baker & hostetler llp all about franchising fall 2009 entrepreneurship and small business series...

Baker & Hostetler LLP

All About Franchising

FALL 2009 ENTREPRENEURSHIP AND SMALL BUSINESS SERIES - HUDSON LIBRARY & HISTORICAL SOCIETY

October 14, 2009

Baker Hostetler2 Counsel to Market Leaders

Introduction

Amy M. Shepherd

• Partner with Baker & Hostetler, working in the Columbus office

• Practice in the general corporate and business area, with an emphasis on securities matters


Introduction

A. What is franchising?B. What are the pros and cons of franchising?C. How is franchising regulated?D. How do I get started?E. Complying with regulations of offers and sales.F. Common issues between franchisors and

franchisees.G. Terminating franchise relationships.H. Questions and General Discussion.


What is franchising?

History of Franchising• Trace back to mid-19th century• Singer sewing machines sold through franchised outlets• Viable alternative for capital raising beginning in the

1960s• Franchising Statistics (from various franchise

consultants):– Approximately 1 out of every 12 businesses in the U.S. is a

franchised business– Believed to be more than 750,000 franchise businesses in the

U.S.– A new franchised business is opened every 8 minutes of every

business day



• Franchising is a method of raising capital for expansion of a business and as a means for distributing goods and services.

• More than 75 different industries use franchising as a means to distribute goods and services:– McDonalds, Wendys, Subway, Quiznos, Dominos, Pizza Hut, Dunkin

Donuts, Krispy Kreme, Baskin Robbins– Curves– Liberty Tax Service– AAMCO Transmission, Precision Tune– 7-Eleven– Molly Maid, ServiceMaster Clean, Jani-King



• Regulated at the federal (Federal Trade Commission) and state levels

• There are generally two forms of a franchise:– The “traditional” or “product” franchise is a product distribution

arrangement, in which the franchisee is to some degree identified with a manufacturer’s supplies. Typical types are automobile and truck dealerships, gasoline service stations and soft drink bottlers.

– A “package” or business format franchise, is a business relationship in which the franchisor licenses a fully integrated operation to the franchisee. In this type of franchise, the franchisor provides the franchisee with a plan or system for conducting the franchised business and the franchisee contributes the daily management and operation of the business. Typical types are fast food restaurants.



FTC definition of “franchise” – the three elements:• Distribution of goods or services associated with the

franchisor’s trademark, servicemark, trade name, advertising or other commercial symbol (essentially any relationship in which a franchisee attempts to gain the benefit of the franchisor’s reputation will satisfy this element)

• Exercise of significant control over, or the giving of significant assistance to, the franchisee by the franchisor (the requisite level of control or assistance may be found upon a rather modest showing)

• Payment by the franchisee to the franchisor of at least $500 before the expiration of the first six months of operation of the franchised business



There are exemptions and exclusions from the FTC requirements, including:

• Fractional franchises – an established distributor adds a franchised product or service line to its existing line of goods or services (two conditions must be met)

• Leased departments – an independent retailer leases space from a larger retailer to sell his or her goods or services in the larger retailer’s store

• Oral agreements – the franchise relationship must be purely oral, and there can be no written evidence (even if unsigned) of any material term or aspect of the relationship

• “Sophisticated Investors” (added in 2007)



“Sophisticated Investors” exemptions include:• “large franchise investment” exemption which exempts

franchise sales where the initial investment is at least $1 million

• “large franchisee” exemption which exempts franchise sales to ongoing entities with at least $5 million net worth and 5 years of prior business experience

• “insiders” exemption which exempts franchise sales to owners, directors, and managers of an entity if such individual was associated with the company within 60 days of the sale and was involved with the company for at least 2 years


What are the pros and cons of franchising?

Pros (Franchisor):• Expansion (financing mechanism for franchisor)• Brand Exposure (and appreciation in the monetary

value of the mark)• Franchising revenues (cash flow for the franchisor)• Incentive to run the franchised operation at peak

efficiency because owner-manager has an equity interest in the franchise

• Risk spreading



Cons (Franchisor):• Loss of control• Compliance with regulatory requirements• Cost to administer and provide on-going

assistance



Pros (Franchisee):• Ability to open own business with proven concept• Access to training and assistance from Franchisor• Brand recognition and advertising• Research and development



Cons (Franchisee):• Significant controls on operation of business,

including sourcing of supplies, design or appearance standards, goods or services you may sell, method of operation, and sales area

• Costs such as initial franchise fee, on-going royalty fees and advertising fee

• Restraints post-termination• Restraints on succession• Limits on expansion


How is franchising regulated?

• Federal and state disclosure requirements and state registration requirements

• Servicemark/Trademark Matters

• State relationship statutes

• Other – Antitrust


How do I get started?

