In simple terms, a franchise is a license agreement from the franchisor to a third-party, the franchisee. The franchisor licenses its trademarks, business know-now, and trade secrets to the franchisee for operation of a uniform business by the franchisee. Famous franchises include McDonalds, 7-Eleven, Re/Max, Great Clips, Twin Peaks, and Anytime Fitness. However, there are also thousands of smaller franchises across the country in many industries, including restaurant concepts, commercial and personal services, entertainment, and event planning. Franchising is a very popular business model in the United States, and it continues to gain popularity all around the world.
What is a “franchisor”?
A “franchisor” is the franchising business entity that owns the rights to license its trademarks, trade secrets, and general business know-how. A franchisor is typically the owner of the franchise concept; it then licenses the trademarks and business know-how to third-party independent business owners. Franchisors or its affiliates may also operate corporate-owned locations, and should generally direct and monitor the franchise business for quality control purposes.
For access to proprietary information and business format, franchisors charge their franchisees franchise fees, including an initial fee, and on-going royalty fees and marketing fees.
What is a “franchisee”?
A “franchisee” is a third-party, independent business owner who obtains a license from a franchisor to operate a franchised business. This relationship is governed by a franchise agreement, which is a binding contract that lays out the terms of the franchise relationship, and the rights and obligations of the franchisor and the franchisee to each other.
What is an FDD?
A franchise disclosure document, or FDD, is a federally required disclosure document that most franchisors must provide to potential franchisees. The contents of the FDD is governed by the Franchise Rule, which is enforced by the Federal Trade Commission. In addition, each state has its own rules and regulations, typically under its business opportunity statues, specific franchise laws, or relationship laws, which may require certain additional disclosures in the FDD.
In summary, in order to franchise, a franchisor should have an FDD to disclose to a potential franchisee. There are exceptions; some very large franchisors are exempt from this requirement.
Why is the FDD useful?
The FDD is a very useful document that can be used to get a glimpse of the franchise system. It contains the basic information necessary to determine whether the franchise opportunity is right for you and if doing business with the franchisor is a viable opportunity.
It can help you do research one or more franchise opportunities in a certain industry, help you ask better questions, and negotiate a deal that works for you. Additionally, the FDD gives information so that you can contact existing franchisees and speak with them about their experience in the franchise system which can be critical to understand the value of the business, the risk factors, and the culture of the franchise.
What is a Franchise Agreement?
The franchise agreement creates the contractual relationship between the franchisor and franchisee and lays out the obligations of each party. It establishes the framework for the franchised business relationship, and along with the operations manual, instructs the franchisee on how to adapt the franchisor’s business model for his or her local market. While many a franchisors claim that they “never make changes to their franchise agreement,” a good franchise attorney can often help you negotiate some reasonable terms that are helpful when committing to a long-term business relationship.
“Business in a Box”
Many franchisors sell their franchises as “business in a box,” promising to provide you with all the necessary tools, products or services, training, and information to get you running as a turn-key operation.
In realty, every franchisee should remember that starting any business — including a franchise — is not easy. The difference is the trademark license, basic guidelines on getting your business off the ground, training and coaching, and consistent operations during the term of the franchise. While these things are valuable, and can save you time and money along the way, you still have to put in a lot of hard work, and there are no guarantees that franchising will result in a successful business.
What a Franchise is Not.
A franchise is not a multi-level-marketing scheme, pyramid scheme, direct marketing, or any other type of business relationship where a series of third-parties receive a commission for the sale of goods or services. While franchises are considered a “business opportunity,” requiring registration under certain states’ business opportunity laws, a distinguishing characteristic of a franchise is the required disclosure by the federal Franchise Rule. Just like with any business opportunity, there are fraudulent opportunities masquerading as franchises. If you are ever in doubt as to the validity of a franchise opportunity, contact your franchise attorney.
Do your research.
Franchising can be very successful. It can provide you with a bit of independence, and some peace of mind knowing that you have a framework (the franchisor) in place to help you if you have issues in your small business. You also benefit from the name recognition associated with the trademark, which will grow in value as the franchise system expands. However, all business ventures come with risk. You can also lose money, the business can fail, or the franchise you bought could have been fraudulent. Therefore, it is very important to do your research when buying a franchise. Not all franchises are the same, even ones in the same industry.
Farheen Ibrahim is a business lawyer who writes on various business trends, including franchising, employment, and dispute resolution. She is a partner at Canada Lewis & Associates PLLC, and can be reached at firstname.lastname@example.org and here.
The contents of this article do not constitute legal advice, nor does it create an attorney-client relationship with Canada Lewis & Associates PLLC.