FRANCHISING
Copyright 2011
Ronald Peter Roman, Esq.
8306 Mills Drive, # 699
8306 Mills Drive, # 699
Miami, Florida 33183
(305)-279-5180
ARE YOU CONSIDERING FRANCHISING OR REPRESENTING
A PARTY TO A FRANCHISE RELATIONSHIP?
THEN STOP, LOOK, LISTEN AND READ!
Franchising has grown from its infancy to a point where it is now in its adulthood. Today, over one-third of all retail sales are made from franchise outlets.
Franchising is more than just fast food. While McDonald's and Burger King are two of the best known franchises, a myriad of products and services are sold by independent businesses employing business format franchising. The following is a very abbreviated list of some of the products and services sold by franchise outlets: auto products, services and rentals; beauty aids; beverages; books; clothes; educational and electronic products; employment services; home furnishings; lawn and garden supplies; hotel and motel services; pets; photo services and equipment; printing; real estate; travel; and weight control.
What does franchising mean to the prospective franchisor? It can mean rapid expansion and greatly increased revenues without equally great risk. If a company expands by merger or acquisition or by adding new outlets, the company is taking on an increased risk. It must use its own money, or obligate itself for a loan; it must increase its staff in such a manner as to create duplicate jobs; and it must risk its existing operation.
On the other hand, if a company resorts to a franchise system, new unit development can be financed by the franchisee. Moreover, since each unit and/or each franchisee is independent from the franchisor, the initial company operation is not put in jeopardy. Finally, the franchise system, like group insurance, spreads the risk among a class or group of persons.
Each participant in the system, including the franchisor, benefits, both financially and otherwise. The franchisor's economic gains include the franchise fee, royalties and, in certain franchises, increased product sale revenues. The franchisor's non-economic gains come in the form of greater public acceptance and market penetration, increased advertising and corporate growth.
The franchisee's gains generally include a proven business system, training, corporate assistance and support, greater profits and significantly reduced risk. In fact, a franchisee's risk of failure is significantly less than a new non-franchised business -- greater than 75% less chance of failure (according to statistics published by the U.S. Department of Commerce).
From a franchisor's standpoint, he must develop a standardized business format, a uniform image and a strong product mix. These areas should be developed in conjunction with the legal compliance documents. Specifically, the Federal Trade Commission requires a disclosure document that meets certain criteria.
In addition to the FTC requirements, 14 states now require franchise registration and disclosure and one state requires only specific disclosure. Beyond the franchise registration and disclosure states, some states will require registration and disclosure under their business opportunity laws and other states have termination, non-renewal or other laws that impact on franchising.
The basic cornerstone of the franchise system will be its service marks, trademarks and trade names. These should be registered with the U.S. Patent and Trademark Office and, if appropriate, with State Trademark Offices. Once the marks and names are filed, the legal requirements will include the Franchise Disclosure Document, formerly known as the Uniform Franchise Offering Circular (disclosure document), the Franchise Agreement (contract) and other related documents or contracts as necessary.
It is critical to realize the importance of registration and disclosure compliance. Beside possible state penalties, a failure to comply with the FTC requirements can result in a monetary penalty. In other words, a franchisor must make sure of total compliance. Due to the detailed nature of the current status of the laws impacting on, or directly regulating, franchising, the franchisor's attorney must be very careful.
From the standpoint of the franchisee, disclosure helps to assure that the franchisee has as much relevant information as possible prior to committing his money and efforts. Every prospective franchisee should have the disclosure document and franchise agreement reviewed by an accountant and by an attorney who is well versed in the various franchise laws.
If each of the parties, the franchisor and franchisee, does his homework and if each is open and honest, a rewarding franchise relationship will ensue. Each party will reap financial rewards, both will grow in size and the franchisee will become a successful independent business person.
THE TRADEMARK
A franchise system, like any chain of stores, can only develop acceptance and recognition by the use of a standard logo. Whether the franchisor uses trademarks, service marks or both, it is imperative that the mark be registered with the United States Patent and Trademark Office.
