Most business owners do not realize that there is a difference between a franchise and a business opportunity. Franchises are regulated by both the federal law (FTC regulation) and by certain state franchise laws. Business opportunities are also regulated under both certain states’ laws and the FTC. Currently the FTC is in the process of promulgating new laws governing business opportunities.
Franchises, under the federal franchise law are business arrangements that meet three criteria: 1) there is a trademark owned by the seller under which the investor operates; 2) the seller receives $500 or greater in the first 6 months that the investor is in business (for product, training or anything else); 3) the seller exercises sufficient control over the investor and the investor’s business. If these criteria are met, the FTC franchise law states that the seller/franchisor must provide a regulated franchise disclosure document (FDD) to a prospective franchisee/investor at least 14 calendar days prior to accepting any money from the investor and prior to the investor signing any contract with the franchisor/seller.
What are business opportunity laws and why were they promulgated? The business opportunity laws were designed to reach distribution arrangements that are typically different than franchises, such as dealerships, vending machine businesses, certain work-at-home businesses and other “seller-assisted” marketing plans. A business opportunity is defined as an arrangement in which a person 1) offers, sells or distributes goods, commodities or services to another and 2) the goods, services or commodities are provided by the seller of the opportunity or by someone affiliated with the seller or required by the seller and the seller secures business for the purchaser or retail outlets or accounts for the purchaser and 3) the purchaser is required to pay or commit to pay to the seller or its affiliates at least $500 within six months after commencing operations. The purpose of the business opportunity laws is to protect the investor in these business schemes from questionable or fraudulent offerings. The legal definitions of a business opportunity are intentionally broad and unclear to cover a plethora of unconventional marketing schemes and businesses. Franchises are typically excluded from the definition of business opportunity in these laws. However, without a specific exemption or exclusion, there may be franchises that will fit within the state definition of a business opportunity.
What are the requirements of the business opportunity laws? The statutes typically require a disclosure document in a prescribed form be delivered to the prospective investor prior to the time any agreement is signed or any monies are paid for the business opportunity. This form varies from state to state and under the FTC. Unlike franchise laws, there is no uniformly accepted business opportunity disclosure format that all states and the FTC accept. Many states also require that the business opportunity disclosure document be filed or registered with the state prior to selling any business opportunities in that state. Many states also require that a surety bond or trust account or letter of credit be posted so any future claims by business opportunity investors can be paid. Some states also require escrow accounts if greater than 20% down payments are required prior to the investor’s receipt of the goods promised. Many states also have certain required language in the business opportunity contract with the investor, including cancelation rights. There are also typically prohibited acts, such as making earnings claims without substantiation. In certain states a violation of their laws on business opportunities may be a felony or misdemeanor.
A seller of any type of business opportunity, including franchises, should be cautious about meeting the requirements of the various state and federal laws governing the sale of the opportunity. Penalties for failure to comply can be steep and should be avoided.