienced in franchise to help you set up and launch your franchise program. You can get more information on FTC requirements here: http://business.ftc.gov/documents/franchise-rule-compliance-guide.