Prospective clients who are new to franchising usually ask us the same key questions. We cannot give legal advice without entering into a written agreement to represent you and learning the facts of your particular situation. \But we hope that the information below will help you to focus your inquiry. "
Frequently Asked Questions About Franchise Law
- Should I franchise my business?
- Should I buy this franchise?
- Is this contract a franchise?
- What should I do if the opportunity I want to offer is a franchise?
- How can I make this contract not a franchise?
- Should I license instead?
- Why doesn't my competitor have to comply with franchise laws?
Should I franchise my business?
The key point to remember in addressing this issue is that the reason a person (a "franchisee") buys a franchise instead of starting a business independently is that the franchisee assumes that buying the franchise will make the new business successful. Regardless of how many warnings and disclaimers are added to franchise documents, a would-be franchisee will still expect the franchise seller (the "franchisor") to make the business successful--or at least to greatly improve the odds. Keeping that in mind, ask yourself the following questions:
- Is this business concept very profitable?
- Do you have experience in operating multiple locations?
- Is it easy to teach someone else how to succeed in this business?
- Are you willing to devote a major portion of your time and energy to assisting your franchisees?
- Does success in this business depend on skills that many people have?
- Do you have enough start-up and operating capital to provide proper support to franchisees?
- Will franchisees be able to finance their franchised businesses from commonly available sources?
- Is the market for the franchised product or service stable or growing?
- Will you have something of clear value to offer your franchisees after they have been in business for a year or more?
If your business can be successfully franchised, the answer to most of the questions above will be “yes.”
Should I buy this franchise?
Before deciding whether or not to take the plunge -- to sign a franchise agreement-- you should do the following:
- Obtain a copy of the franchisor's disclosure document or offering circular (a type of prospectus) and review it carefully. The disclosure document is even more important to you than the franchise agreement. The disclosure document not only describes key provisions of the franchise agreement but also provides crucial information about the franchisor and its personnel. Pay particular attention to these points:
- Is the disclosure document up-to-date? The date should be on the front cover. If it is more than a year old, it may have expired. If it is close to a year old, check to make certain that a newer version has not already been prepared. If it has, wait until you can see the updated document.
- Read the most recent audited financial statement first. It will tell you whether the franchisor can afford to fulfill its promises to you and whether the franchisor is likely to remain in business. By studying the financial statements, you can often tell how successful the franchisor is and how well its existing franchisees are doing. The auditor should have independently verified the information in the financial statements to give them an added layer of reliability. Study the footnotes. If you do not understand the significance of any aspect of the statements, take them to an accountant and discuss them with him or her.
Signing a franchise agreement is often described as " buying a franchise," but in reality, the transaction is more like a marriage or partnership, with ongoing rights and obligations on both sides. The franchisor agrees to provide training, a manual and other benefits to you in return for your promise to operate a franchised business and pay franchise fees throughout the entire term of the franchise agreement, even if you are losing money.
Is this Contract a Franchise?
We will not attempt to summarize here the definitions of "franchise" under the franchise laws of the various U.S. states and federal government. This is a complex subject. Instead, we will give you a rough rule of thumb to apply preliminarily to any arrangement you suspect may be a franchise. If it meets the test, the odds are pretty good that it is a franchise and worth investigating further.
According to our rule of thumb, a franchise agreement must have all of the three elements described below:
- 1. Unifying name or mark
- One of the parties (Party A) gives the other (Party B) the right to operate a business in association with Party A's trade name, trademark, service mark, logotype, or other "commercial symbol." Third parties are given the impression, usually through Party B's advertising, that Party B belongs to a chain or association of businesses which are associated with this commercial symbol.
- 2. Business assistance or control
- Party B has the right and obligation to operate a business according to Party A's marketing plan or business system. Alternatively, Party A agrees to give significant assistance to Party B in operating its business or has the right to exercise significant control over the manner in which Party B operates its business.
- 3. Franchise Fee
- Party B must make a payment to Party A as a condition of entering into the contract. Since Party A could try to evade the franchise laws by claiming that the payment was for training, inventory, or a trademark license, the law ignores Party A's characterization of the payment. Subject to a few narrowly drawn exceptions, the law will consider the payment to be a franchise fee.
