Franchising: Is it For You? Part I
This newsletter will be
the first of a two-part discussion of franchising.
This issue will outline the nature of the franchise relationship, while
the next issue will look at franchising as a business opportunity.
The original meaning of
“franchise” in the dictionary is “freedom or immunity from some burden or
restriction vested in a person or group.”
Today, that meaning is rare. Instead, we commonly think of a franchise as
the right or license granted to an individual or a company to market goods or
services in a particular territory. There
are both “public” and “private” franchises. If a government grants a
company the right to market cable television in the locality, that is a
“public” franchise.
Here we are concerned
with “private” franchises, where the owner of a trademarked brand of goods
or services (called the “franchisor”) enters into a contractual arrangement
to allow someone else (“the franchisee”) to market those goods or services,
under the brand name in a particular location. For example, McDonald’s®
enters into a franchise contract to allow another person or company to open a
McDonald’s® restaurant and sell hamburgers at a particular location, often
approved by the franchisor.
In recent years, the
popularity of franchising as a method of doing business has expanded enormously.
By some estimates, as much as 40% of total
The Federal Trade
Commission (FTC) requires virtually all franchisors to prepare a detailed
offering document, much like a securities prospectus, that describes the
franchise and its risks. This document is usually called a “Uniform Franchise
Offering Circular” (UFOC).
In addition, about 15
states, including
A would-be franchisor
who fails to register its franchise offering, where it is required to do so, may
encounter many problems, apart from the direct violation of the law.
For example, such a franchisor may be unable to enforce the terms of its
franchise agreement, if the registration requirements were not met.
Franchises usually
involve a trademarked product or service. As a result, most franchisors will
exercise considerable control over the franchisees to ensure that they meet
uniform standards of quality, cleanliness, appearance, etc.
Conversely, most franchisees want as much freedom and as large a
territory as the franchisee can obtain.
Most franchises involve
an upfront payment called a franchise fee, which may be quite substantial.
In addition, most franchisees must pay the franchise a regular fee or
royalty, often based on a percentage of sales.
In addition, many franchises require franchisees to pay various other
costs, often to the franchisor, for things like training, signs, or supplies.
A franchise usually
grants a franchisee the right to sell the goods or services in a designated
territory. The territory and the definition of it can be vitally important to
the franchisee.
Let’s say, a
franchisor, Hen Doodles (“Hen”), told its franchisee, originally in Bristow,
that it could have all of Prince William (“PW”) County as its territory.
Later, after Hen takes off, it becomes apparent that the Bristow
franchisee cannot adequately serve the booming market in PW County.
Can the franchisor add outlets in PW County?
Many franchisors make
considerable money by selling new franchises, and there is often the possibility
that a franchisor will put more franchises in a given area than the market will
bear. Franchisees must be careful to make sure that their territory is large
enough to be profitable.
Franchisors will
usually retain the right to audit the franchisee’s business. Such audits
insure that sales are being correctly reported to the franchisor.
Next
time, we will look
at franchising as a business opportunity.
Copyright 2004
Published by the law firm of Newland & Associates, PLC
9835 Business Way
Manassas, VA 20110
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