The down side of franchising is the unpleasant way franchise relationships can end.   When buying a franchise, typically neither the franchisor’s representative nor the prospective franchisee look at how the relationship might terminate—voluntarily or not.  It is all about the positives and the prospect of independence as a business owner.

Depending on the particular franchise system, the philosophy of management and the goals of the franchisee, it is possible to avoid some of the worst consequences by planning an exit strategy and negotiating critical terms.  Then it’s all about the boilerplate. That boring part of the contract near the end where all the bad things that can happen to a franchisee are listed. [After all, it is inevitably one sided since the franchisor writes and so controls the contractual consequences.] Often there are unpleasant surprises for the franchisee lurking as the franchise relationship unravels.

Even when a franchise business is profitable, things can go wrong.  So finding the “best franchise” is no guarantee of success.  When things go wrong, everyone starts pointing fingers.  The big challenge is to keep communications open if possible.  When franchisors and franchisees stop communicating, both are left to find a solution in the franchise agreement.   Promises and good intentions won’t matter.  When the ship is sinking, that one big happy family becomes “sauve qui peut” [every one for him or her self].

How are your problem solving skills? There will be no easy answers, so think ahead.

Whether buying or selling, there are two schools of thought:  1.  Being a franchise is good; or 2.  Being a franchise is bad.

Why good?  It has become a more understood method of expansion.  It is true, you can grow a business using other people’s money.  You can buy a “proven” concept with support and know how—if you do your homework and apply critical judgment.   There is a network of common experiences, a community of entrepreneurs with the same focus and desire. There’s an income stream for the franchisor that grows with the success and the expansion of the system.  There is strength in numbers in building a brand.

Why bad?  There are federal and state laws that regulate the sale of franchises—think selling securities—so it’s expensive to put a franchise program together and comply with the law.  Sorry, but there’s no way around paying some real $$$ to get real documents that fit the business model, make sense for the short term and long term plans of the franchise company  AND  actually fully comply with state and federal laws.  Some entrepreneurs practice denial  — “it’s just a trademark license”, “it’s just a business opportunity.”  Then they take shortcuts that shortchange the buyers of the opportunity of the information and protections to which they are entitled.

Well, it is what it is.  If the business model doesn’t fit the overriding FTC definition of a franchise, then at least one legal process and set of documents won’t be needed.  Any time someone is taking money for giving another a right or opportunity to start into a business, there are other potential legal issues — but that’s a different discussion.

But is it a franchise?  Judge for yourself.  The rule is not hard to read.

16 CFR § 436.1  [aka “The FTC Franchise Rule”]  Definitions.

h)        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.

Authority:   15 U.S.C. 41-58. Source:   72 FR 15544, Mar. 30, 2007.

This is really a simple three part test, and if each of the three parts is satisfied, then you are looking at a franchise with all its rights and legal obligations.

Following was originally posted on the Dallas Bar Association site.

by Kat Tidd

A franchise is not a magic word, it is a legal definition:

1. license a trademark or permit substantial association with the trademark or trade name;
2. accept payment of consideration; and
3. provide significant assistance, control or other forms of ongoing support or a continuing relationship.

If that definition is met, then the franchisor has certain obligations concerning the timing and manner of offering and selling a franchise, and the use of a Franchise Disclosure Document.

Keep in mind that a franchise is essentially a specialized form of business opportunity, with the additional element of a trademark or trade name license. And, generally, a franchisee has no special rights except those that the franchisor grants by contract or those accruing through reasonable reliance on franchisor promises. In some states, there are specific statutes that regulate relationships and/or termination, like Arkansas, New Jersey (Franchise Practices Act) and Wisconsin (Fair Dealership Law).

Pricing

While many antitrustissues have fallen into disfavor, pricing controls traditionally unquestioned as per se unlawful price-fixing practices were rehabilitated by the Supreme Court in Leegin Creative Leather Products Inc. v. PSKS, Inc., 127 S. Ct. 2705 (2007).

