winning with Franchises

Copyright 2006 by Catherine Cary

How many are winning with franchises today?  The numbers are impressive.  It is estimated that there are over 400,000 franchise outlets in the United States generating almost $150 billion in annual sales.

With those numbers the question becomes: Is franchising right for you?  Which is followed by the second question: Are you a Franchisee or a Franchisor?  This article will explore both issues.  In Part I, we’ll explore signing up as a Franchisee and in Part II, we’ll discuss starting your own business as a Franchisor.  In Part III, we’ll look at what is in a Uniform Franchise Offering Circular. 

Part I – Becoming a Franchisee

Franchises are so ingrained in our society that many may not even realize that they are purchasing goods or services from a franchise.  While your favorite fast food restaurant is a Franchise. You may not know that your favorite hotel, clothing store and work out center/spa are Franchises.   Clearly, franchises are successful business models.  And they are here to stay. 

Franchises have come a long way from infancy starting with car dealerships and gas stations.  There are now a wide variety of franchised businesses.  Chances are much greater now that you will find a franchise that fits not only your personality but also lifestyle and budget. 

The beauty of franchises is that you can buy into a proven system, use the Franchisor’s know-how and not have to reinvent the wheel when you start your franchised business.    The Franchisor should train you, show you how and show you what sells based on their past experiences. 

Yes, you do have to put some money up front to purchase the grant to use the Franchisor’s system, trademarks, knowledge and the like.  Of course, in addition to the up-front fee(s) there are monthly or yearly costs and percentages of sales costs associated with owning a Franchise.  But remember, you would have had to put up capitol if you were to start your own business anyway.    And hopefully, those ongoing costs are worth the brand recognition, shared volume buying power, proven business operation standards and all of the uniformity factors you can achieve with a franchise.  

But remember this: You still own a business.  Like all business adventures, you have to stay on task.  You cannot just sit back and rely on the Franchisor to generate sales.  We’re talking about work here. 

Lets review some key points that prospective franchisees should be aware of when entering into the franchise relationship.  First of all, many states as well as the federal government require certain disclosures to be made in a written document, which is known as the Uniform Franchise Offering Circular (or “UFOC”). 

If the franchise business you are considering can’t provide you with a UFOC, you should continue your search.  A UFOC is just the starting point for franchising. Failure to have one prepared means that the Franchisor is not following basic legal requirements.  You don’t want to do business with such a company. 

If the UFOC is prepared you need to read it carefully.  A great deal of important information can be learned from it.  You may want to have your attorney or other advisor review it as well.  Another pair of eyes on a fairly technical (and sometimes intentionally boring and sleep inducing) document is an excellent idea. 

After a close reading of the UFOC, you may want to write down a list of your skills, goals and your financial capabilities.  Ask yourself, do you have the technical know-how or education to run this type of franchise.  Is it something that that can be learned from the Franchisor?  Do you have the financial resources or money to invest in this type of venture?  And if so, how long can you run the franchise with out a steady income to live on while the business is growing?  Is this list of goals truly what I want to do and will the franchise fulfill these goals? 

Next, do some research on the type of business you are about to buy into.  What is typical, standard or customary in the industry and does the franchise system adhere to this standard? 

Look at the Franchisor.  A lot of background information will be (or at lest should be) in the UFOC.  But you may want to double check and deem whether the information provided is accurate.  Are these actually federally registered trademarks you will use in the franchise business?   Is the business truly qualified to sell franchises or conduct business in your state? 

Next speak with both current and former franchisees.  Speak with several of them and not just one current and one former franchisee.  Ask current and former franchisees about their thoughts, trials, tribulations, and resulting economic status.  You may wish to follow up with the Franchisor on what you found; especially if it was questionable information.  

Discuss your franchise opportunity with professionals.  Seek an attorney’s advice on the requirements that are particular to your state.  Go to an accountant or CPA to have them crunch the numbers.  How long will it be before you recoup your investment? 

With due diligence on your part and with the help of an advisory team, you will be better prepared to make the right choices when buying a franchise. 

Part II – Becoming a Franchisor     

Becoming a Franchisor is not one to take lightly but the rewards can be significant.  When becoming a Franchisor, one must plan, plan and do some more planning to start the whole process of developing a franchise.  A Franchisor may be a small start-up that has found a system that can work as a “franchise” or someone whose mature business has “franchising” in mind from the start.  Please keep in mind that while there are strict and demanding rules that govern this type of venture, starting a Franchise is not impossible.  Certainly others have done it before you.  

