Franchising and the Law
Franchising brings considerable benefits for both the franchisor and franchisee. For the franchisor, it is a route to expansion without the investment costs of the conventional model. For the franchisee, it is the opportunity to start a business without the risks involved in a traditional solo start-up.
Setting aside the excitement briefly, take some time to consider the practical realities that will accompany you on your journey. The relationship between franchisor and franchisee, if it works out, will be mutually beneficial, but it is built on a deep and complex bedrock of legal agreements. You may have heard of due diligence as the key factor in company mergers and acquisitions, and this is no less important for the franchisee.
Franchising is regulated by the U.S. Federal Trade Commission, and the laws in this area relate to three areas: disclosure, registration and relationship. Disclosure requirements are set down in federal law, but provisions for registration and relationship fall to the jurisdiction of state law, which means there are many variations across the country, although the principles are effectively the same.
Two documents are central to any franchise arrangement: the Disclosure Document and the Franchise Agreement. Let's consider each one.
The Disclosure Document is generally a long and complex document designed to give you all the information you need to make the decision to go ahead. It gives you the background on the franchisor company itself and of all its key personnel, its directors and anyone who plays a significant role. It will outline the startup and running costs you’ll be expected to find, in addition to identifying the kind of training and support the franchisor undertakes to provide. It will disclose details of any unpleasant incidents in the past, such as bankruptcies, litigation, civil action or convictions – and that covers the controlling individuals as well as the company itself.
It also lists the franchisor’s assets – not just physical ones but also trademarks and any intellectual property rights – and gives a lot of financial detail on the company’s overall performance in recent years, its profits, losses, liabilities and earnings. It may also specify anonymous examples of the performance of the franchisees for the sake of comparison. It will also give contact details for all other franchisees, past and present.
It’s a difficult document to understand and assess, which is why it’s worth paying for professional legal and accounting advice to make sure you follow it. Lawyers, accountants and franchise consultants can all offer you the knowledge and insights you’ll need and may even suggest points of negotiation. What it also gives you is a degree of insight and detail you could never hope to have in a traditional startup.
Reviewing the Disclosure Document
You’ll generally see the Disclosure Document once talks with the franchisor have gotten serious. Your lender will probably want to see it, too. Once you’re happy with it, you may find it’s worth contacting some of the franchisees listed because you could learn a lot from their experience that isn’t contained in facts and figures on paper.
Your work isn’t done yet. Up next is the franchise agreement. It may be shorter, but it’s every bit as important because while the Disclosure Document tells you everything about what you’re getting into, the Franchise Agreement is what cements your relationship with the franchisor and bestows rights and imposes obligations on both parties. It is a legally binding contract, and like all contracts, it seeks to clarify and protect all the positive aspects of the relationship while simultaneously legislating for what happens if something goes wrong, such as a violation or a breach of duty. It contains precise guidelines for the conduct of both parties in terms of day-to-day operations as well as the use of the brand name and site maintenance.
Get Legal Advice
It’s one of the most significant legally regulated relationships you’re ever likely to enter, so it would be wise to seek the best legal advice you can find before proceeding. That said, the right franchise is potentially the most lucrative decision you will ever make.