A franchisee expects that he/she will be furnished a proven concept, a well-recognized trademark, initial training, ongoing supervision, marketing support, new product development and bulk purchasing power.

Is your business a good candidate for franchising?



To be a successful franchise system, your business should have the following characteristics:

• Your business should have a proven track-record with experienced management.

– Does your company have experienced management? A track-record over time? Is the concept proven?

• Your business should be unique. – Is your business adequately differentiated from its competitors? Is it marketable

as a business opportunity? Does it have a sustainable competitive advantage? • Your business must be “teachable.”

– Are the systems in place? Are operating procedures documented? Could someone learn to operate your business in three months or less?

• The business needs to provide an adequate return. – The business must be able to generate a significant return on investment after

deducting the franchise fee/royalty.



Franchisor:– Trademark/Servicemark protection– Operations and Training Manuals (to replicate

business)– Franchise Agreement (structure of franchise

system and terms to consider)– Franchise Disclosure Document– State registrations– Personnel and infrastructure to support

franchisees



Franchisee:– Consider franchise broker or franchise tradeshows to help you

consider alternatives– Consider how much you are able to invest (and lose), your abilities

and your goals– In selecting a franchise, consider demand for the franchisor’s product

or service, competition in your area, your ability to operate the business, the name recognition of the franchise, training and support services offered by the franchisor and the franchisor’s experience with operating similar businesses and managing a franchise system

– Review disclosure documents– Consider terms of franchise contract– Develop business plan– Access necessary capital



Choose a franchise that closely matches your skills, personality traits, budget constraints and risk tolerance – not the current “hot” franchise. [Joel Libava, Cleveland, Ohio franchise consultant

and marketer, December 9, 2008]


Complying with regulations of offers and sales.

Federal and state disclosure requirements – FDD has 23 separate items of

information, including: Franchisor’s Background – how long franchisor has been in business; likely competition;

regulation of the particular industry Business Background – experience of franchisor’s executives Litigation – prior litigation involving franchisor and its executives Bankruptcy Initial and On-Going Costs –costs involved in starting and operating the franchise Restrictions – restrictions on suppliers, goods and services offered, customers, etc. Terminations – when the franchise can be terminated and post-termination obligations;

conditions with respect to renewals, sales and transfers Training – franchisor’s training and assistance Advertising – advertising fund and how advertising dollars are spent Current and Former Franchisees Earnings Information Financial Statements



Some states require a franchisor to register (file registration and disclosure documents and receive approval from states before offering or selling a franchise in that state):

California Michigan (notice only) Rhode Island

Hawaii Minnesota South Dakota

Illinois New York Virginia

Indiana North Dakota Washington

Maryland Oregon (no registration) Wisconsin



• The offer and sale may be subject to state Business Opportunity statutes

• Some states (requiring registration) may require a new franchisor to escrow the initial franchise fee for some period of time



Timing for offers and sales:– The Franchisor must provide the franchise

disclosure document at least 14 calendar days before execution of the franchise agreement or accepting payment for franchise

– If the franchisor unilaterally and materially changes the terms of the franchise agreement attached to the disclosure document, then an additional 7 calendar days must pass before the revised agreement is signed



Advertising regulations• Advertising is considered an offer – so

care should be taken with respect to registration states

• Some states also require that all advertising be filed with state franchise regulators at least three business days before they are first used for review by the regulator



Franchise brokers:

• Washington and New York require registration of franchise brokers

• Franchise brokers must provide the disclosure required of franchisors



Options for territory or franchise

• An option to develop a franchise location(s) is an offer of the franchise – so comply with registration and disclosure requirements


Common issues between franchisors and franchisees.

• Encroachment

• Advertising

• Product Development

• Assistance

• Fees, Fees, Fees

• Termination Events


Terminating franchise relationships.

• Contractual provisions may be superseded by state relationship laws

• Many states have laws that bar termination by the franchisor prior to expiration of its stated term, except for “good cause” (after notice and time to cure)

• Some states apply this “good cause” standard also to franchisor’s refusal to renew the franchise

• Many states require a franchisor to repurchase franchisee’s inventory, supplies, equipment and/or furnishings on “good cause” termination by franchisor

• Some state relationship laws limit the right of a franchisor to control transfers of franchises


Questions and General Discussion.

Questions? Discussion?

Baker & Hostetler LLP

Cincinnati • Cleveland • Columbus • Costa Mesa • DenverHouston • Los Angeles • New York • Orlando • Washington, DC

International AffiliatesSão Paulo, Brazil • Juárez, Mexico

2 0 0 5 N E W P A R T N E R P R O G R A M

baker & hostetler llp all about franchising fall 2009 entrepreneurship and small business series...

Documents