First, ask yourself is what I wish to do truly a “Franchise?”  There are three legal elements that would indicate that you do indeed do have a franchise.  You need all three of these elements in your business plan to constitute as a “Franchise.”  If one is missing, you do not have a franchise.    If you have the following elements you have a Franchise: 

1.  You require someone to follow your marketing scheme, you exert significant control over the other party in the agreement or you have some interest in this person’s/entity’s business;

2.  You have a trademark that will be licensed; and

3.  You are charging a fee that is $500 or more within the first 6 months of the agreement.   

These last two legal elements are the same required across the board, be it on a federal or state level.  However, the first legal element’s definition or interpretation can and do differ from state to state.  The best way to determine if your business system truly satisfies all three elements is to check to check you state’s rules.  I am sure your legal advisor would be willing to see if your proposal qualifies as a “Franchise.”  Why this third element can be confusing is that some state laws may define this element differently.  One state may define this third legal element as a “Community Interest” whereas other states would be define it as a  “Marketing Plan.”  “Community Interest” can have a much broader definition than just having a marketing plan.   “Community Interest” may mean that there is an on-going, interdependent relationship between the parties of the agreement.  For example, you have a situation where you and another person/entity have a community of interest in the marketing of goods/services either by lease, agreement or otherwise thus you may have “Community Interest” if that states definition is worded as such.   Keep in mind some states may also have these legal elements divided into 4 elements and so on. 

As a Prospective Franchisor, you must be aware of a number of considerations, not all of which are covered here, when starting a franchise.  Many states require certain procedures to be followed and disclosures to be made in the franchise offering.  For example, you must register the Offering first before offering the franchise to any prospective franchisee in the State of California.  On the other hand, Nevada, next door, does not require the Offering to be registered.  Laws vary from state to state and will change even after the printing of this ebook. 

As a Franchisor, it is always best to contact a franchise lawyer when you intend to enter into this type of business venture.  A lawyer specializing in this area on the proper disclosures for the state you intend to offer a franchise in is highly advised.  Both state and federal law require proper disclosure. In fact, legal services to draft the UFOC, register the offering and drafting the accompanying agreements should be included in your business plan and start up costs.  It is money well spent.

As a Franchisor, not making the proper disclosures for the state you intend to offer a franchise can be problematic.  If you are missing the information for those items in the UFOC, get it.  Civil and criminal penalties can be levied if not all the required information in the Offering is present. 

Information about you, the Franchisor, must be placed in the Offer to sell Franchises.  The important information in the offering is discussed below in Part III.  As a Franchisor, you should read the above section for franchisees to get a feel what it is that they need to look for. 

Before starting, a Franchisor must have an established trademarks or franchise system.  This needs to be done, if it is not done already, prior to starting the Offer of franchises. 

Termination, transfer, renewal and non-renewal are all important elements of the Offering and the franchise agreement itself.  Any details on how, when, where, why, who and how the Franchisor wishes to terminate the relationship, transfer of the franchised business or renewal of the franchise agreement needs to be present in the Offer for it to be a valid offer as well as the franchise agreement itself.  

These issues can be problematic in that they deal with the potential loss of a Franchisee’s rights.  As the Franchisor, you must comply not only with disclosure laws but statutory and common-law rights that govern all types of agreements, not just franchise agreements.  Planning on the situation that would cause you to terminate a franchisee is important.  Some examples are:  when the franchisee becomes insolvent, the Franchisee is incarcerated for fraud, the Franchisee fails to pay fees, expenses, charges or other amount when due to the Franchisor, the Franchisees financial statements are understate or missing figures that constitute a percentage difference, the list can go on and on.   Regardless if you exercise your right to terminate or non-renew the franchise agreement in the future, it is important that you state these things to the Franchisee at the inception of the relationship.  If you do not states these conditions the Franchisee may be quite shocked that they are being terminated by you and potentially argue, “I had no clue that I could be terminated for that!”  If this issue goes to court, the court may sympathize with the clueless Franchisee rather than your reasons for termination.   

Something else to be aware of as a Franchisor is that you should prepare a franchise manual, a guidebook that assists the Franchisees in operating your Franchise.   To start, the manual assists the Franchisees with the Franchisor’s basic business plan, which will be beyond the initial training that Franchisees go through.  One can say that the manual provides a systematic approach to the franchise system and insures continuity of that system.  The Franchisee might turn to the manual first when a question arises.  By having a manual in place, hopefully the Franchisee is more aware of what you expect as well as cutting down on the possibility of disputes latter.  The manual can take many forms but it should contain such topics as operating procedure, employee/human resource policies, job descriptions, supplies, goods services provided, maintenance procedures, customer services, advertising and the like.  An example of what would be in the manual; the procedure to make the Franchised “signature hamburgers” would be contained in this book.  In sum, any planned marketing strategy, business system/methodology; advertisement materials and so on should be in this Manual. 

