Newland's Business Notes

Franchising:  Is it For You? Part I

Volume 8 Issue 2 -- March/April 2004

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 US retail sales can be attributed to franchises.  Today, it is possible to find franchises for almost any conceivable product or service, many of which are slickly advertised on the Internet.

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 Maryland and Virginia , require would-be franchisors to register their franchise offering, much as the sale of securities must be registered. Registration of the franchise does not guarantee that the statements made in the UFOC are accurate. Regardless of whether the franchise offering must be registered, the FTC disclosure requirements must still be satisfied, usually by the use of a UFOC.

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
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