Franchise Basics

People dream of starting their own business, but getting a new venture off the ground is
extremely risky, given the time and financial commitments involved. One way to effectively
offset the risk is to buy a franchise business instead of trying to develop a new concept on your
own. Operating a franchise business allows you to capitalize on the success of an established
business while still enjoying many of the benefits of owning your own business.

What is a Franchise?

A franchise is a type of license arrangement that allows the franchisee, the person buying the
franchise business, to utilize the franchisor’s already established business concept, including all
proprietary information, intellectual property and proven business models. After learning about
the franchise and completing any required training, the franchisee is allowed to offer services
and/or sell merchandise under the name of the franchisor.
In a typical franchise arrangement, the franchisee pays the franchisor an initial fee, commonly
referred to as a “franchise fee,” as well as an ongoing licensing fee or royalty which is usually a
set percentage of the business’ revenues for an established period of time, such as ten years. The
ongoing fees are typically collected on a weekly or monthly basis.
Beyond the basics, franchise arrangements can differ significantly from one to another. Some are
heavily structured with a high level of oversight, while others provide franchisees a considerable
amount of autonomy in how the business is operated. The details of the franchise relationship
are set forth in a written contract typically referred to as a “Franchise Agreement.” Information
about the franchise and the financial investment required to start the business is provided to the
franchisee in a document called a “Franchise Disclosure Document” or “FDD.”

What are the Benefits of Franchising?

Both the franchisor and the franchisee can greatly benefit from a successful franchise
relationship. From the franchisee’s perspective, he or she is able to leverage the name
recognition, training, and knowledge from a business that already has a proven record of success.
All of that can dramatically shift the odds in favor of success for a new business owner. At the
same time, the franchisor is able to profit even more from its prior success by charging its
franchisees a franchise fee for the right to use of its name and knowledge, and by earning
ongoing royalties from the franchisee’s revenues. In essence, a franchisor builds a successful
business, profits from that business, and then profits a second time by allowing new business
owners to benefit from its name recognition and proven track record. Additionally, the franchisor
is able to expand its business without investing or risking any additional capital. When the
arrangement works properly, the franchise model is a win-win for both parties.

Are Franchises Regulated?

Due to the sizeable nature of the investment necessary for a franchisee to open a franchise
business, the government regulates the sale of franchise opportunities. On the federal level, the
Federal Trade Commission (FTC) governs the sale of franchises pursuant to 16 C.F.R. Part 436,
otherwise known as the “Franchise Rule.” This rule requires the franchisor to provide every
prospective franchisee with certain information about the franchise and the investment before the
franchisee signs any contract or pays any fee. This disclosure is commonly referred to as a
“Franchise Disclosure Document” or “FDD.” The FTC does not require franchisors to file or
register their FDDs, but thirteen (13) states have enacted laws that do require some level of
registration and approval before franchisors can sell franchise locations in their state and/or to
their residents. In addition to these disclosure laws, some states have enacted laws that govern
the relationship between franchisor and franchisee, including how the Franchise Agreement
should be interpreted. Typically, these laws are designed to provide supplemental protections for
the franchisee.

Recommendations

The franchise relationship is, by nature, very complicated and complex. There is usually a
significant amount of money at stake and numerous laws and regulations that have to be
complied with to avoid costly penalties. There are risks and concerns for both the franchisor and
the franchisee. Accordingly, LegalStandard.com recommends anyone considering franchising their
business or buying a franchise business to consult with an experienced attorney before making
any binding decision. LegalStandard.comsm offers services for both the franchisor and the franchisee.
For the franchisor, LegalStandard.comsm can draft the FDD, help with registering the FDD or assist with closing a
transaction with a franchisee. For the franchisee, LegalStandard.comsm can review and explain the
FDD so that you are aware of your rights, obligations and risks under the Franchise Agreement.