Since Leegin’s holding that vertical price restraints are to be evaluated under the rule of reason, Pandora’s Box has opened. Leegin offers franchisors some comfort in their ability to dictate at least the parameters of a franchisee’s pricing as a reasonable resale price maintenance program. Any challenge will now be scrutinized under a rule of reason analysis that calls for establishing several ambiguous and difficult-to-define factors (e.g., such as what is the relevant product market). This may make plaintiff’s counsel more reluctant to challenge such practices.

Several states, however–Illinois, Michigan and California among them–have reacted negatively to Leegin and maintain that minimum resale price maintenance is still per se illegal. And with less certainty, friction seems inevitable.

Encroachment

Disputes over the proximity of competing franchisees, solicitation and diversion of customers, and sales of product within a franchisee’s trade area or exclusive territory are being litigated with more frequency. Some states like Iowa have passed protective legislation.

Franchisors have reacted by broadening the reservations of the rights to encompass everything not specifically granted to the franchisee.

With such clauses in place, more franchisors are exercising their contractual right to place franchises closer together and to sell products and services directly by “alternative distribution channels,” e.g. Internet sales and discount membership chains like Costco. Where the franchisor diverts–real or perceived–business and customers that would otherwise go to a franchisee, disputes and litigation ensue.

Duty or Implied Covenant of Good Faith and Fair Dealing

In franchising, this is typically asserted by a franchisee. Numerous states recognize this duty or implied covenant–sometimes by statute and sometimes by common law–including Oklahoma, Tennessee and Georgia. However, Texas courts have yet to find that a franchise creates a special relationship beyond that of a normal commercial contract and, so far, have not found that a franchisor owes its franchisees such a duty.

Breakaway Franchisees

Franchisors often assume they can keep franchisees from going into the same business or from competing with their franchisees. They often fail to grasp that there is a patchwork quilt of state laws affecting restrictions against competition. They must balance the scope of protection they want in the franchise agreement against what is most likely to be enforced in the greatest number of jurisdictions in which they will franchise.

In some states, like California, a post-termination restriction may not be enforceable at all. In Georgia covenants against competition in franchise agreements have long been disfavored and subjected to the difficult standard of strict scrutiny.

In Texas and several other states, the scope must be reasonable in duration and geography. What constitutes “reasonable” remains unpredictable and intensely fact-driven. Amerispec, Inc. v. Metro Inspection Services, Inc., 2001 US. Dist. LEXIS 9259 (N.D. Tex. 2001) had the odd result of finding the franchisee in the wrong, but refusing to apply the contractual provision prohibiting the franchisee from competing in the territories of other Amerispec franchisees in Texas.

Whose law?

Franchising reaches across state borders. It is an industry regulated at both the federal and state level in a way much like securities are. Whether representing franchisees or franchisors, Texas counsel needs to be sensitive to the laws of other jurisdictions that may apply, such as state franchise registration laws, franchise relationship and protection laws, “little FTC” acts and, of course, the overriding umbrella of the Federal Trade Commission’s Franchise Rule, 16 CFR § 436.1 et seq. Much useful information and a copy of the Franchise Rule and the proposed new business opportunity regulations can be found at business.ftc.gov/legal-resources/13/33.

Kat Tidd, Law Offices of Kat Tidd, P.C., advises franchisors, franchisees, dealers, and entrepreneurs and advises other attorneys on franchise and business opportunity transactional and dispute resolution matters. Ms. Tidd may be reached at kat@tiddlaw.comor (972) 247-6934.

Time for an iPad post acquisition update. iPad is the best thing since sliced, I mean organic, bread!

Not only did my iPad steer me to a mediation located in a maze like part of town after I missed my exit, but it kept me both informed (email,google and safari for quick research) and entertained (USA Today, AP, NPR, and even Plants vs Zombies) during the inevitable dead time while the mediator bounced between sides.

This is a great tool for the everyday activities of any mobile attorney. Email is so much easier to receive and to answer. The keyboard is simple to use and more accurate than thumbing a phone. You can actually write not only blogs but actual documents with some ease. That being said, it is not formatting friendly. I still need to figure out how to actually work in a document in a format that will be useable by client and attorney. I am unlikely to write a Franchise Disclosure Document on an iPad any time soon, much less the more complex franchise agreement.

