What is a franchise?

A franchise is a license that grants the receiving party, the franchisee, access to the issuing party, the franchisor, proprietary know-how, processes, and trademarks. This allows the franchisee to sell products or services under the franchisor’s business name.

How are franchises regulated?

Franchises are regulated at the state level. However, the Federal Trade Commission issued a Franchise Rule that requires franchisors to disclose any risks, benefits, or limits to a franchise investment to prospective franchisees in a document known as the Franchise Disclosure Document (FDD). Additionally, the FDD must lay out any fees or expenses, past litigation, approved vendors and suppliers, estimated financial performance, and other essential information.

What is a franchise agreement?

A franchise agreement is a contract that describes the license granted by the franchisor, the payments required of the franchisee, and the rights and obligations of the franchisee and franchisor. The primary purpose of the Franchise Agreement is to protect the franchisor’s intellectual property and guarantee that each franchise operates consistently with one another. These contracts are not permanent and typically last between five (5) and thirty (30) years. They do not grant the franchisee any ownership in the franchisor’s property.

How much does a franchise cost?

The cost of starting up a franchise depends on the industry, location, and type of franchise. When a franchisee opens a new franchise location or gains ownership of an existing franchise, they are typically expected to pay an initial franchise fee at signing. This initial franchise fee covers the application and vetting costs of the new franchisee, as well as their training, advertising for the new franchise, and other onboarding assistance. Once they have paid the initial franchise fee, the franchisee receives authorization to use the franchise’s trademark, branding, and intellectual property.

In addition, a new franchisee will incur additional start-up costs for business necessities such as equipment, real estate purchases or leases, administration, initial inventory, and signage. The franchise agreement will specify any requirements that will need to be acquired, such as the number and type of inventory or equipment and the size of real estate needed.

After paying the initial fees and start-up costs, franchisees must make periodic royalty payments for using the franchise’s name and intellectual property. These royalties are generally paid quarterly or monthly and calculated as a percentage of revenue in the same period. Franchisees typically also owe advertising and marketing fees to the franchisor, which are calculated as a percentage of the franchisee’s revenue.

How do you become a franchisor?

When deciding whether to franchise your business, you should ensure that your decisions align with your long-term business goals. Some questions to consider are:

•  Is your business scalable?
•  How profitable is your business currently, and how profitable is it expected to remain?
• What is the state of your industry like currently?
• How much capital do you have available to invest?

Once you have decided that your business would work as a franchise, consider establishing a franchise company. Creating a new company to handle franchising can be important as your current company’s business purpose may include something other than handling the business of a franchise, such as selling franchises, collecting fees and royalties, and supporting franchisees. Further, by forming a franchise company, you will shift any future franchise obligations and reporting requirements from your current company. This may make start-up easier as a new business will have less activity that may need to be disclosed.

The next step is drafting your Franchise Disclosure Document (FDD). The FDD is a legal document required by federal law; it must contain the 23 specified disclosure terms and must be updated annually. For specifics, please see https://www.ftc.gov/legal-library/browse/rules/franchise-rule. The FDD will also include copies of your franchise agreement and all the other documents a new franchisee must sign. If you are in a franchise registration state or a franchise filing state, you must file your FDD with the state before selling franchises there. When selling a franchise, you must disclose your FDD to the prospective buyer 14 days before they sign the franchise agreement or pay any fees.

After drafting your FDD, you will also need to draft the franchise operations manual, which will serve as your franchise system’s guide. The operations manual should set out your brand’s purpose, goals, and visions, as well as how to open a franchise location, product and service requirements, and everything a new franchisee would need to operate a franchise successfully.

If you have more questions about franchises or need help drafting or reviewing your franchise documents, please contact Penwell Law.

Sources:

• Pros and Cons: Startups and Franchises. https://www.sba.gov/blog/pros-cons-startups-franchises
• Advantages and Disadvantages of Franchising. https://www.nerdwallet.com/article/small-business/advantages-of-franchising
• Successful Franchises Not Related to Food – Radio Santa Clara. https://www.radiosantaclara.org/successful-franchises-not-related-to-food/
• Reviewing the Franchise Agreement Before You Buy a Franchise | The Internicola Law Firm. https://www.franchiselawsolutions.com/learn/buy-a-franchise/reviewing-the-franchise-agreement-before-you-buy-a-franchise
• Average Franchise Fees: What are They? | Lendio. https://www.lendio.com/blog/average-franchise-fees/
• Documents a franchisor must give a franchisee before starting | ACCC. https://www.accc.gov.au/business/industry-codes/franchising-code-of-conduct/beginning-a-franchise-agreement/documents-a-franchisor-must-give-a-franchisee-before-starting
• What is a Franchise? – Studenttimes Staffing Solutions. https://studenttimes.com/what-is-a-franchise/