During the process of offering and selling franchises, some issues can arise that the Franchisor must be aware of.   One rule of thumb is to present the official offering to the prospective franchisee at least 10 business days prior to the signing of any documents.   You should stress that this is for their benefit and you appreciate their eagerness to enter into the franchise however it this rule must be followed. Another fact to remember is that any type of misrepresentation made by the Franchisor during the sale of a Franchise could result in adverse consequences, which would affect both the entity and certain individuals.  A misrepresentation can arise when the Franchisor claims that the prospective franchisee “will be making money hand over fist” when in reality there is no data to back up this statement or assertion.  As a Franchisor, you should always stress the above points with all of your Sales Agents. 

Once the Franchise System is established, franchises are sold and operated by Franchisees, you need to properly document and enforce your system, Trademarks and other proprietary issues.   By not doing this, as a Franchisor, you run the risk of losing your valuable rights, good name and in some cases your customer base.  Obviously, by having this some type of compliance program to enforce the System, this not only furthers your objectives but helps lessen the opportunities of franchisee litigation.  For example, evidence that you not only followed the agreements to the letter but that you consistently enforced and followed reasonable polices/procedures of the franchise system will assist in defeating a franchisee’s claim of wrongful termination.   Being consistent in your enforcement of the system is especially key when your franchisees are similarly situated.  One of the top contentions between the Franchisor and the Franchisee is that the Franchisor was not consistent in their enforcement of the system.

Establishment of a Compliance Committee or Franchisee Group may also be something to consider.  By having Franchisee input, you as the Franchisor can better assess what works and what doesn’t in the Franchise System.  This will also help insure that the Franchise System is properly enforced.  In some cases, it can ease termination of a franchisee if the Compliance Committee or Franchisee Group deems that the franchisee in question is not complying with polices and procedures.

As stated above, this is not an exhaustive list that qualifies as a valid Franchise.  With an advisory team and due diligence on your part, you will make the right choices when starting a Franchise.   

Part III – The Document Important to Both Parties           

The UFOC, short for Uniform Franchise Offering Circular, is a federally required disclosure document.    The UFOC should be offered at least 10 days prior to signing any documents or it could be in violation of your state’s laws.  The UFOC also should contain 23 items of information about the Franchise as well any agreements or other important details that assist a Prospective Franchisee in determining if this is the right Franchise for them.  If the UFOC does not contain the following items, please be wary as a Prospective Franchisee.  If you are a Franchisor, get this information in pronto!  

Item 1:  This contains foundational information about the Franchisor.  This section should contain information about the history and operations of the Franchisor, the franchise being offered and the type of competition that the Prospective Franchisee might face.

Item 2:  This section has important information about the individuals that make up the management of the Franchisor.  This section is in a sense a resume or curriculum vitae on each individual involved with the entity that is offering the Franchise. 

Item 3:  This section lists litigation that the Franchise entity may be involved with.  If you are a Prospective Franchisee, it is always a good idea to start with this section first.  As Prospective Franchisee, you can evaluate the Franchisor by the type of litigation they are involved with.  If the Franchisor tends to be sued for “breach of contract” time and again, do you really want to be a Franchisee?

Item 4: In this section, the Franchisor, its Directors, Offices and even its Predecessors must disclose any bankruptcy or reorganization under bankruptcy laws that they have been involved with.  As a Prospective Franchisee, is it a business venture you want to participate in if the Officers have bankrupt pervious ventures of the type of Franchise Offered?  Probably not. 

Item 5:  This section sets out the initial fees that the Prospective Franchisee must pay upon signing the agreements.  This section will also tell you what fee is refundable, what fee is not and method of payment.  The Franchisor should be aware that they might be required to provide their services first prior to receiving payment.  For example, the Franchisor may have to provide the training first before they receive payment for it.  Therefore, the Franchisor should anticipate having this money on hand prior to starting a Franchise and not rely on the Franchisee’s payments.

Item 6:  As a Prospective Franchisee, this section really tells what you are in for.  Here, the Franchisor provides all the fees that are involved with doing busyness as a Franchisee.  Fees such as annual royalty payments, annual license fees, rents or the like will be mentioned here. 

Item 7:  This section will list all the initial costs to get the franchise business up and running.  As a Franchisor starting a Franchise, this may be difficult to do at first.  However, once you receive the feed back form the Franchisee, you should be able to reasonably pin down these costs.  As a Prospective Franchisee, this section will help you estimate if you have the capital required to enter into the type of business venture. 

Item 8:  Here, this will inform the Franchisee what goods or services need to be purchased and from what designated source the purchase must be made from.  This section will also specify, among other things, the monetary benefit that designated source will reap when the Franchisee purchases the items or services from them. 

