If you are a successful business owner, franchising may be an attractive method to take your growing business – and profit margins – to the next level. Indeed, development of a franchise system can be a great way to help your business continue its success on a larger scale. With franchising, the brand grows but the unit investment and unit management costs are incurred by independent franchisees. People often think “burgers and fries” when thinking about business systems that are franchised. However, the world of franchising is quite diverse and business systems in many different industries are developed through franchising. In addition to restaurants, other sectors include retail, hospitality, real estate, optical, recreation, business services, childcare and household, and home improvement services, to name a few. However, prior to franchising your business, there are a few important factors to consider.
What Is A Franchise?
Do You Have What Is Needed To Franchise Your Business?
There are many issues to consider when converting a business into a franchise, which is one reason an experienced franchise lawyer is such an asset to business owners considering franchising. For one thing, your business must be replicable. Also, you will be required to have certain legal and financial documents drafted and compiled before you can sell a franchise. These documents can be extremely burdensome to produce and can create liability for the franchisor down the road if the documents are not accurately drafted or properly registered with any applicable state authorities. In addition to having the necessary documents, the prospective franchisor must understand that operating a franchise system is a different business than operating a unit within that system.
The Federal Trade Commission requires franchisors to provide potential franchisees with a Franchise Disclosure Document (FDD) before there is an exchange of money or a franchise agreement is signed. This document includes 23 items that provide the franchisee with information about the operation of the business and financial information about the franchisor and franchise system.
The FDD is an incredibly useful tool for potential franchisees to assess the viability of their potential business venture. The FDD provides information about the Franchisor and any parent companies, predecessors or affiliates of the franchisor. It will give information about how long the franchisor has been in business, its competition and special requirements unique to the franchisor’s industry to aid the franchisee in assessing potential costs and overhead. The FDD will also provide an overview of the franchise itself, including executives of the franchise system and potential financial or legal problems the franchisor is facing or has faced, including litigation or bankruptcy filings. The FDD must disclose the initial franchise fee and franchise investment costs, if any. Many states require a minimum fee. The FDD will also flesh out other miscellaneous costs associated with starting up a franchise, as well as ongoing fees the franchisor may require the franchisee to pay through the term of the agreement. Restrictions on distribution, sources of products, development of new products or marketing approaches are laid out in the FDD, and are crucial to developing a full picture of the franchisee’s responsibilities down the road. Territory and exclusivity are included in the FDD, as are the terms to renew the franchise agreement after its expiration, or to resolve disputes during its term. Perhaps most importantly to the franchisee, the FDD must give audited financial information, including accurate earnings projections.
Some states also have specific registration or notice requirements that franchisors are required to uphold, or risk voiding their sale. Each state has different parameters for registering franchise offerings. Currently, there are 13 registration states. Franchisors must register their FDD in a registration state before selling a franchise in that particular state. Handling and understanding the FDD can be a tedious task, thus it is sensible for franchisors to seek the assistance of a franchise attorney to help prepare and file these documents, and to re-file when necessary.
In addition to preparing and registering the necessary legal documents, the franchisor must be prepared to provide training and support to franchisees. Indeed, providing training is a crucial aspect of the franchise relationship, as the guidance and advice the franchisor can provide can be the difference between recreating a successful and profitable operation, or financial struggles. A franchise attorney can help a franchisor identify and locate the resources needed to operate and grow a successful franchise system.
There are many advantages to turning your business into a franchise or becoming a franchisee, but it takes a great deal of work. It also takes the assistance of professionals to prepare the necessary legal and financial documents.
Attorney Julie Lusthaus is a partner in the firm of Einbinder & Dunn, LLP. She focuses her practice in the area of franchise law, serving as counsel to both franchisors as well as franchisees. She can be reached by phone at 212-391-9500 or 914-705-5417 and via email at firstname.lastname@example.org.
Mackenzie Dimitri is an associate attorney practicing franchise law and related litigation on behalf of franchisors and franchisees at Einbinder & Dunn, LLP in New York City.
Special thanks to Margaret R. Poppe for her contribution to this article.
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