Is Franchising Right for You?
Buying a franchise business is often promoted as the safe way to independent business ownership. Since the first decade of the new millennium has introduced us to a time of greater uncertainty with global and domestic turmoil and job instability, more and more individuals are seeking the freedom and perceived economic stability of owning their own business. At the same time, successful business owners may be questioning how to expand in times of tightening capital resources.
Should you franchise your business? Perhaps others have asked you to sell them the rights to operate a similar business. Before answering that question, consider whether your business makes sense as a franchise and what your personal goals may be. Many businesses are successful, not just because they fill a need, but because of the drive, focus and personality of the entrepreneurial founder. Sometimes the success is more the person, than the concept.
A franchised business, however, requires a more methodical, “cookie cutter” approach, rather than the innovative, “fly by the seat of your pants” style typical of the independent entrepreneur. Whether your business is service or product driven-or a combination-as a franchise it must be easily reproduced with a system or formula that the average person can follow. This is one reason restaurants are so often franchised, they are readily packaged and replicated.
Growing and running a franchise company can be rewarding, but it is also demanding. Are you prepared to run two businesses? For most franchisors, it is a constant balancing act between running the original business profitably (e.g. the restaurants), continuing to be innovative and staying ahead of the competition, while at the same time running the franchise system, selling franchises, training new franchisees and providing operational and marketing support to the existing and hopefully expanding system of franchises. These are two very different types of businesses that usually require very different personalities and skills.
What are your goals? To run a big company? To create a valuable and saleable asset? To go public? (Going public may not be an immediately viable dream in the present environment.) How important is your ability to control the business, not only the day to day decisions, but also its direction in the short and the long run? Can you delegate operational and/or creative control? A successful franchise company is not a one woman show, but rather a team effort between management and the franchisees.
So what is franchising really? And how is it different from the other distributorships and business opportunities that are offered in the classifieds? Any licensing or distribution arrangement can be a franchise with these three elements:
1) Granting the right to use a trademark, trade name or other
commercial symbol in the sale of goods or services, or being substantially associated with a common trademark or format;
Comment: If the operation of the business is substantially associated with only the one trademark or trade name of the seller/franchisor, that will suffice without any specific grant of a right to use the mark or name
2) Providing continuing control or assistance, or prescribing the marketing plan or system to operate the business; and
Comment: samples of control include, non-competition restrictions, prohibiting the carrying of competing lines, providing a marketing program or operations manual, price controls, designated hours of operation
3) Requiring payment of a fee, direct or indirect, [typically includes any purchase from franchisor greater that $500].
Comment: It does not have to be a specifically designated initial fee, but can be found in any form a profit or surcharge collected by the seller/franchisor in the first six months.
With such a broad definition not only are many types of business relationships intentionally designed as franchises, but also many can fall inadvertently within that designation. That is especially true of distributorships and business opportunities where the only distinction may be a subtle one, as shown in the comments to each franchise element described above. Twenty-four states regulate business opportunities, generally requiring some form of registration and use of a simple disclosure statement, typically just a few pages. There is less uniformity in business opportunity requirements, but also less complexity and less legal and accounting expense to comply.
Franchising has several attractions. One is using someone else’s money to develop new markets for the franchisor’s products and services; another is the royalty stream which provides a continuous cash flow to the franchisor and increases as the franchise base does. In addition, franchisor and franchisee benefit from group buying power and cooperative advertising efforts, which become more significant as the system goes.
On the other hand, would-be franchisors often underestimate the initial and operating capital required to develop, implement and support a franchise system. Because the offer and sale of franchises is regulated by both state and federal laws, understanding how to comply is critical and legal costs can be high.
Fifteen states specifically require franchisors to use a complicated disclosure document or prospectus called the ” Franchise Disclosure Document (FDD)”. In twelve of them, the franchisor must first register to sell franchises and submit its FDD for review and approval, paying a substantial filing fee for the privilege, and three states require a “notice” filing. The remaining states are only regulated under the Federal Trade Commission franchise rule which does not impose registration, but does require the use of a disclosure document in the FDD format. There are also a variety of state franchise and dealership relationship laws that will affect the franchisor’s conduct after franchises are sold.
