You’d be surprised if you knew just how expansive the variety of franchisors is in the marketplace today. Too often, when people think of franchising, their ideas are limited to well-known food brands like Subway, McDonald’s and Taco Bell. Granted, a large percentage of franchises are restaurants or other food-based concepts, but many of the big names in carpet cleaning, janitorial services, non-medical care for seniors and many other industries are also franchises.
For those who are unfamiliar with the franchise business model, the formula is simple. A franchisee, or independent owner-operator, pays a franchisor a pre-defined fee for the right to operate a branch of their business. Legally, a franchise relationship is defined by three things: the presence of significant operating control or assistance, a common trademark or name and a required payment of more than $500 to the franchisor in the form of fees, royalties or other assessments.
In this relationship, the franchisee takes on the responsibility of running and financing the business while paying the franchisor a royalty on revenues. In return, the franchisor is responsible for providing the franchisee with certain things, including vital training and support to help them understand and operate their new businesses effectively. Depending on the franchisor, what training and support they provide could include any number of things such as operational support, help with marketing and advertising, location scouting, strategies to help them build and protect the brand, and even financial guidance.
This legally binding relationship is governed by a number of rules and regulations that vary based on the state in which the franchisor is located. What follows is a short list of rules that govern franchise sales.
1. Franchisors have to provide a franchise disclosure document, or FDD, which discloses 23 prescribed pieces of information to the franchisee at least 14 days prior to a franchise sale. They also have to give the franchisee a completed franchise agreement at least seven days prior to the sale.
2. Franchisors must limit commentary about financial performance and other money matters, so as not to misrepresent the opportunity and mislead a potential investor. For instance, the franchisor can only discuss potential earnings if they are disclosed in Item 19 of the franchisor’s FDD — and there are rules as to how this information can be disclosed — if the franchisor chooses to disclose at all. These requirements are designed to protect franchisees and ensure all are treated the same way. That means, no negotiating different terms for franchise agreements unless you’re willing to provide the same deal for everyone.
3. Franchisors also have to deal with specific state laws. Currently, some 26 states regulate franchising and business opportunities in general, and many have their own definition of what constitutes a franchise. Some of those states have different rules relative to post-term non-competition, franchisee termination and renewal and other vital contract terms.
Of course, to franchise in the U.S., you do not need to register in all states. The situations that trigger a need to file paperwork could be related to any number of factors. In determining those factors, consider the following questions:
• In which state is the discussion of the franchise sale taking place?
• Is the franchisor located or incorporated in a particular state?
• Is the franchisee a resident of the state where their territory will be?
The variety of situations and statutes that crop up on a state-by-state basis are why it’s critical that franchisees and franchisors navigate the rules and regulations with help from a franchise attorney and/or franchise consultant. Franchisors who simply cut and paste from competitor’s documents or boilerplate forms do so at there own peril. In addition to significant fines and penalties, in some states, violations of franchise law is a Class 4 felony.
At the end of the day, there are state and federal regulations that franchisors need to consider before they offer an investment opportunity to franchisees. It may seem like a complicated business, but with the right help, both franchisors and franchisees can focus on building their respective businesses and satisfying the customers who need and want the products and services they provide.