I can however review documents emailed to me in various formats, e.g. Word, Excel and .PDF which has proved very useful with an often mobile practice.

The “apps” are fun to explore and many are quite useful. I am currently working on planning a project using mind mapping with an app called iThink. It has proved helpful and is a quick visual reminder of all the pieces and how I think they should fit.

And naturally, the Internet is at my fingertips 24/7. Social media, information, shopping, research. And did I mention Plants v. Zombies?

Lately some franchise and business opportunities seem to be more like a lot of the mystery business web sites on the Internet. Can you tell who you are dealing with? Let’s start with the company. Where is it located? State and city? Can you even tell what country? Is it a corporation or an LLC?

Even more importantly who are the people? Running the business? Who are the decision makers? Is this a real biz or are they operating on smoke and a pretty web site? Is there a president of the company? A name and a face of the founder. Is the staff real? Is support and assistance really available? how long has the business been operating? How many names of real people?

Sad to say but there are also a number of mystery franchise services firms and websites out there that raise these questions as well. Who are the experts they claim? Any names? Bios? Where are they actually performing their services?

Bottom line: Give no one money and sign nothing without knowing who is taking it and ensuring that their part of the bargain is kept.

My iPad 3G has landed on U.S.soil.  It’s in Anchorage Alaska…Hope they move it out before it freezes the circuits.  Really wish I could say made in the USA. 

Oh, well,  franchising and franchise law is now an international form of business, so I guess the tools can be too.

Wonder where the iPad will touch down next?

I have never been much of a first adapter when it comes to technology…except cameras, but after careful consideration I decided that an iPad was an essential piece of equipment for a mobile franchise attorney—and cost effective too, of course. 

I am still not one for standing in lines, so after returning the iPad wi-fi to wait for 3G.   I went online to the Apple Store and ordered an iPad 3G 64GB.  Happily, I received a confirmation that said “delivery by May 7” with a hyperlink to check progress of order.

Happily yesterday ( rather late the night before) I received notice of shipment.  It is in transit but still in China!  Next I received a notice of Fed Ex Shipment with tracking number..so far I have checked it 3 times today—and it is still in China!   The good news is it must be leaving China soon because Fed Ex says it is scheduled for delivery Friday morning the 7^th.

When my iPad gets here from China, I am sure I will be blogging more useful information     or at least more often. 

             I counsel prospective buyers frequently about how to evaluate franchise opportunities.  One of the traps they fall into when buying a franchise is just falling in love with the business and wanting one badly.  If it is a newer and/or smaller franchise system, or one of the ever increasing numbers of start up franchises, it can be really difficult to get an accurate picture of the franchised business’s true probable profitability.

            My Jedi Knight Ninja Social Mediaist Guru (whom I constantly frustrate by being too busy to participate in social networking the way he says I should) emphasizes that social media is about the connection to a real person. He also says that effective social media activities generate trust between the connections made through participation in social media.   In my sporadic forays onto Twitter, I have seen that there are many franchise developers and franchise sellers active on Twitter.

            Here’s the number 1 pitfall in the effects of social media used by those who pitch buying a franchise is the: 

Franchise sellers – and really anyone in sales and marketing.  They attempt to build a relationship with the prospect that has an implicit “trust me” element to it. 

“Trust me”, I won’t steer you wrong;

“Trust me”, this is the business opportunity you have been looking for;

“Trust me”, this franchise is in the top 100 list of Know All Business and Franchise Opportunities Magazine;

“Trust me,” this is a proven concept;

“Trust me”, this fits your personal passion for [saving the planet, offering healthy meals, making a million dollars......]

            There are many franchise sellers who are honest, accurate and play by the rules set by state and federal franchise law who don’t need to imply you can trust them.  However, there are many who sell franchises who really don’t care and make their living by selling and that is where “trust me” can tip your decision making in the wrong direction.

            Following your passion may lead to personal fulfillment, but it may not lead to profitability.  To paraphrase what the Dormouse said to Alice:  

“Use your head!”