Every entrepreneur who has developed a successful business concept and is considering franchising must consider carefully and be able to answer the following questions positively:
Will the franchised business be profitable enough not only to return the initial start-up investment in a reasonable amount of time, but also to support the continuing royalty and advertising fees that will be charged?
Not only is it right that your franchisees be able to operate profitably after paying their franchisor, you need their positive feedback to support continuing franchise sales and growth of the franchise system.
Can you define and describe your business and methods of operation in writing so others can follow it?
If you have adequate market appeal/demand, are you prepared to meet the management and staffing needs of:
producing a training program and materials covering everything needed to start and run the business
providing experienced training personnel
holding your new franchisees’ hands and walking them through every step of starting their business
providing on-going counseling and periodic on-site support, especially the first year
developing marketing and advertising from an initially minimal fund to promote regional/ national identity
Have you developed a trade name or trademark unique enough that it can be federally registered and not conflict with “prior users” of the same or similar name elsewhere in the country? State and county filings are not enough. Federal protection is essential in franchising.
Can you maintain quality control throughout the system while allowing your franchisees, who are independent business people, to run their own businesses.?
Being in the franchising business means being in the relationship business. Poor planning and implementation of a franchise company, often combined with inadequate capital, result in an inability to fulfill these operational needs adequately or to meet the expectations the franchisor has raised in its new franchisee. If the relationship gets off to a bad start, you eventually find yourself in constant disagreement with your most experienced franchisees who feel they’ve done as much as you to build the franchise system — if you get that far.
For some service businesses and for businesses centered on products especially, a simpler distributorship, multilevel marketing or other business opportunity format may be a less expensive, but effective way to market. By imposing fewer controls, minimizing or eliminating initial fees and focusing efforts on what is being sold rather than business package, both your company and the distributors can minimize start-up costs and grow — possibly more slowly– but with less risk. In some cases, however, even what looks like a traditional distributorship will fall within the broad definition of a franchise unless carefully structured and marketed.
As a general rule, however, if expanding your business through some form of licensing or distributorship system is appealing, design your business format to fit the needs of your concept and your vision. Don’t let legal technicalities make your business decisions. Frame out your business, then assess how your model may be affected by the law. Get advice from experienced business, legal and financial counselors on the options available to you-there are always choices.
Regardless of the method you choose for expanding your business, thorough planning, adequate operational capital, expert counsel, and careful structuring and implementation are the real formula for successful expansion.
By Kat Tidd
Kat Tidd founded her law firm in 1994, emphasizing franchise, business, and distribution law. She counsels entrepreneurs, businesses and other attorneys in franchising and various distribution methods for starting and expanding businesses, as well as creative problem solving for franchise clients and entrepreneurs. For a discussion of franchise related topics, see her blog site www.texasfranchiselawyer.com. She can be reached at 972-247-6934, or by email at [email protected].
Franchise Disclosure Document – Table of Contents
These items of information must be disclosed under Franchise Disclosure Document Guidelines of the FTC Franchise Rule
1 – History of Franchisor and Franchise
2 – Business Experience
3 – Litigation
4 – Bankruptcy
5 – Initial Fees
6 – Other Fees
7 – Initial Investment
8 – Restrictions on Sources of Products and Services
9 – Franchisee’s Obligations
10 – Financing
11 – Franchisor’s Obligations
12 – Territory
13 – Trademarks
14 – Patents, Copyrights, and Proprietary Information
15 – Obligation to Participate in Actual Operation
16- Restrictions on What Franchisee May Sell
17 – Renewal, Termination, Transfer and Dispute Resolution
18 – Public Figures
19 – Financial Performance Representations
20 – Outlets and Franchisee Information
21 – Financial Statements
22 – Contracts
23 – Receipt