Before Franchising Your Business, First Consider These Factors
Chair, Franchise & Distribution Practice Group
by Barry Kurtz
818-907-3006
Franchising is so much more than casual burger chains with drive through windows and dollar menus. It’s an industry that incorporates a wealth of blue and white collar services; distributes both high- and low-end products (consumables and non-consumables) around the globe; and provides the means for many first time entrepreneurs with the formulas to launch businesses successfully.
According to the International Franchise Association, franchises will generate over $700 billion in 2017.
While most people have a general sense of the structure of the franchise model, few realize the breadth of businesses that successfully employ the model, despite their interaction with these businesses on a daily basis.
Almost any successful business can be franchised, including those providing services in automotive, pet, business, personal care, real estate, and many other industries. They also include businesses selling products, whether the goods are foods, flowers, vehicles, clothing or other items.
However, franchising is not right for all businesses or business-owners. A certain mind-set is required to be a successful franchisor. Because the industry is highly regulated and laws vary state-to-state and country-to-country, starting a franchise requires the investment of a lot of heart and soul, as well as a lot of time and money.
Selling Franchises Means Starting Another Career
Keep in mind: selling franchises is a totally new and separate line of business.
For example, after selling her first franchise, the owner of a bedbug remediation service is no longer solely in the business of pest control; she is now in the business of selling franchises, too. To be successful, she will not only need to be able to sell the concept, but she will need to comply with all applicable laws and regulations relating to the sale of this type of investment, which is likely to be something that is outside of her wheelhouse. For these reasons, a business owner should evaluate whether the business would be right for franchising.
Franchising is regulated at the federal level by the Federal Trade Commission (FTC). In addition, many states have enacted franchise specific laws, and 13 states require franchisors to register before offering franchises within their states to provide additional protections to potential franchisees. These “registration states” have taken the position that franchise arrangements provide a greater potential for fraud, noting that franchise agreements are typically drafted by the franchisor’s attorneys and usually favor the franchisor.
Before offering franchises, the franchisor will have to prepare a franchise disclosure document (FDD) that complies with the FTC’s Franchise Rule.
An FDD is an offering prospectus that provides prospective franchisees with information pertaining to 23 specific items about the franchisor and the proposed franchise. The FDD must include, among other things, background information about the franchisor and its executives, fee and cost information, samples of the contracts franchisees will sign, and information about the franchisor’s trademarks and patents.
Franchisors will generally need audited financial statements to include in its FDD. The FDD will have to comply with the laws of any of the “registration states” in which the franchisor intends to sell. The franchisor must register in those states before selling.
Formula for Franchise Success Required
Franchises must be attractive to prospective franchisees. A franchisor’s business model is attractive if it is based on a concept that is sustainable in the marketplace. Franchises based on fad products or services rarely survive. To be sustainable, the concept must be unique enough to withstand competition and must be one potential franchisees are willing to pay to learn.
Other factors to consider include:
- Laws and regulations that are applicable to the particular type of business;
- Whether it is clear the concept will be profitable for both the franchisor and its franchisees;
- Initial cost of creating the franchise;
- Length of time it will take to achieve success;
- Rate at which the franchisor can reasonably expect to expand; and
- Franchisor’s ongoing ability to ensure its franchisees will be supplied with the inventory, supplies and equipment they require to operate.
Franchising is a proven means for successful businesses to expand, but choosing to franchise one’s business is a decision that must be well considered.
In some cases, a business owner looking to expand may be better off selling licenses or distributorships instead of franchises if it is legally possible to do so. An experienced franchise attorney can help answer those questions.
Barry Kurtz is a California Bar Certified Specialist in Franchise & Distribution Law.