This document is provided for informational purposes only. The contents of this document do not constitute legal advice.
What is franchising?
Franchising is a way for a business owner to expand a business. The business owner, or franchisor, licenses independent franchisees to use the business name, logo and method of operation to sell a particular product or service. In return, the franchisee is generally required to pay the franchisor a franchise fee and ongoing royalties. Franchisors generally provide franchisees with pre- and post-opening training.
What kinds of businesses can be franchised?
Many types of businesses can be franchised. Franchised businesses may sell products or services, at retail or wholesale, from a storefront or from home. Examples of franchised businesses include fast food restaurants, bakeries, printing services, construction firms, hotels, furnishing outlets, pharmaceutical companies, cleaning businesses, restaurants, and fitness centers.
Franchisors – Does it make sense to franchise my business?
A franchise offers you the opportunity to expand your business without being responsible for the day-to-day operations of each new business location.
Because the franchisee is spending the time and money to establish a location, expanding a business by franchising can help grow a business concept faster and often more economically than other methods of business growth.
An individual buys a franchise because they believe that they have a better chance of success than starting a business from scratch. The franchisee expects that the franchisor will increase their odds for success. In considering whether or not to franchise your business, consider the following:
- Is your business financially successful?
- Is it easy for someone else to acquire the skills necessary to operate and promote this business?
- Is your industry growing or stable?
- Do you have experience in operating multiple locations?
- Is the franchise easily fundable? Can the buyer obtain funding from commonly available sources?
- What, precisely, are you offering the buyer? Will you still have something to offer once their business has been in operation for a while?
- Is there a sufficient profit margin in this business to profitably support the franchisee and to pay you a franchising royalty?
Franchisors – What are the drawbacks to franchising?
As a franchisor, you do not have the complete control over a franchised location that you would with a company-owned location.
Also, not all business concepts are suitable for franchising. Factors to consider: marketability of the business in other geographic areas, the presence or absence of competitors, the ability to replicate your business model successfully, and your capacity to train and support your franchisees.
Franchisors – Are there ways to expand my business other than franchising?
Yes. Depending on your revenue goals, your need to maintain control over your business, and your marketing plan, you may want to explore alternatives, such as licensing, distributorships, business opportunities, multilevel marketing, sales agencies, partnerships, or joint ventures. Different laws – many of them varying from state to state – govern these forms of businesses, so even if the initial start-up work and associated costs are less than establishing a franchised business, the legal risks may be greater. NB Uniform federal franchising laws often remove uncertainty and make franchising a better choice.
Franchisees – Should I buy a franchise?
If you want to run a business, buying a franchise allows you to own and operate a business using a proven concept and established name, rather than trying to build a business from the ground up. Additionally, instead of learning how to run a business through trial and error, as a franchisee, you will be provided with the tools and training necessary to setup and run the business successfully. Before deciding to become a franchisee, however, you should consider many factors, including your prior business experience, your knowledge of the particular industry in which the business will operate, your financial resources, the amount of competition in the area, and your tolerance for business risk. NB Even an established franchise does not guarantee the franchisee’s success.
Franchisees – What things should I do before I purchase a franchise?
Perform due diligence (research all available information on both the franchisor (including the names of all franchisor officers and owners) and franchise system) before purchasing any franchise. Obtain a copy of the franchisor’s disclosure document (FDD). The FDD describes key provisions of the franchise agreement and also provides important information about the franchisor.
- Speak with as many franchisees as possible, including franchisees recommended to you by the franchisor as well as those that were not.
- Is the FDD current? An FDD expires after a year. You should insist upon seeing the currently registered version.
- Study the audited financial statements, particularly the most recent one. By studying the financial statements, you should be able to determine how successful the franchisor is and how successful its existing franchisees are. Question any aspect of the statements that aren’t clear to you. Ask your accountant to review them and provide feedback to you.