While the registration process is initiated by filing an application, a thorough records search should be conducted prior to filing. The object of the search is to determine if the chosen name is available.
In the event that the search reveals a very similar name, trademark counsel must decide whether or not the names are deceptively or confusingly similar. The result of using and/or filing a name which is too similar will be a litigation or opposition. Either result can be costly and can lead to the loss of the name.
Assuming that the trademark or service mark is available, the registration process will take approximately one year. The procedure includes publishing the proposed mark in the Official Gazette and, if no opposition or objection is received, registration. After a mark is registered for a set period of time the mark will become incontestable.
State trademark filings can be useful in some states where the business opportunity law exempts compliance if the company has a registered trademark. Since state trademark registration takes between three and five weeks, as opposed to one or more years at the federal level, the franchisor may be able to avoid registration under the business opportunity law.
Ideally, trademark development should be accomplished by, or in conjunction with, the franchise attorney. This will assure a continuity of effort in the overall franchise development.
STATE FRANCHISE REGISTRATION AND
THE FEDERAL TRADE COMMISSION'S
TRADE REGULATION RULE
The FTC rule developed as a corrective measure to abuses of the franchise system in the sale of business opportunities. While several states developed franchise and/or business opportunity laws in the late sixties and early seventies, a majority of states failed to regulate or control franchising. Therefore, the Federal Trade Commission, perceiving abuses and irregularities, stepped into the mainstream of franchising on October 21, 1979, with its trade regulation rule entitled "Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures" (16 CFR 436).
While the FTC did not pre-empt state regulation, it did impose stringent rules. The FTC rule provides that the franchisor must develop an offering prospectus using Franchise Disclosure Document format (more about the “FDD” later). In either format, specific disclosures concerning the franchisor, the franchise system and the franchise relationship must be made at least ten (10) business days prior to the execution of documents or the receipt of money by the franchisor or at the first face-to-face meeting, whichever occurs first.
The original Uniform Franchise Offering Circular, referred to above, was developed by the Midwest Securities Commissioners' Associations as an attempt to provide a uniform disclosure document. However, despite their efforts, almost every franchise registration state has amended the requirements, thereby reducing the uniformity of the document.
THE FRANCHISE DISCLOSURE DOCUMENT
The FDD is composed of twenty-three specific disclosure categories, plus an acknowledgment of receipt to be executed by the prospective franchisee. While the contents of each section will vary according to the franchise being offered, the cover page and certain sections will require the use of specific language.
Section XIX on earnings claims can create problems. If any actual or average sales, profits or earnings figures are used, the franchisor must identify all of the relevant factors used in developing the numbers and the number of actual locations which have met or exceeded the figures must be disclosed. Finally, there are other facts which must be considered and adhered to before a franchisor can disclose sales, earnings or profits, or their projections.
In addition to the contents of the FDD, several other documents must be prepared in order to fulfill the filing requirements of the various states. These additional documents include a standard application or facing page, a uniform consent to service of process, a supplemental information page, a cross-reference, a verification, a corporate acknowledgment, and, in some states, a salesman's disclosure. Besides these documents, certain states will require copies of all proposed advertising, brochures, pamphlets and sales literature.
The following states require registration and/or specific disclosure under their franchise laws:
Registration and Disclosure | Disclosure Only | |
California | New York | Oregon |
Hawaii | North Dakota | |
Indiana | Rhode Island | |
Illinois | South Dakota | |
Maryland | Virginia | |
Washington | ||
Minnesota | Wisconsin | |
BUSINESS OPPORTUNITY AND OTHER LAWS
THAT IMPACT ON FRANCHISING
The following jurisdictions have laws, other than franchise registration and disclosure laws, that directly or indirectly impact on franchising:
Arkansas | Missouri |
Connecticut | Nebraska |
Delaware | New Hampshire |
Florida | New Jersey |
Georgia | New York City |
Idaho | North Carolina |
Iowa | Ohio |
Kentucky | South Carolina |
Louisiana | Texas |
Maine Michigan | Utah |
Mississippi |
Of the above listed jurisdictions, Connecticut, Iowa, Maine and North Carolina have business opportunity laws that directly affect many franchisors. Under the terms of these laws, franchises are deemed to be business opportunities and subject to registration. The only exemption applicable to most franchisors requires that the franchisor have a federally registered trademark. Since federal trademark registration can take one or more years, most new franchisors will be required to comply.
