The Accidental Franchisor

Open Season
If, in fact, you are a duck operating without proper documentation, the fines and remedies can be substantial. Under the FTC Act, the FTC has the right to seek both preliminary and permanent injunctions against rule violations and can, in effect, ban you from franchising. They have the power to freeze assets both at the corporate and personal level. Civil penalties of $11,000 per violation can be assessed (the largest civil penalty in a Franchise Rule case to date is $870,000). In addition, the FTC can seek monetary redress on behalf of those injured by Franchise Rule violations (the largest "consumer" redress to date stands at $4.9 million).

While there is no "private right of action" under the FTC Act (franchisees cannot sue you under the act), there is more bad news to be found in the FTC Rule: "Franchisors and their key officers and executives are responsible for violations by persons acting in their behalf, including independent franchise brokers, sub-franchisors, and the franchisor's own sales personnel."

State laws can add to the damage. First of all, franchisees will have a "private right of action" under many state laws, and can thus sue you for damages without having to wait for the FTC to step in. In addition, these state laws will also provide for various incremental fines and redress. In some states, violation of their various franchise laws can even be a felony.

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So Why Aren't Ducks an Endangered Species?
After reading through the first half of this article, it's a wonder why anyone would want to be a franchisor. Multimillion-dollar fines and felony convictions aren't what most entrepreneurs dream of when they go into business. But the fact remains that franchising remains one of the most robust sectors of the economy today, with continued explosive growth and more new, successful franchisors joining the market every day.

So how do you sleep at night as a franchisor?

The fact is, being a franchisor isn't all that difficult or scary--if you do it right and seek qualified legal counsel. In order to operate as a franchisor, you must simply develop a Uniform Franchise Offering Circular (UFOC) and register that document in the appropriate states based on your expansion strategy. You must then follow a fairly simple set of rules governing the sale of franchises that include:

1. Presenting the UFOC to a prospective franchisee when you initiate your conversations about the sale of a franchise (usually at the first face-to-face meeting). You must not have any serious conversations with prospective franchisees without taking this step.

2. Waiting 10 business days between the time you present this document to your prospect and the time you sign an agreement or take money from your prospect.

3. Limiting what you say on certain matters (earnings claims, etc.) to what you have included in your UFOC, and, of course, always being truthful and forthright in any franchise sales presentations.

And while there are other compliance and documentation issues you'll need to be aware of, the process is fairly simple.

Start by developing a strategy for your growth. If your growth strategy involves third parties, don't worry so much about whether or not it's a franchise, but instead address the key elements of the relationship. How will you be compensated? Will the third party use your brand? How will you control quality?

The next critical step is to hire an experienced franchise attorney. (This holds true whether you want to be a franchisor or want to avoid triggering franchise laws.) Experience doesn't mean an attorney who has worked with franchisees in the past or has reviewed UFOCs for prospective franchise buyers. It means an attorney who has specialized in the development of UFOCs and the registration of franchises for at least five to 10 years. Even if the attorney is at a big firm, ask him or her directly how many years he or she has specialized in representing franchisors. This is a vital step. (For more information on finding a franchise attorney, contact the American Bar Association and the International Franchise Association, and read this article on finding the right advisors.)

Once you've retained your attorney, developed the appropriate legal documents and registered your franchise offering (if necessary), you must make sure you train your staff on the intricacies of franchise sales and franchise compliance. Finally, on an ongoing basis, make sure you audit your staff's performance to ensure they continue to operate safely within the law.

Follow these steps, and you should be able to fly safely above the hunters. Ignore them, and you can quickly find yourself spiraling toward the cold waters of the pond below.

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