- Prepare a business plan. Be as realistic as possible with your projections. Get actual numbers whenever possible. Ask your accountant to review the plan and provide feedback.
- Check references. Phone or visit both current and prior franchise owners. Ask probing questions.
- The FDD is a very important source of information, but it is not the only source. For example, information regarding the franchisor and the franchisor’s officers and owners usually can be found by searching the Internet and using public records search services.
Who regulates franchising?
Franchising is regulated by the U.S. Federal Trade Commission (FTC) and by various state agencies. The FTC Franchise Rule applies everywhere in the U.S., but a state’s franchise laws usually apply only if the offer or sale of a franchise is made in the state, the franchised business will be located in the state, or the franchisee is a resident of the state.
With regard to state law, although some states have enacted franchise laws, many have not. Where states have enacted laws, the laws fall into two broad categories: “sales” laws and “relationship” laws.
“Sales” laws govern the offer and sale of franchises. They do not govern the ongoing franchise relationship between the parties. “Sales” laws generally provide prerequisites that a franchisor must meet before it offers franchises in the state. For example, they may require the franchisor to register its franchise offering in the state or to file its franchise documents with the state. They may also require a franchisor to file advertising material with the state, or they may require a franchisor to give state-specific disclosures, in addition to the disclosures The Rule requires, to a prospective franchisee.
“Relationship” laws govern the ongoing franchise relationship between the parties; e.g., they regulate matters like the franchisee’s right to renew the franchise, the franchisee’s right to transfer the franchise, discrimination among franchisees, breaches of the franchise agreement, and termination of the franchise.
What is a Franchise Disclosure Document (FDD)?
The FTC governs franchising. The FTC Rule requires that franchisors provide potential franchisees with a Franchise Disclosure Document (FDD). Before a franchisor is legally permitted to sell a franchise, the franchisor must comply with certain rules by the FTC and/or statutes enacted by the state the franchisor is selling from or the state the franchisor is selling into. The purpose of these rules and/or statutes is to require the franchisor to information for the franchisee to use to make an informed decision about whether or not to purchase the franchise.
What information does an FDD contain?
The Franchise Rule states what must be disclosed and provides its own disclosure format. It is published in the Code of Federal Regulations, Volume 16, Part 436 (16 CFR § 436), which may be found by link to the following page: www.ftc.gov/ogc/about.shtm
The FDD is similar to a securities prospectus in that the purpose is to provide sufficiently accurate information so that you can make an informed investment decision. Among the items of information contained in the FDD are the history of the franchisor and its founders, information about the types of products offered under the franchise and the general condition of the marketplace for those types of goods, a description of the initial franchise fees and all other fees you will pay during the course of the franchise relationship, a description of the kinds of assistance the franchisor will supply to you, an explanation of the system standards for advertising development and placement, site selection and build-out and computer systems.
The FDD also details the size and scope of the territory granted to the franchisee and will discuss the rights retained by the franchisor. Franchisors may choose to disclose information relating to the financial performance of the franchise system or franchisees operating within the system.
Where can I get a company’s pre-sale disclosures?
Thirteen (13) states (California, Hawaii, Illinois, Indiana, Maryland, Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, Washington and Wisconsin) keep franchise offering circulars on file, and 23 states require business opportunity disclosure filings. The Franchise Rule requires franchise and business opportunity sellers to provide to prospective purchasers a disclosure document. A total of 13 states keep these on file, and 26 states require business opportunity disclosure filings. Most states provide copies of these disclosures, usually by allowing visitors to their offices by appointment to review or copy the documents.
A few private companies may make franchise disclosure documents filed in one or more states available for a fee. The FTC doesn’t support or endorse these companies:
1665 North Fort Meyer Dr., Suite 410
Arlington, VA 22209
101 Executive Boulevard, 2d Floor
Elmsford, NY 10523
Also, consumers searching for franchise documents may wish to check an online database maintained by the California Department of Corporations, known as Cal-EASI: visit site.