Franchises

Sherrie Bennett

A franchise is an agreement by which the franchise business (the franchisor) licenses the business operator (the franchisee) to operate a business under the name of the franchisor. The franchisee is authorized to use and market goods or services under the franchisor's trademarks, service marks and trade names, for a specific length of time.

The logic in buying a franchise is usually that there is significant value in the goodwill and other rights associated with the franchised business model that has previously been developed and operated successfully by the franchisor. This may or may not be the case in a given situation.

Generally, the franchisee will pay an up-front fee as well as continuing fees based on the dollar amount of goods or services sold. The franchisor offers services such as training the franchisee and providing market research to determine a favorable location for the business. The franchisor typically has strict rules and standards as to how business is conducted, the goods and services to be sold and the design and construction of the business location.

Lenders may be more willing to finance the franchisee of a reputable and established franchisor than the entrepreneur seeking to open an unproven business. Although by no means free from risk, a franchise with well-known and well-accepted products or services can significantly reduce business risks and enable you to own and operate a business on your own with no previous training.

If you're considering franchising, you'll want to carefully investigate:

  • The specific costs
  • Whether financing is available
  • What your expected earnings might be
  • How long the franchise agreement runs

Types of Franchises

Basically, there are three types of franchised businesses:

  • Distributorships—In this kind of franchise, a manufacturer (franchisor) licenses another businessman (franchisee) to sell his product either exclusively or in conjunction with other products. The franchisee may be given an exclusive right to sell the product within a specified territory. These are known as product franchises.
  • Business Format Franchises—Here, the franchisee operates his business under the franchisor's trade name. The franchisee is identified as a member of a select group of dealers and is required to follow standardized methods of operation. The aim of this type of franchise is to build nationwide or worldwide consumer recognition and acceptance of trademarks and the products and services associated with them.
  • Manufacturing or Processing Plant—In this kind of franchise, the franchisor transmits to the franchisee the essential ingredients or formula for making a product to be manufactured or processed and marketed either at wholesale or retail in accordance with the franchisor's standards.

      Regulations

      A franchise business must follow both federal and state regulations adopted to guard against abuses in the franchisor-franchisee relationship.

      At the federal level, franchising is regulated by the Federal Trade Commission ("FTC"), which requires franchisors to give an extensive disclosure document to prospective franchisees so that they can evaluate the financial and business risks associated with the business to be operated.

      The FTC has recently changed the rule governing disclosure documents. It replaced the old document, the Uniform Franchise Offering Circular (UFOC), with a new document, the Franchise Disclosure Document (FDD). Beginning July 1, 2008, franchisors must use the FDD and comply with the Revised Franchise Rule. The amended Franchise Rule states what specific information must be disclosed. You can find the amended Rule in the Code of Federal Regulations, Volume 16, Part 436, 16 CFR ยง 436. The Franchise Rule Compliance Guide, which is designed to assist franchisors in complying with the amended Rule is available at the FTC's Web site.

      The FTC also requires franchisors to provide prospective franchisees with a copy of the franchisor's current disclosure document at least 14 calendar days before the prospective franchisee signs a binding agreement with, or makes any payment to, the franchisor or an affiliate in connection with the proposed franchise sale.

      Many states have franchise laws that are similar to the federal law. These franchise laws attempt to level the playing field between franchisor and franchisee in order to prevent the abuses that can arise in the franchise relationship and to establish certain minimum rights of the parties.

      Well-established and successful franchisors are usually unwilling to make significant changes to their standard franchise documents. Less established franchisors, needing to expand their business base, might be somewhat more flexible. In setting up a franchised business, third parties, such as landlords and lenders, may also be involved.

      Because of the complexity and length of the franchise agreements and the added complexity of third-party arrangements, you should consult with a franchising attorney and accountant early in the process of considering or negotiating a franchise agreement.

      Questions for Your Attorney

      • What is a franchise?
      • What advantages are there in becoming a franchisee rather than starting my own business?
      • Which federal agency regulates franchises?

      Sherrie Bennett is the former director and staff attorney at the University of Washington Student Legal Services in Seattle.

      Related Resources on Lawyers.comsm
      - Inquiries to Franchiser About Parent Company
      - Inquiries to Franchiser About Operation Policies
      - Letter to Government Official
      - Franchises and Franchising articles and information
      - Find Franchises and Franchising Lawyers in your area
      - Find a Business Lawyer in your area
      - Visit our Buying & Selling a Business Message Board for more help

      Related Web Links
      - FTC Franchise and Business Opportunities Rule
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