Expanding your business can be an exciting but daunting prospect—including financially. Traditionally, entrepreneurs have relied on their own resources and capital to grow their businesses; however, there are other options available that are less onerous and capital intensive, such as joint-venture transactions, licensing arrangements and franchising systems. While each of these options has its own advantages and disadvantages, franchising has become increasingly popular due to its potential for rapid expansion and revenue growth with potentially lower business and legal risks.
A franchising system is a business model under which you, as the “franchisor,” retain ownership of your intellectual property (“IP”) assets that you license to others (known as the “franchisees”) to use in connection with their own business(es) via a comprehensive franchise agreement and an “FDD” (Franchise Disclosure Document). Additionally, a franchise allows you to maintain significant control over the use of your IP and the franchisees’ operation of their businesses using your IP, and you also receive several forms of monetary remuneration from the franchisees (e.g., initial franchise fees, franchise royalties, marketing fees and other amounts) rather than share in the profits or losses of the franchisee’s own business.
To successfully launch a new franchise business, franchisors must carefully consider several legal and business aspects, including state and federal rules and requirements, as well as key launch considerations, projects and tasks.
State Rules and Requirements
From a legal standpoint, it is essential to comply with state rules and requirements when launching a new franchise. This typically involves providing written notification to the respective state(s) in which you would like to franchise before any advertising or sales of your franchise can begin. Michigan’s notification requirement is less onerous and rather simple compared to many other states, requiring only a written statement of your intention to sell or offer for sale franchises without having to submit an FDD with the franchise notification. Each state has different rules, requirements and procedures (for example, submitting the FDD with the state notification and/or requiring state feedback or approval of the FDD before launching the franchise), so it is important to consult with legal counsel familiar with franchise law to ensure compliance.
Federal Rules and Requirements
While no written notification to the federal government/FTC is required to launch a new franchise, it is mandatory to prepare an FDD, with the following among the key requirements:
- 23 specific items must be disclosed in detail, including the estimated total financial investment, initial franchise fees, ongoing royalties and other fees, franchisee’s obligations, restrictions on franchisee’s sourcing and sales of products/services, franchisor’s assistance, territory, trademarks and existing franchisee information;
- A copy of the Franchise Agreement form document must be included in the FDD, along with numerous accompanying informational exhibits and schedules; and
- The FDD must be provided to prospective franchisees in advance of any Franchise Agreement signing or any monetary payments to the franchisor by the franchisee.
Business Considerations for Launching a Franchise
From a business perspective, franchisors must undertake several projects and tasks to prepare for the franchise’s successful launch. These include, among others:
- Identifying the goals, objectives and strategies of your franchise system and overall operations;
- Determining in what state(s) to launch the franchise initially and other states to follow in subsequent prioritizing phases;
- Identifying what franchisor resources are needed to successfully launch and support the franchise system;
- Determining all other business and legal areas on which to focus in preparing your franchise (e.g., business entity structure, IP protection, confidential operations manual, and the key disclosure items, terms and conditions of your FDD and Franchise Agreement);
- Preparing and finalizing cost projections and budgets (including professional services fees and state filing fees); and
- Establishing priorities and a timeline to prepare and handle all of these projects and tasks.
If you are considering starting a franchise or have any questions related to franchising, contact Timothy K. Kroninger or Timothy D. Kroninger.