What is a Franchise?
The legal definition of a franchise comes from the Federal Trade Commission through Rule 436, amended in July 2007. It defines a franchise as a business relationship with three primary components:
- The use of a common name or trademark
- The presence of significant operating assistance or control of a prescribed method of operation, including such things as procedures, practices, and techniques
- A required payment by the franchisee
It is important to remember here that regardless of what someone may wish to call a business relationship--whether it's distributorship, joint venture, or business opportunity--the FTC will tell you that if it walks like a duck and quacks like a duck, it is a duck and therefore is subject to regulation as a franchise. Failure to observe federal and state franchise regulations can subject you to severe fines and even felony convictions. And infractions must be reported in your disclosure documents for 10 years, something that can seriously hamper your future franchise sales activities.
When one well-known franchisor was in its infancy, one of the principals was meeting with what he thought would be a dealer in California, and he had taken a check to cover the dealership fee. But his partner was back at the office reading up on franchise law and put in a frantic call to his eager colleague telling him to return the check and come home. A visit to a qualified franchise development consultant shortly afterward helped them develop a proper franchise program, which they then registered with the appropriate state authorities. They now have a network of 200 franchise locations plus 20 company stores, but if they realized their mistake back when they started, they could have been barred from franchising for life.
More than one entrepreneur has fallen into the trap of becoming an accidental franchisor and rued the day. So if your plans include expansion in any way through third-party investors, you are strongly advised to engage the services of an attorney experienced in franchise law.
Getting Started as a Franchisor
Developing a franchise program does require an investment of time and funds, but the cost of the services of professional advisors to get you going the right way is often less than the cost of opening one additional company store. Let's take a look at the elements of a good franchise program:
The protoype: One of the primary ingredients for a successful franchise program is a proven prototype. While it's not a legal requirement, it is the best possible illustration that you have something of value to offer. The legal by-ways are littered with the sad stories of hotshots who thought they could sell franchises based only on an idea. One company I know of was formed by a trio of professionals: a lawyer, an experienced advertising executive, and an operations person. They believed they could create the perfect franchise concept despite the fact that none of the three had worked in the particular field they had in mind: the alteration of clothing in a shopping mall storefront. It just seemed like a good idea. They spent hundreds of thousands of dollars starting up and operating a prototype, creating glossy franchise marketing pieces, and memorializing store procedures in an operations manual. There was just one problem: The store was not profitable. This team was sunk before they even got started.
The lesson? There's nothing like a successful prototype to show your prospects something real, that they can experience and appreciate first hand. A successful prototype is a real-life example of the possibilities of your business. An active, exciting operation allows prospects to paint themselves into your picture. But beyond a demonstration of the viability of your concept, an original location can also become a live training center for future new franchisees and a testing laboratory for new products, services, or techniques.
Documented systems: A direct offshoot of a functioning prototype is the documentation of how the business operates--in other words, the written procedures that memorialize your methods and that will become your textbook for training new franchisees.
These procedures become your operations manual, a valuable document that should cover everything from startup activities to marketing, office procedures, and personnel management--everything that makes your business what it is. Illustrations, tables, and lists help make this kind of information lively and accessible. Depending on the depth and talents of your home office staff, you may be able to create much of the manual yourself, but you may need assistance from professional technical writers who know how to create procedures that are easy to read and follow and that will avoid getting you into legal hot water. At the very least, be sure to have this document reviewed by a competent franchise consultant as well as an experienced franchise attorney.
A protected trademark: One of the most valuable assets of a franchise program is a protected trademark. A trademark represents the brand--the whole identity and mystique of the concept. Failure to protect a trademark is a typical mistake made by new franchisors, so the first task is to develop a name that can be protected--that is, one that isn't in use by anyone else so it can be approved by the U.S. Patent and Trademark Office. Securing a registered trademark is an easy but tedious process that can often take a year or more to complete. But while many companies will begin franchising before their trademark is fully registered, you will certainly want to have at least begun the process. Your rights to your trademark vest on the date you file the trademark application, and without this protection you will be throwing away marketing dollars--and throwing a monkey wrench into any plans to franchise.
You'll want to find yourself an experienced trademark or intellectual property attorney to do the recommended search and application process for you. It's not a very expensive project--perhaps a couple of thousand dollars--but it is worth every penny. And until you are awarded the coveted R symbol, you can use the TM symbol to let the world know that you are protecting your mark.
Marketing materials: While your legal documents are being developed and submitted to states for required review and registration and your operating methods are being developed into training materials, you will also need to develop the marketing tools that will help you sell your franchise opportunity. You will want to engage a franchise development consultant who has experience designing the powerful sales tools necessary to put your business in the best possible light. These tools will most likely include a franchise brochure, perhaps a DVD that introduces your concept and company to potential investors, and training on franchise sales techniques, including the proper way to disclose prospects and how to avoid pitfalls like making illegal financial performance representations.
Of equal importance, you will need to develop a marketing plan to optimize your franchise advertising budget and ensure that you will generate an adequate number of franchise leads to meet your franchise sales goals. Again, there is no substitute for experience here. With literally hundreds of web sites and publications targeting franchise prospects, you will need to spend your money wisely. You will need to carefully track the results of each medium to see what works and what doesn't so you can adjust your plan as necessary. You will be well advised to seek the counsel of development professionals who can help you make the right decisions--particularly at first, when you need to make crucial decisions before you have much experience.
The Franchise Disclosure Document: Franchising starts with the development of a Franchise Disclosure Document, or FDD, that must be prepared according to strict guidelines. It will outline your offering, your business history and the resumes of your principal officers, and it will report your financial preparation for franchising. The FDD needs to be submitted and approved by the various states that regulate franchising before you ever even speak to anyone about your program. The intent of this requirement is to protect potential investors from shady operators by requiring franchisors to disclose their credentials. Included in the FDD is a copy of the actual franchise agreement, along with any other contracts that you will execute with your franchisees.
It is important to note that many of the topics covered in your legal documents will be business decisions, not legal ones. For example, what will your franchise fee be? How much royalty will you need to support your franchise company? What advertising will you require? Will you establish and contribute to a national consumer marketing effort? What will the franchise term be: five years? 10 years? Longer? Will you have renewal provisions? How much training will you offer? How big will an individual territory be, and how will it be defined? Will you offer area development rights? These documents contain all of the key decisions that you will live with for years.
Because of the importance and lasting effects of these decisions, you will want to work with an attorney who specializes in franchise law. It is recommended that new franchisors prepare a detailed business plan--often with the assistance of a professional franchise consultant--that will document these business decisions before legal documents are drafted. Your plan should include a realistic financial analysis that will test a variety of options for fees, royalties, territory size, organizational structure and growth options before these details are finalized.
When you are ready to get your legal documents drafted, you will again want to work with an experienced franchise attorney. While this may sound like a difficult or expensive task, a well-prepared FDD is the foundation of a solid franchise program. And using an experienced attorney is often less expensive that paying an inexperienced attorney to learn on the job.