Where to Begin?
The cornerstone to starting a franchise is the strength and scalability of your current business. That “model location” will be the basis for others to duplicate using your experience, training and mentorship. Before you begin your journey of starting a franchise, you need to look internally to ensure your business is running well, making money and ready for duplication.
The First Step: Securing Your Intellectual Property
Once you have a successful business concept that is potentially scalable through franchising, your first step is to secure your intellectual property rights. The best way to do that is with a federally registered, or at least applied for, trademark(s) with the US Patent and Trademark Office. Your trademark is the foundation to your franchise system. Unfortunately, many many companies that are exploring franchising need to make adjustments to their name and/or logo once they dig into the trademark process. We have done this with many clients over the years (both franchised and independent) and would welcome an initial no-cost consultation on the trademark viability of your name.
Registering your name and logo will help prevent copycats who may attempt to build their business on your goodwill. However, you should know that anyone using the name or close approximation of your logo prior to your registration could potentially have superior rights. Those rights can range from their ability to continued use up to their ability to prevent your current use. An extensive national search is advisable before applying for your trademark so you will have a better handle on the likelihood of a successful application and the boundaries of your marks even with a federal trademark secured. We can help you with that search. Even if you ultimately decide not to franchise your business it is advisable to secure a federal trademark for your name and logo. It will make your business more unique, valuable and secure from imitation.
Franchise Disclosure Documents (FDDs) and Franchise Agreements
Franchising is regulated at the federal level under the Franchise Rule 16 C.F.R. part 436 and at the state level by a myriad of franchise, business opportunity and relationship laws. The federal rule requires you to draft a Franchise Disclosure Document (the FDD), which will explain your offering and detail the opportunity to potential franchisees. Some states, commonly referred to as the registration states, require the FDD to be filed with the state attorney general for approval.
At the federal level and in the non-registration states, franchising is essentially a self-regulating system where the franchisor has an obligation to comply BUT the Federal Trade Commission (the FTC) and the non-registration states have neither reviewed nor approved the document. As the business owner, it is your legal obligation to be sure the documents you present to prospective franchisees are compliant with the law. Below is a map of the current registration and non-registration states.
Drafting your FDD
When you are ready to launch your system, you will need to have a franchise attorney draft your FDD and your Franchise Agreement. The FDD must contain specific information in 23 specific “Items” that disclose such details as:
- Background information about the franchisor and its affiliates
- Predecessors and parents
- Competition and regulations in your specific industry
- Bios and work history of the management team
- Bankruptcy and litigation history of the company and management team
- Franchise fees, royalties and other fees payable to the franchisor or affiliated companies
- Financials Representations on your current unit (not required)
- Estimated costs of starting the franchise
- How a territory is given (based on what factors)
The information in these 23 items must be very specific and detailed and cannot be misleading in any way. A properly drafted FDD is the bedrock for protecting your intellectual property and the future enforcement of your franchise agreements. These documents, although standard, can change based on your circumstances and the inexperienced drafter, non-franchise attorney or worse the non-attorney consultant that simply takes a template off the internet will be creating latent risks in your system that can be very costly in the future. You are going to teach and share very sensitive information that took you years and hundreds of thousands of dollars to create. Unless your legal documents are in order, you risk having your franchisees walk away with your intellectual capital and your hands will be tied to do much about it if you didn’t build your documents properly from the beginning.
Making the Distinction: FDD vs. Franchise Agreement
Many prospective franchisees, and–quite frankly–many franchisors, are confused as to the difference between the FDD and the Franchise Agreement.
The Franchise Disclosure Document aka the FDD:
- The FDD is a picture in time and a representation of certain information, financial and otherwise, on the business opportunity the franchisee is purchasing
- It follows the specific FTC requirements of disclosure so prospective franchisees can compare your offering with other franchise offerings
- The FDD is an outline of the major terms in the Franchise Agreement for quick reference and comparison
- A good analogy is the “Renters Disclosure Statement” many cities impose on residential landlords or “Disclosures” mutual funds and public stock companies are compelled by law to prepare – these disclosures are not a contract between two parties, but information the government is requiring the perceived stronger party to disclose to the weaker party to level the information playing field – in this instance you are the stronger party and under a legal obligation to properly disclose your offering to prospective franchisees
The Franchise Agreement aka the FA:
- The contract that will govern the relationship between the franchisee and the franchisor
- Creates legal obligations on both parties
- The license agreement for the use of the trademarks by the franchisee
- Sets the term, royalties, brand fund fees and other payment obligations
- Will cover dispute resolutions if the franchisees are not compliant with the system
- Like many things in life, it is not that cut-and-dry – certain state laws will override provisions of the Franchise Agreement, even if not stated or agreed to by the parties.*
*A franchisor must discuss these nuances with their franchise attorney to ensure they don’t get in trouble with state regulators or give ammunition to a non-compliant franchisee by trying to enforce provisions in their franchise agreement that are not enforceable under state law
The rules are not excessively onerous. However, they are nuanced, evolve over time and must be followed, or the foundation that you will be building your company on will not be able to withstand the stresses of growth. Remember, along with your trademarks, your executed franchise agreements are the real value of your franchise system. These are the contractual promises by franchisees to pay a royalty over time to the franchisor. How enforceable, compliant and organized a franchisor’s franchise agreements are will directly correlate to the enterprise value of the franchise system. If franchisees have not been properly disclosed, if your FDD is not compliant with federal or state laws your resulting franchise agreements and entire enterprise will be less valuable.
Listen to our Franchising Clients
Ready to Explore Taking the First Step?
We would love to have a more detailed conversation about your specific business and its viability as a franchise. This would include helping you understand the cost, timeframe and next steps. Feel free to contact us to set up an initial free consultation. We love franchising and can talk with entrepreneurs about this stuff all day long! You can also read our timeline to launching a franchise.