What Is “The Best Franchise” to Buy?

Everyone wants to know the best franchise to buy, but it is really a meaningless question.  There is no such thing as best franchise or even worst franchise. The “question” covers a lot of ground.  The purpose of owning a franchise is to own a profitable business.  So what franchises are profitable? Some of them, sometimes.  As in certain to make money? None are a certainty.

What does the “top 10 hottest franchises” or the “10 best new franchises” get you?  The current winners in a popularity contest where the rules change and no one knows who makes the rules–or picks the best franchises or the hottest franchises.  Just because the sheep follow the leaders over a cliff, doesn’t mean you have to. 

Even the most solid of business concepts, the most thoughtful and most comprehensive in training, systems and support can result in a failed investment. 

Here are five reasons a franchise fails:

*life cycle of the business model is nearing its end (used records, video rentals,

*wrong location/wrong demographics

*underestimating the various ways the business can be affected by competition

*overestimating the market for the service or product (especially true in this economy)

*bad operator (you need to have confidence in your abilities, but few are good at everything they try)

  No franchise is certain to succeed – even the largest franchise systems in the country have far from a perfect track record– there are some that seem virtually certain to fail. 

Here are some red flags:

1.  the business being franchised has not been operated long enough to do much more than make a profit but it is promoted as a proven concept.

2.  the founder of the business has either: started the business for the sole purpose of franchising it and has no real passion for the business or decided to franchise without understanding how to be a franchisor and has focused on selling franchises and–more or less–getting them started rather than a small core of truly successful franchises

3. franchisor has no money, no ongoing business advisors

4. franchisor uses a franchise “packager” to put together its franchise documents who profits primarily from the start up package and/or sale of franchises, but not from on-going counseling of being franchisor, or….   

5. franchisor copies the franchise documents of a similar business concept to cut costs which means they are basically clueless about the whole business

6. when franchise fees/royalties/mandatory purchases are added to operating costs, the probability of the business being much better than a low paying job  

7. the franchisor cuts corners on legal compliance because it’s too expensive           

The best franchise is the franchise that will be profitable for you, achieves breakeven at a point in line with your expectations  and is supported by a franchisor that meets or exceeds the expectations they create.

When you think about buying a franchise, you need to investigate the franchise carefully.  One of the most important things you should do is talk to other franchisees.  Listed below is a list of questions to get your evaluation of the franchise or business opportunity started:

1.         How long have you been operating this business?

2.         Did the cost of your start-up fit within the initial investment numbers set out in the Offering Circular you received?  

            — if not, what was different?

3.         Did the training program prepare you adequately to open and operate your business?

            — if not, why not?

4.         How would you describe the quality of the training program? the instructors?

5.         Did the training meet your expectations and the description given in the Offering Circular? given by the franchisor’s representatives?

6.         How long from the time you signed the franchise agreement and paid the franchise fee until your business opened?

7.         How long did it take you to reach breakeven (or enough positive cashflow to pay your operating expenses for a period of  consecutive months)?

            –including a salary for yourself?  – how profitable do you believe this business can be in one year?

8.         What kind of help did the franchisor give you in actually setting up and opening your business?  and how many days was a representative present at your opening or start-up?

9.         When you opened, do you feel you were prepared?

10.       How did you choose your location or territory, what help did you receive and are you satisfied with it?

11.       If an advertising fee is required and/or advertising support promised, is it what you expected?

12.       What do you think of the management of the franchising company?

            –are they good leaders for the franchise system?  –do they do what they say?

13.       How would you rate the financial stability of the franchisor?

14.       How responsive is the franchisor to your requests for help? 

15.       If you purchase supplies or inventory from the franchisor or required suppliers, do you feel the prices are fair and the quality competitive?

16.       If you have an exclusive territory or other exclusive marketing or customer rights, are you truly protected from other franchisees?       Are your exclusive rights adequate to protect you?

And the closer, when you have nothing left to ask:

17.       If you had the choice, would you buy this franchise again?  Do you recommend it?