New York Franchise Law Blog : Franchise Lawyer & Attorney Charles N. Internicola, Providing National Representation of Franchisees and Franchisors

For existing franchisees and individuals considering the purchase of a franchise,anextremely instructive - but unfortunate - discussion appeared on the question and answer section of CNNMoney's Small Business website.  In the article, "Escaping a franchise deal gone bad", the franchisee of a children's entertainment franchise inquired about her legal options following what appears to have been the unsuccessful launch of her business.  In the article, the franchisee mentions a couple of important factors/issues that all prospective and current franchisees should consider:

Issue I  - Insure that You Possess Adequate Capital before Committing to a Franchise, In the article the franchisee mentions that to open the franchise, she needed $250,000.00 in capital.  She attributes a portion of her failure to her inability to raise adequate capital.  However, this franchisee readily admits that she did not "attempt" to raise capital until after paying her franchise fee and signing the franchise agreement.

• How this Issue Should be Approached by Prospective Franchisees - Do not commit to a franchise agreement or pay a franchise fee until you are certain that you will have access to adequate capital.  If this cannot be determined until you sign a franchise agreement then speak with your attorney about making the franchise agreement (and the payment or refund-ability of your franchise fee) conditional and subject to obtaining a specified amount of financing. 

Issue II - Be Cautious with "Light or Express" Versions of a Full Service Franchise Concept, Although specifics are lacking in the article, the franchisee mentions that since she did not possess the recommended level of capital, she was permitted by the franchisor to open a "smaller version of the franchise".

• How this Issue Should be Approached by Prospective Franchisees - Do not consider a "light" version of any full-service franchise concept unless the "light version" has been tested and successful in the marketplace.  In other words, don't become a Ginnie pig in an experiment where your life savings and financial stability is at stake.  Also, be cautious of any franchisor who is willing to modify the established capital criteria and requirements.

Issue III - Be Cautious of Post-Termination Restrictive Covenants and Obligations, The franchisee mentions that she is looking to get her money back and set up her own, non-franchised, competing business.  

• How this Issue Should be Approached by Prospective Franchisees - Initially it is critical to recognize that, as a franchisee, your obligations (including your non-compete) will, in most instances under most franchise agreements, exist for a set duration commencing from the date of termination of your franchise.  This is a critical and important protection necessary for franchisors to preserve the integrity of their franchise system.  For the prospective franchisee you must recognize - before signing a franchise agreement - that once you become a franchisee, your future actions will be restricted.  Always obtain a clear understanding as to the scope and extent of these restrictions.

For current franchisees who find themselves in a similar situation, the article offers some good advice from Ed Teixeira of franchiseknowhow and attorney Robin Day Glenn. For prospective franchisees, the critical factor remains "look before you leap", consult with an experienced franchise lawyer and do your homework.

• Email This
• Print
• Comments (2)
• Trackbacks
• Share Link

“Franchising” has been and remains one of the most successful vehicles for the multi-unit expansion of a business. However, for many entrepreneurs looking to expand their business and brand,“franchising” is too often disregarded as a viable business model. For these entrepreneurs, the establishment of a franchise system (unnecessarily) appears to be a daunting task and is disregarded in favor of “licensing”. That is, in an “attempted” effort to avoid franchise regulation, but nevertheless achieve brand growth, the entrepreneur (as a “licensor”) licenses his or her trade name and trademarks to third parties (known as “licensees”) who conduct their own business utilizing the licensed marks.

While “licensing” relationships, without question, possess a legitimate purpose, they are extremely limited and cannot serve as an “end-run” around franchise regulation. That is, license agreements cannot be used to create “franchise-type relationships” without the franchise regulation. The reason for this is simple: in the world of franchise regulation, “substance” matters more than “form”, labels do not matter and just because you call something a “license” does not mean that it is not a “franchise”. In short, your license agreement (no matter what you call it) may in fact be a franchise.

So, how do you determine if your license agreement “crosses the line”? You ignore titles such as “licensor”, “licensee”, “license fee” and “license agreement” and evaluate the “substance” of your business relationship. Under the federal Franchise Rule, the defining characteristics of a franchise include:

(1) Continuing Commercial Relationship.  a “continuing commercial relationship”;

(2) Agreement. a written or oral “agreement”;

(3) License. the “license” of a trademark;

(4) Control / Obligation to Support. “significant control” over your “licensees/franchisees” methods of operation, or, an obligation to “support” those operations, and

(5) Fee. the payment of a “fee”.

Since, factors (1), (2) and (3) are, by necessity, inherent to both franchise and license agreements, the determination as to whether or not your license agreement “crosses the line” into franchise territory, boils down to an evaluation of “control” and “fees”. That is:

• Will you possess significant control over your “licensee’s” methods of operation, or, in the alternative, are you obligated to provide significant support to your “licensee’s” operations? and

• Will you receive or be owed a fee as a condition for your “licensee” to commence its operations?

If the answer to both of these questions is “yes” or “possibly yes”, your “licensee” may actually be a “franchisee” and you may be subject to franchise regulation. When making this evaluation, you must go beyond labels and consider both the substance of the relationship that your are creating and the long-term goals that you are attempting to achieve.

