So your business is successful. You have a proven business model with effective marketing and distribution systems in place. You are producing profits and steadily capturing market share. Yet, you ask yourself, “How can I take my operation to the next level?”
On the other hand, you may be trying to start up a business, but be tired of re-inventing the wheel. You want to own your own business, but don’t know what policies and procedures to implement. You wonder, “Isn’t there an easier way to improve my chances of success?”
Franchising can sometimes be the fitting solution. A franchise is a relationship between a franchisor and a franchisee. Franchisors are those who seek to expand their reach beyond a local or regionalized market. Franchisees are the ones who get access to an established brand, a proven business model, and marketing and supply support. In exchange, the franchisor collects a front-end fee, ongoing royalties, and the ability to increase brand recognition and market share on a larger scale.
Entering into this relationship, either as a franchisor or franchisee, has many legal implications. The documentation, including the franchise agreement and the disclosure documents (regulated by the Federal Trade Commission). Whether starting a franchise or buying into one, talk to a franchise attorney about these important documents.
Inadvertent Franchising: How the FTC Defines a Franchise
One of the biggest misconceptions is that an idea can be patented. Even a Yahoo or Google search about patenting an idea will lead people to believe that this is the case. Often, I will have a creative mind book a consultation with me to discuss patenting an idea for an invention. Truth be told, their ideas usually are very good ones. However, they have no idea how to make or build this invention. For example, if someone told me that a great invention would be a machine that would stop world hunger. Although it’s a fantastic idea, unless this inventor knows how to build one, there is no patentable subject matter.
Building a business so successful that others want to emulate it is the ultimate American Dream. However, going big has its restrictions. Even without formally calling it a “franchise relationship,” if the arrangement walks like a franchise, and talks like a franchise, chances are….
The Federal Trade Commission (FTC) defines a commercial relationship to be a franchise when:
- the franchisee is permitted to use the franchisor’s trademarks;
- the franchisor has the ongoing right to control significant aspects of the franchisee’s operation; and
- as a condition to continue this relationship, the franchisee pays the franchisor.
When a business relationship falls under this franchise relationship, the FTC requires that the franchisor discloses specific information to the franchisee. The items to be disclosed are outlined in 16 CFR 436.
Items Required in the Franchise Disclosure Documents
The Federal Trade Commission requires that a franchisor provides potential franchisees with Franchise Disclosure Documents compliant with 16 CFR 436 at least 14 calendar-days before the prospective franchisee signs a binding agreement with, or makes any payment to, the franchisor.
The itemized list of information franchisors are required to disclose to potential franchisees are:
- The Franchisor and any Parents, Predecessors, and Affiliates
- Business Experience
- Initial Fees
- Other Fees
- Estimated Initial Investment
- Restrictions on Sources of Products and Services
- Franchisee’s Obligations
- Franchisor’s Assistance, Advertising, Computer Systems, and Training
- Patents, Copyrights, and Proprietary Information
- Obligation to Participate in the Actual Operation of the Franchise Business
- Restrictions on What the Franchisee May Sell
- Renewal, Termination, Transfer, and Dispute Resolution
- Public Figures
- Financial Performance Representations
- Outlets and Franchisee Information
- Financial Statements
- Franchise Agreement
Important Lessons Before Becoming an Entrepreneur
Many individuals starting their first business first look to friends as co-founders. What could possibly go wrong? You know your friend well, have socialized with him or her for years and the kids go to the same school. But do you really know the “business side” of your friend? Before you act, it is a good idea to take a step back and assess your decision before embarking in a new business with them. Would you want to work with this person if they were not your friend? Also assess your friendship. Are they trustworthy and loyal? Will they help broaden your network to help with the amount of connections you will have for your business. Having individuals above you to learn from is also important, as well as building a business with people who will be dedicated to work full-time. You have to convince individuals to take a chance on your by selling key positions within the company.
Assess the work style of your potential partner and whether it is a good match for you. Assess their aversion to risk and their willingness to take a leap of faith. Do you both have the same passion to succeed? Are you equally situated financially? After you think through these questions, talk to a lawyer to determine what type of business structure you need to put in place – an LLC, a corporation or a partnership?