Eric Pritchard is a Philadelphia Lawyer who spends his workday making the world safe for electronic security providers. He can be reached at firstname.lastname@example.org. This column does not constitute legal advice; contact an attorney with questions.
Franchising permits franchisors to expand their business ideas more quickly with reduced capital while their success is fueled by the motivation and efforts of its franchisees.
This month’s cover story focuses on franchising in our industry. Ever thought about becoming a franchisee? Grab a cup of coffee for this thumbnail introduction to franchising law from the perspective of a potential franchisee.
What makes a franchise? It depends (written like a true lawyer, huh). Many states regulate franchising, which means state law controls in part. The Federal Trade Commission (FTC) also regulates aspects of franchising at the federal level. State laws vary. Generally speaking, there are three primary elements of a franchise under the law of most states and the FTC – first, a substantial association with a trademark, second, the payment of fees, and third, a community of interest.
“Substantial association” with a trademark is pretty easy – if you are trading under the franchisor’s marks, you have it (think Baskin Robbins or Service Pro).
Fees are a little more complicated, but if you are paying ongoing royalties, consulting fees and training fees, you likely the second part of the test.
“Community of interest” revolves around a franchisor’s control and marketing plans. The FTC (and some states) look at the franchisor’s ability to control how the franchisee operates – for example, how long you cook the fries and at what temperature – or if the franchisor offers real assistance in the franchisee’s operations. No matter what you call it, if it walks like a franchise, and talks like a franchise, then, yes, it probably is a franchise.
If it is a franchise, federal law requires disclosures in the form of a “Franchise Disclosure Document” (FDD). FDDs require 23 specific areas of disclosure, can run 100 pages or more and are often extremely detailed. Make sure you understand the FDD before plunking down a franchise fee. Typical disclosures include franchisor’s financials, estimate earnings, fees, terms and conditions, and other data essential to deciding whether to invest a boatload of your money to join the franchise team. Some portions of the FDDs and franchise documents can be negotiated, so don’t be shy – it is your money and your future.
Where do I start? In any business transaction, knowledge if power. Do your homework. Consult Google. Check out what the FTC’s website says. Figure out if your state regulates franchising and if so, how. Buy a good book on franchising.
hen kick the tires. There are franchise trade shows, franchise associations, the Better Business Bureau and a million other places to find information about your potential franchisor. I would informally interview franchisees without letting the franchisor know.
What are some of the important issues to be negotiated? Encroachment is important – do you get an exclusive in the territory? Does exclusive really mean exclusive, or will someone (maybe the franchisor) be competing with you in your hometown? What’s the territory? Can the franchisor change requirements downstream, for example, making you cook hamburgers in new expensive ovens rather than the affordable ones you have? Can the franchisor limit your ability to compete once you’re no longer a franchisee? Can you sell the franchise, and if so, under what circumstances?
There are plenty more issues. Franchise law is complex and contains traps for the unwary. Make sure you have someone who understands and can help you – retain a knowledgeable business lawyer.
In today’s world, why would you ever make one of the biggest investments of your life without legal representation? It reminds me of the old TV commercial for Midas Muffler (ironically, a franchisor): “You can pay me now [to protect you going in], or pay me later [to get you out of your bad deal] – your choice.”