• Email This
• Print
• Comments
• Trackbacks (1)
• Share Link

You have identified a franchise concept that you are extremely interested in.  You have met with the franchisor’s sales staff, completed an application and are impressed, so far, by what you see. However, before taking that next step, before paying a franchise fee or signing a franchise agreement, contact existing franchisees to get the “inside track”. 

Where do you get existing franchisee information?  In the franchisor’s disclosure  document (also known as the “FDD” and formally known as a Uniform Franchise  Offering Circular) that must be provided to you by the franchisor at least 14  calendar days prior to you signing a franchise agreement or paying any fee to  the franchisor.  The FDD is an extensive document and, quite frankly, one of the few “life-lines”  that will be available to help you make a true assessment of the franchise opportunity that you are considering. The legally mandated information contained in the FDD, and thereby disclosed to you as a prospective franchisee, is extensive, extremely relevant and should be reviewed with both a franchise lawyer and business accountant.  However, sticking to the point of this article, that is obtaining information from existing franchisees, please know the following:

• Item “20” titled “Outlets and Franchisee Information” should contain extensive information about (a) existing franchisees - including their names, addresses and contact information, (b) the number of franchise outlets in operation (at least as of the date of the FDD), (c) the number of franchise outlets that are expected to open within the next fiscal year, and (d) the number of franchise outlets that were closed, sold or terminated in the last fiscal year;

• Contact existing franchisees (not just the “star” – multi-unit franchisees who the franchisor suggests you speak with) and politely ask them about their experiences as a franchisee, the support given to them, the quality of the product (or service) and, if possible, the cash flow and profitability of the business;

• Pay particular attention to the number of franchise outlets closed, terminated or sold during the past year.  If there are a significant number (relative to total overall outlets) of closed, terminated and/or sold outlets, proceed with caution and ask lots of questions. Please keep in mind that while it may be inevitable to have a few closed outlets due to a “franchisee’s mismanagement or lack of effort”, look out for a pattern of closings, terminations and outlet sales and do not just accept an explanation blaming a closed outlet on a franchisee’s lack of effort.  In many cases, a closed outlet may be a function of neglect by both the franchisor (in terms of support and product development) and the franchisee; and 

• If the franchisor is projecting a significant increase in the number of projected outlet openings (a projection that should be included in Section 20 of the FDD) question whether or not the franchisor possesses the managerial staff and infrastructure to properly support all of these new outlets.  

When purchasing a franchise, there is a lot to consider and, inevitability – like every entrepreneur, you are bound to make mistakes. However, by contacting existing (and terminated) franchisees you can learn from some of their mistakes and cut down on your own.

• Email This
• Print
• Comments
• Trackbacks (1)
• Share Link

“Unstable” would qualify as a mild assessment of the current state of our economy and the job market.  In the face of historic corporate layoffs, many skilled and hardworking individuals are considering a leap from corporate employee to small business entrepreneur and franchisee.  After speaking to many clients who have successfully made this leap, one thing is clear, before you put your savings, severance package or financial stability on the line, be prepared for some “culture shock” and understand that there are some fundamental differences between the life of a corporate employee and that of a franchisee.

Difference No.: 1 - “You are on your own”

I know this may initially sound conflicting, especially since you are considering a franchise for the very opposite reason, i.e., the support and backing that you (hopefully) will be obtaining from the franchisor and the franchise system that you select – but you must keep in mind that we are discussing the differences between life as a “corporate employee” to that of a “franchisee”.  While a franchise will afford you distinct and tangible benefits over the typical small business (benefits such as an established system, a known brand name and tested products and services) you must nevertheless remember that you will be moving from a structured corporate environment with layers of management and delegated decision making, to the “heart of small business” where every decision and every problem will be presented to you (and only you) on a daily basis.  Gone are peers and “colleagues” to “run things by” and in their place are “employees”. Employees that may even include that high school delivery boy who forgets to show up on your busiest night. 

Difference No.: 2 – “Profits Matter”

I understand that this is an obvious point.  But this is so important that it should be mentioned again and again.  So, here goes: “profits matter”.  Gone are “bad corporate quarters” that do not have a direct affect on your weekly paycheck and in its place is the reality that the success of your business will be measured on a daily, weekly and monthly basis based on how much money you earn and get to take home to your family.

Difference No.: 3 – “ Sales Skills Required”

As a franchisee and small business owner, just working hard is not enough.  You will be the face of your business and must be front and center interacting and building relationships with your customers and clients each and every day. You can’t overlook this business necessity and must make sure that you are prepared to take this step.

Difference No.: 4 – “Adjustments to your Social Calendar”

If your new business involves retail sales, be prepared for an adjustment to your social calendar. Since your new business will, most likely, experience its busiest days on the weekends, be prepared to work on the weekends and take days off on weekdays when most of your friends and family are at work.

If you have the right expectations, select the appropriate franchise and commit to hard work, the life of a franchisee can prove rewarding and add a level of independence unavailable to corporate employees.  However, before making this leap, be prepared for some culture shock and give some serious thought as to both the positive and negative adjustments that you will be required to make.  Get it right, and, hopefully, you may be on your way to adding some independence and balance to your life.   

• Email This
• Print
• Comments
• Trackbacks
• Share Link