By Marian L. Faupel
FAUPEL, FRASER & FESSLER
Ann Arbor, MI
2010
There are many ways to go into business in this country. Kids have lemon-aid stands, and usually no one complains about their lack of records and failure to pay taxes on profits. Adults, however, have many options. They can conduct business as a sole proprietor and list their earnings on their own tax returns. They can form a partnership with another person, which is similar to being a sole proprietor except that more than one person owns the business.
Sole proprietors and partnerships can operate under an "assumed name," often referred to as a "d/b/a" (doing business as...) You can file a certificate of assumed name with the local County Clerk's office, and that will give notice to the world of who owns the business operating under that assumed name.
There are further options. A business owner can form an limited liability company ("LLC") through the State, and this will isolate the owner from liability related to the company's debts. The LLC, again, is like a sole proprietorship or partnership in that earnings are reported on the owner's personal tax return; however, sole proprietors and partners are not insulated from the company's debts like members of an LLC are.
Corporations are yet another way of conducting business. There are several types of corporations: professional ones for licensed professionals such as doctors and lawyers; "C" corporations, like Ford or General Electric; and "Sub-S" corporations, which are usually smaller-scale corporations. Most corporations file tax returns separate from their shareholders, but Sub-S corporations report their earnings on the shareholder(s)' personal tax return, much like LLC's do. Corporations are popular because they continue on even if a shareholder dies (unlike a partnership or sole proprietorship); they insulate shareholders from personal liability for corporate debt; and shares in the corporation can often be sold or pledged to secure a loan.
There is yet another business form that has gained wide acceptance over the past 30-40 years: franchises. Distributors of food, printing services, automotive services, and other goods and services long ago discovered that they could teach other people their business and leverage their business opportunities as a result. This is called a "franchise." While Franchisees must still choose the type of form that their franchised business will take (i.e., corporation, LLC, partnership, etc...), franchisors generally prescribe what the business will offer and how that product will be marketed.
Typically, franchise agreements require two kinds of "fees." One fee is called the initial franchise fee. This fee covers the franchisor's expense for approving a site for the franchised business; approving a lease; approving construction on the site; providing franchisee training; and assisting the new franchisee in opening the business. The initial franchise fee is normally non-refundable.
The franchise agreement, which is often a ten-year agreement, requires a second fee which is usually a percentage of gross monthly revenue (not just profits). There may be a term in the franchise agreement that sets a minimum monthly fee in case the percentage of gross monthly revenue does not yield that fixed amount. This monthly fee is generally called a "royalty" and compensates the franchisor for the fact that the franchisee is using the franchisor's trademark, trade secrets, and know-how.
States have laws governing franchise relationships. Generally, the franchisor must provide substantial written information about the franchise prior to accepting the initial franchise fee. That information has to be given in a relatively standard format so that the prospective franchisee, and/or his representative or attorney, can easily find the information needed. In Michigan's Franchise Investment Law, MCLA 445.1501 et seq., Michigan permits a franchisee to escrow the initial franchisee fee or require the franchisor to post a bond until the obligations to provide real estate, improvements, equipment, inventory, training, or other promised services are provided if the franchisor's net worth is less than $100,000. MCLA 445.1512. This is a substantial protection. If an escrow is used, then the escrow agent must be a financial institution authorized to do business in Michigan. Escrowed funds may be released only if the agent receives an affidavit from the franchisee stating that the franchisor has fulfilled all or part of its obligation to provide real estate, improvements, equipment, inventory, training, or other items. If only part of the obligation has been met, then only part of the initial franchisee fee will be released.
"Franchise fairs" are often held all throughout the country to provide a forum for businesses which are franchised to meet people interested in becoming franchisees. Franchisors prefer mature people who are able to follow direction and are responsible. If the business is a franchised restaurant, the franchisor does not want a franchisor offering menu items that are not approved by the franchisor. The franchisor has field representatives "out there" to visit franchisee sites and audit earnings to assure that the franchisee is complying with the franchise agreement and paying the appropriate royalties.
It is imperative that prior to signing a franchise agreement or paying the initial franchise fee, the prospective franchisee has the proposed agreement and information circular reviewed by an attorney familiar with franchise law. If after the agreement has been signed, the franchisor lodges a complaint against the franchisee, the franchisee, again, should seek competent legal counsel. These agreements often require any litigation to take place in the state where the franchisor is located, and there is usually a clause in the agreement requiring the franchisee to pay the franchisor's attorney fees if the franchisee falls into default. In Michigan, a franchisee may be able to contest the venue provision. Franchise agreements also often include arbitration clauses which require the parties to submit any disputes to binding arbitration.
Anyone wishing to sell franchises in Michigan must register with the Department of Attorney General, Franchise Section, prior to offering or selling franchises. A prospective franchisee can call the Attorney General's office at (517) 373-7117 to determine if a franchisor is registered.
If you consult an attorney about a franchise opportunity, be sure to bring with you all the information provided by the franchisor. Unfortunately, franchisors often will not release the actual franchise agreement until later in the negotiation process since the agreement itself may contain proprietary information, so attorney services may be needed at several different points in the transaction. Just remember that franchise agreements often run for 5-10 years, and once the agreement is signed, you are bound by its terms for a very long time.
