Published for the
Clients and Friends of Zegarelli Associates Professional
We must begin this issue by thanking you for your
loyalty and patience during our period of transition and
expansion, which is now complete. We did our very best to ensure
that we continued to serve you in the highest-quality manner
during the transition.
Like you, we understand the complexities, challenges and
responsibilities of growing a business. Of course, if it were any
other way, it just wouldnt be fun.
Like you, we represent the entrepreneurial spirit.
It Right For Your Business?
Thinking about franchising in 1996? The following is a
nutshell summary of points you need to consider in deciding
whether a franchise is right for your business:
1. Franchises Generally. In short, franchising is
essentially a contractual relationship for marketing and
distributing the goods and services of a company (the
"franchisor") through a network of distributors (the
"franchisee"). The contractual relationship is embodied
in a written franchise contract. Pursuant to the terms of the
franchise contract, a franchisor grants the right and license to
a franchisee to market a product, service, or both, by using the
trademark and/or the business system developed by the franchisor.
2. Advantages vs. Disadvantages of Franchising.
Expansion. Franchising provides a company the
opportunity to expand its operations more quickly, especially in
a capital intensive type of business by distributing risk among
Recognition. Franchising gives franchisees the
opportunity to own their own business, and, at the same time, to
have nationwide recognition, which is often important to the
success of a business.
Leverage. Franchising maximizes the franchisors
rate of return on the development and replication of a system,
while, at the same time, allowing the franchisee to leverage time
and experience based upon implementation of a tested system.
Control. The franchisor may lose the ability to change
the business model once franchise agreements are in place, and
may restrict the choices for business models available to the
Compliance. Franchising involves the costs and
restrictions imposed upon the franchisor by federal and state
franchise regulations. As explained below, these laws are
generally for the protection of the would-be
franchiseebasically, to ensure that the potential
franchisee is provided with proper information relating to the
nature of the particular franchise being considered.
3. What is a "Franchise."
The most commonly used definition of a "franchise"
is provided by the Federal Trade
Commission (the "FTC") in Rule 436. The FTC defines
the term "franchise" to cover two types of commercial
"package and product franchises"; and
"business opportunity ventures"
(the "FTC Rule"). Under the FTC Rule, a continuing
commercial relationship would be classified as a franchise, and
subject to the requirements of the rule, if three central
characteristics are present:
1. Trademark. The franchise distributes products or services
associated with the franchisors trademark or identifying
2. Assistance. The franchise provides significant assistance
and/or control over the franchisees method of operation;
3. Payment. The franchisee is required to pay at least $500
in payments to the franchisor during the first 6 months of
We note that, because acquiring strong trademark rights is so
important and intertwined with growing a business, we
consistently stress the importance of federal trademark
registration and choosing "clean" business names,
logos, etc. for new businesses. (See Trademarks
and Eight Common Questions About
Trademarks, Legal Links, Chain 1, Links 3 and 3A,
respectively.) The "assistance" issue is why we
stress that our clients develop business models and documented
procedures that can be replicated, replicated, replicated. Replication
is the cornerstone of growing a business.
4. State and Federal Laws.
Remember, the definition provided above is the federal
definition of a franchise. In addition, most individual states
have laws which regulate franchises. Since the definition of a
"franchise" varies widely from state to state, it is
imperative that a company seek professional assistance in
examining the applicable state federal statutes to determine
whether it is engaged in franchising or some other regulated
activity. For example, many states have "business
opportunity" laws which do not rise to the level of a
franchise, but are nevertheless regulated. The state research is
also the primary reason why franchising often requires a
significant initial investment.
At least thirteen (13) states
require annual registration of an offering circular prior to
the offer or the sale of a franchise, two (2) additional state
statutes require the delivery of an offering circular, but not
registration thereof, and the FTC Rule mandates the delivery of
an offering circular prior to the offer or sale of a franchise.
It is important to note that the mere fact that the parties
identify their relationship as a "franchise" does not
make the relationship a franchise. Conversely, an express
disclaimer in an agreement stating that the relationship does not
constitute a franchise will not negate coverage under the
relevant laws, if all definitional elements are met.
5. Disclosure Requirements.
Franchises are required to make disclosures of business
information to potential franchisees. The purpose of this
requirement is similar to the requirement of disclosure for
securities offerings (see Investors? Comply or Die,
Client Update, April,
1995). Under the FTC Rule, the franchisor is required to
disclose detailed information relating to at least twenty
separate aspects of a franchise offering. Information to be
disclosed includes all relevant facts about the identity,
location, business experience and financial background of the
franchisor, detailed descriptions of the franchise opportunity,
including all initial and continuing fees and payments, and an
explanation of all requirements in the franchise agreement.
The disclosure document is in addition to the franchise
agreement. Therefore, when considering a franchise, there are
generally always two primary documents: 1) the disclosure
document, which describes the franchise and risks; and 2) the
franchise agreement, which embodies the contractual relationship.
6. Alternative to a "Franchise."
Because your business model will be a franchise if it meets
the definition of a franchiselike it or notyou
must be careful. For example, if you license your business name,
provide business assistance to the licensee and require a
payment, you may have a franchise. If this happens, you must
automatically comply with the FTC Rule and disclosure and
registration requirements of all states having jurisdiction. Of
course, by then it may be too late.
For this reason, sometimes you may want to structure your
business intentionally to fall outside of the definition of
"franchise." In such cases, you may want to consider
distributorship agreements. Many types of distributorship
agreements are not a "franchise" within the meaning of
the FTC Rule or state laws for franchises. For example, if the
only "fee" received by the franchisor is the bona fide
wholesale price of merchandise purchased by the franchisee, such
payments may not be considered to be a "fee" within the
meaning of the FTC Rule. However, you should consult a qualified
attorney before setting up a distributorship agreement, since you
could be subject to substantial liabilities and penalties if your
business fails to comply with applicable franchise registration
and disclosure laws by inadvertence.
So, all that being said, heres the bottom line.
Would-be franchisors should consider: a) whether they have
developed a tested system; b) whether they can replicate the
system efficiently; and c) whether they can afford the initial
research and development investment into creating the business
model. Would-be franchisees should consider: a) whether they have
the requisite entrepreneurial spirit to own their own business;
b) whether they need to leverage on a pre-tested business model
(rather then create their own). If structured properly,
franchising can be extremely profitable for both the franchisor
and franchisee. (See also Franchising, Legal
Links, Chain 2, Link 2, and the Client Update,
April, 1995, for a more detailed analysis of franchising and
and back issues of the Client Update are available upon request.
As always, please call
us if you have any questions or if we can be of
assistance to you in any way.
Contact us today! Our firm can assist
you with understanding and applying the law to your particular situation.
Represent the Entrepreneurial Spirit®.
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Articles and information are for general information only, and often address
issues, without expressly indicating, in generalizations. Laws vary between and
among jurisdictions. You should not rely upon any
information provided by or on the website, including articles, as applicable to your
particular situation. The
law, filing fees, etc., change often, so the information in this document may
not be current. The laws of various jurisdictions may be different than provided
here. Please contact us at email@example.com
if you are interested in becoming our client--only then would this office be in
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