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.

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:

1. Life cycle of the business model is nearing its end (e.g., used records, video rentals)

2.  Wrong location/wrong demographics

3.  Underestimating the various ways the business can be affected by competition

4.  Overestimating the market for the service or product (especially true in this economy)

5.  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.

Oh, and wouldn’t it be great, if you had fun  too?

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Before you start looking for a franchise to buy, think about why you think you want to buy a franchise opportunity in the first place.

            What benefits do you expect to receive from a franchise that are more or better than what you could gain from starting a business on your own?  While federal and some state laws define what business opportunities are franchises–and that definition is very broad–there are no laws that require franchisors to provide their franchisees with anything specific. Or with anything at all. 

            No minimum level of assistance, no ongoing support, no marketing help, no on-site visits, not even phone calls or emails, and certainly not innovations and further development of the business model UNLESS it’s in the contract!     

              Will you still be willing to pay royalties and operate by someone else’s rules after you’ve been in business for a couple of years, and are comfortable that you now understand the business and what you are doing?  Are you a follower? Can you play by the rules?  For as long as you have the business? 

            Are you a risk taker?  Willing to take a chance on a new concept, a new company? .Do you need a mature, well proven business. How much are you willing to risk?  Are you prepared to deal with the consequences of failure?

            Everyone will tell you to do your homework on researching a business or franchise opportunity, but start with yourself.  What is going to work for you?

Here are Five Tips on Buying a Franchise Business Opportunity

1. Do your homework, don’t just fall in love with the business.  Be sure it is right for you and profitable enough to meet your needs.
2. Promises really are just as good as the paper on which they are written–this is especially true in franchising.  The person you trust today may not be with the company tomorrow.
3. Can you be a team player and follow direction?
4. Investigate your franchisor, that means ownership, management and financial stability.
5. Think about consequences.  What happens if things go wrong?  Maybe investing in an experienced franchise attorney is worth it.

The Best Franchises

The best franchises are profitable.  Seems obvious.  Stay tuned……

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.

             Last week an online article was published about McDonald’s aggressive actions to stay ahead of  consumer trends by being willing to continually implement both change and innovation.  These are attributes that can certainly benefit small businesses and franchised businesses as well, and I applaud the general idea.

However, if you read further into the article (See,  McDonald’s Sales Growth Comes at a Price to Franchisee Profit Margins you will learn that McDonald’s profits and increases its bottom line while franchisees on the front lines see a decrease in theirs.)

            Unfortunately, I see this as part of an ugly industry trend. Many franchisors are sacrificing their franchisees’ financial well being to their own profit margin, frequently without regarding to the ability of many franchisees to survive the hit to their own bottom line..or just plain staying at or above breakeven. Market encroachment that cannibalizes their franchisees on the ground and in cyberspace are other ways that some franchisors may generate more revenue to the detriment of individual franchisees.

            Such actions by franchisors cannot be concealed.  Prospective franchisees who go the extra mile on their due diligence (some prodded by yours truly) will learn where their prospective franchisor’s priorities lie.  When the chips are down, they discover they will be thrown under the bus.  To add insult to injury, these are often the same franchisors whose franchise agreements claim the right to go after the franchisee for liquidated damages or lost royalties when the franchise business fails!  Yes that is another ugly trend.

            Franchisors–and those planning to franchise–should take heed.  People do not want an “invest-to-rent a business” solely for the fun of it.  They want and should have a fair return on the business, or alternatively a franchisor who will share or at least attempt to ease the burden of hard times.  Certainly they should not have to worry about their franchisor creating the problem. 

            How about this for a franchise mission statement:   “all for one and one for all”?

Or, why not just save a little money?

            The Internet is a tremendous source of information.  A lot is written about franchises and franchising unfortunately, I am still waiting for the next gen to produce infallible Truth or Lies software.

            In the meantime it is all about Truth or Dare.  You can find a franchise agreement for any type of business somewhere in Cyberspace.  Anyone with a good grasp of the English language (sadly less common with our weakened education system) can change the wording a bit to fit a different business.  Sometimes they can get lucky and write a new paragraph that really says what they think it does and IT is enforceable–at least in most states.

            So often I get to read junk agreements all the time.  Some from prospective clients who used them to franchisor need them fixed, and–the most fun, from prospective franchisees who want to know what I think.  Would I think of the contract?  Of the franchise?  Of the deal?

            Here is what I often think:   this contract puts the foot of the franchisor on the throat of the franchisee. It is indentured servitude… pre-paid.

            Ironically, at least half the time the franchisor is a well-meaning entrepreneur who is determined that “his or her” franchisees will succeed.

            One of the many problems with cut rate or plagiarized franchise agreements is that the franchisors using them often don’t understand what the cloned agreement really means, nor the consequences of using it. I tell them, sometimes directly and sometimes through the client: “this is what your contract says you can do which makes your franchise a really bad deal.  Is this really what you would do to your franchisee?”

            Usually the answer from the franchisor is “of course not, but I was told by my lawyer that I need this language.” But if you don’t mean it, why say it?!  I take the tone of the franchise agreement as the tone of the franchise system.  Mean contracts make for an unpleasant, ultimately and trusting relationship.  Sticks and stones won’t hurt, but lousy your heartless contracts will do yourself a favor. If you care about your life savings, if you care about the success of your company, see an experienced franchise attorney.  This applies to both sides of the deal.

            By the way, there is a reason for the saying: you get what you pay for.

There are many things you should be asking a Franchisor about the franchise he sales.  Here are the Top Five Things to Ask Every Franchisor

1.  How long have you operated this exact business model you are franchising?

2.  What is your five year plan?

3.   What continuing assistance are you promising to give me while I operate this business?

4.   If the business fails and I stop operating the franchise, what happens?

5.   How am I protected from losing sales to other franchised and corporate businesses? 

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?