Item 9:  This section is important to the Prospective Franchisee because it lists all of the obligations to the Prospective Franchisee will have to perform under the franchise agreement.  The format of this section is that it states the obligation and then refers the Prospective Franchisee to the section in the contract or offering.  An example is it will list, if any, requirements for site selection and other pre-opening requirements of the Franchisee and refer the Prospective Franchisee to where it is listed in the franchise agreement or Offering. 

Item 10:  The terms of any financing the Franchisor may offer is listed here.

Item 11:  This section lists on the initial and ongoing support or obligations the Franchisor provides under the franchise agreement.  This will assist the Prospective Franchisee in determining if the Franchisor will be there to lend a helping had or if the Franchisor just sells the Franchise and leaves the rest up to the Franchisee to handle.    

Item 12:  This section describes any exclusive territory that the Prospective Franchisee may be granted.  Concerning the Prospective Franchisee’s location, the Franchisor will disclose here if it may establish company owned franchises or offer other franchises using the Franchisor’s marks, with or with out an ”exclusive territory” agreed upon.   

Item 13:  Here, the section lists the trademarks that will be licensed to the Prospective Franchisee and what actions the franchisee must take upon any infringement.  The trademark is an important asset to the Franchisor.  The trademark’s worth can be lost due to infringement issues if the Franchisor does not resolve them.  As a Prospective Franchisee, is that the case in your situation?  No matter what side of the fence you are on, your legal advisor would assist you with this determination. 

Item 14:  This section will list other propriety information of the Franchisor, including but not limited to patents and copyrights that will be licensed to the Prospective Franchisee.  The same concerns for a Prospective Franchisee in Item 13 apply here as well. 

Item 15:  This section discuses the Prospective Franchisee obligation to participate in the actual operation of the franchised business.  The Franchisor should think about whether they alloy a Franchisee operate the franchised business form far away.  The Prospective Franchisee should beware if they have to have direct involvement with the franchised business or if the can have a manager manage the operations instead. 

Item 16:  Here, the restrictions of what type of goods and services the Prospective Franchisee is to provide in the franchised business. 

Item 17:  This section explains the details terminating the relationship, transfer of the franchised business or renewal of the franchise agreement.  Although no one wants to anticipate something negative happening in a relationship, it is always a good idea for either party to be aware of and understands how, when, where, why, how and who can terminate, transfer or renew the contract. 

Item 18:  This section will inform the Prospective Franchisee whether or not the Franchise has any celebrity endorsements.  If it does, it should state how much the celebrity how much the Franchisor gets.  

Item 19:  This section will state what earnings claims are being offered.  As a Franchisor, do wish to state any earnings claims?  There are two modes of thought on this, one you state an earning claim and one you do not.  If you do not have this in there, there are no expectations that the franchise needs to live up to.  If at any time during the sales process of the franchise, and a sales person makes a claim, despite its absence in the UFOC, and that earnings claim is not realized then the franchisee has a legitimate earning claim complaint. So if you do have some type of earnings claim in place, make it as minimal as possible. 

Item 20:  Here, the Franchisor lists all franchised outlets, the current, prospective and terminated outlets.  This section will help the Prospective Franchisee understand the geographic scope or the franchised business.   

Item 21:  This section will contain the Franchisor’s financial statements.  These statements can assist a Prospective Franchisee if the Franchisor is operating is making money or losing it. 

Item 22:  This section states all the contracts or agreements included in the UFOC that the parties sign in order to enter into a franchise relationship. 

Item 23:  The last page of the UFOC is a detachable document known as the “Receipt.”  This is an acknowledgement that the Prospective Franchisee received the UFOC. This insures that everyone know that an offering was made to the Prospective Franchisee.  The Franchisee is aware that this was a proper Offering and the Franchisor was aware that this was a proper Offering. 

To sum up the UFOC, the above 23 Items should be included in the UFOC or Offering the Franchisor makes to any Prospective Franchisee.  Although important, the 23 Items are just a part of what you need to look at before you leap. 

What are the conclusions you can take away today before you leap into the world of Franchising? 

As a Franchisee, do your homework!  Do you have the skills for this type of franchise?  More importantly, is this franchise a business you wish to be a part of? Do the numbers add up?  From a legal and business standpoint, does this franchise fit you and your goals? 

As that Franchisor, do you have the trademarks and franchise system in place as well as the manuals to navigate that system? Are you in legal compliance with the state or states you wish to franchise in?  Do you have all your documents to start selling franchises?  

As with any venture, whether a Franchisee or a Franchisor, there are rules, procedures guidelines and information that needs to be sought.  If you keep in mind these basic franchise ideas and seek your own legal/business team, then you should be able to navigate the world of franchising and win.