Similarly, Florida, Georgia, Louisiana, South Carolina and Utah have business opportunity laws which provide an exemption for a registered trademark and for franchises that comply with the FTC Rule. However, these states do not require federal registration and state trademark registration is sufficient. In most cases a completed application can be registered in three to five weeks.
Florida, Michigan and Texas, under their Business Opportunity Acts, require the franchisor to file a notice with the Secretary of State of an intent to sell franchises. Other than the notice requirement, they exempt franchisors who comply with the Federal Trade Commission rule from further registration under the Act.
Of the remaining jurisdictions, some have statutes that impact on franchising by limiting termination or non-renewal and some have business opportunity laws which exempt franchising or which exempt a franchisor if it uses a document that complies with the FTC rule.
Of course, virtually all states have "little FTC" acts, deceptive or fraudulent trade practices acts and/or common law limitations on fraud.
The net result of a violation of these other laws can be as severe as a violation of a franchise registration and disclosure law or the FTC rule. In addition to the penalties (both civil and criminal) imposed under these laws, the franchisor will have to disclose the allegation or finding of wrongdoing in the FDD. In effect, the FDD will make public the bad act, or allegation thereof, for all to read.
THE MARKETING AND BUSINESS SIDE OF FRANCHISING
While this article is aimed at an overview of the legalities of franchising, a brief mention of some of the marketing and business aspects of franchising is important.
In order to have a saleable franchise, the franchisor must develop uniform systems of operating, accounting and reporting for the franchised unit. These systems must include sufficient cross-checks to protect the franchisor and to insure the complete and accurate reporting of sales. Since franchisors generally require the payment of royalties based on sales volume, misstated sales can be costly.
A uniform operating systems is essential if the franchisor is going to be able to be sure that each unit offers products or services that at least meet the franchisor's minimum criteria. If the quality and service vary too greatly between units, the goodwill and consumer acceptance earned at one unit will be lost at another. Therefore, an operations manual is the cornerstone of a uniform operating system.
Franchisee selection is very important but, all too often, neglected. The franchisor must identify the criteria which make up a potentially successful franchisee. Then, the franchisor must attempt to recognize these criteria in a prospective franchisee. Obviously, sufficient capital is important, but it is not the end of the search. Those characteristics which can generally be attributed to the successful entrepreneur -- strong work ethic, willingness to take risks, a desire to be one's own boss -- are what is needed to be a successful franchisee.
Another important area is franchisee training. A standardized training manual and an organized training program will greatly increase unit efficiency and sales and aid in assuring uniform quality and service from unit to unit.
A major component of consumer acceptance and the goodwill attached to a trademark is a uniform marketing and advertising program. This program must cover two areas: advertising and marketing the sale of franchises and advertising and marketing the product or service to the ultimate consumer. Both aspects of the program are equally important.
CONCLUSION
Whether or not the word "FRANCHISE" is applied to a business system, if the essence of the program is franchising, then the morass of laws regulating or affecting franchising will be applicable. Attempts have been made to couch franchising in the guise of consulting, or, even more thinly vailed, licensing, but the results have been the same -- the franchise laws apply. The courts and administrative agencies have been, and are, ready, willing and able to put substance over form.
With the above in mind, the prospective, or current, franchisor must be careful; however, if a proposed business system is franchiseable, the potential profits and growth are great.