What should I do if the opportunity I want to offer is a franchise?
You have four choices:
- Find an exemption. Under some circumstances, agreements are exempted or excluded from federal or state franchise sales laws. Finding an exemption may eliminate your obligation to register the franchise offering or prepare a disclosure document or both. Exemptions and exclusions were created to cover situations in which the franchise buyer clearly does not need the protection of franchise disclosure laws. They may depend on strict conditions and filing of a notice and filing fee. A franchise lawyer can help you determine if an exemption or exclusion can apply to your proposed offering.
- Change the arrangement so it is not a franchise. For instructions on how to do this, see the answer to “How Can I Make This Contract Not a Franchise?” .
- Comply with state and federal franchise sales laws. What does this involve? Some issues to consider are:
- Federal law applies everywhere in the United States and requires a franchisor to prepare a detailed disclosure document about itself, its personnel, and its franchise agreement.
- In a "registration state," such as California, Hawaii, Illinois, Indiana, Maryland, Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, or Washington, the disclosure document must be submitted to a state agency for review and approval before the franchisor can offer or sell franchises in that state.
- In a number of states, franchisors must obtain state approval of advertising material to promote the sale of franchises.
- In some states, a franchisor must comply with state business opportunity laws in addition to or instead of state franchise laws.
- In every state, a franchisor must give a copy of its disclosure document to each prospective franchise buyer a specified number of days before the buyer can pay any money or sign any agreement relating to the franchise.
- In many states, a franchisor may not terminate or refuse to renew a franchise agreement without "good cause."
- The Federal Trade Commission and state administrative agencies may enforce franchise sales laws through administrative proceedings, civil lawsuits, criminal actions, or a combination of the foregoing. State laws may also be enforced by private citizens in civil lawsuits and arbitrations.
- Do not offer the opportunity.
How can I make this contract not a franchise?
To make the contract not a franchise, you must remove at least one of the three elements that make the agreement a franchise. In doing this, consider the following:
- If you eliminate the franchise fee, you may be left with a distributorship, one in which the distributor does not pay for the right to be a distributor. In a non-franchised distributorship, the manufacturer makes its money on the bona fide wholesale price of goods rather than on the right to distribute the goods or payment for a territory. Markup of the goods above the bona fide wholessale price of similar goods on the open market will be considered a hidden franchise fee, however.
- If you eliminate the association of the franchisee's business with your trade name or commercial symbol, what is left may be a business opportunity. Many franchises are also business opportunities. Franchisors are often exempt from state business opportunity laws if they comply with franchise laws, which are generally stricter, but it does not work the other way around nor in every business opportunity state. Business opportunity laws differ quite a bit from state to state. They may require a business opportunity seller to post a bond, honor a "cooling off" period after each sale, or file a special notice with the state.
- If you eliminate the right to operate a business under your marketing plan or business system, what remains may be a standard trademark or service mark license. However, if a trademark owner does not monitor its licensees' activities to make certain that quality standards associated with the licensed marks are maintained, it may lose the rights. Sometimes there is a thin line between maintaining quality standards (necessary to protect a trademark) and prescribing a marketing plan or business system (indicative of a franchise).
If you decide to take your arrangement outside the scope of the franchise laws by eliminating one of the elements of a franchise, make sure you do so with the guidance of a good franchise attorney. It is easy to slip into a definitional element that you thought you had eliminated.
Should I license instead?
All franchises are licenses, but not all licenses are franchises. If you are licensing a business system together with an identifying name or symbol, the license is probably a franchise. In that case, you will be franchising, whether you comply with the franchise laws or not.
Why doesn't my competitor have to comply with franchise laws?
Sometimes people ask us why none of their competitors franchise. What they really mean is, "If my competitors don't have to comply with the franchise laws, why do I have to comply?" There are several possibilities here. Your competitor may have found an exemption to cover its offering. It may, in fact, be complying with franchise laws. All your competitor's units may be company-owned. Or possibly your competitor is violating the franchise laws and simply has not been caught — yet.