Faupel, Fraser & Fessler

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SO YOU WANT TO FRANCHISE YOUR BUSINESS

By Marian L. Faupel, Esq.

Franchises represent a growing business model in the United States.  The theory is that someone developed a successful business.  He or she, the franchisor, is able and willing to share the good will that attached and can transfer know-how to another person.  In return, a franchisee is willing to follow the business plan and share the profits through an initial franchise fee and continuing royalty payments.

The states throughout America are divided into “registration” states and “non-registration” states.  In the some registration states, such as Illinois and California, a state office actually reviews proposed franchise materials and approves them before the franchise is offered for sale.  In non-registration states, such as Florida, there are generally no requirements before a franchise is offered for sale.  In Michigan, a franchisor is required to file a notice with the Attorney General that a franchise is being offered for sale, plus pay a $250.00 filing fee, but no review of the materials occurs before the franchises may be sold.

While some states have laws specifically applicable to franchise sales, the federal government, through the Federal Trade Commission, also regulates franchise sales.  Most states accept compliance with federal franchise law as sufficient compliance with state law when it comes to disclosure.  The Federal Trade Commission permits franchisors to comply with its FTC rule or with a format developed by the North American Securities Association of America known as the Uniform Franchise Offering Circular.  The following site provides ample information about both the FTC rule and the UFOC: http://www.ftc.gov/bcp/franchise/netrule.htm.  Because many franchises are marketed nationally, most franchisors rely on the formats approved by the federal government, not the individual state governments.

The offering circular (like a prospectus) must be given to a prospective franchisee at least 10 business days before any payment is required.  Among the more than 20 items that are addressed in a UFOC are descriptions of any pending litigation; criminal problems with the franchisor or its executives (“bad boy” clauses); earnings claims; and audited financial statements.  It is important to have these offering circulars reviewed by competent counsel before the franchise agreement is actually signed.

Michigan law contains a broad definition of “franchise.”  If an initial franchise fee is required, followed by continuing royalty payments, a Michigan court is likely to find that a franchise was sold.  Michigan actually has a very protective law because it permits a new franchisee to escrow the initial franchise fee until initial services (such as training and consulting services, such as demographic studies) are received.  If the franchise laws are violated, a franchisee may rescind the agreement and receive back fees that were paid to the franchisor.  Additionally, a franchisor who violates Michigan or federal franchise law may face other civil and even criminal penalties.

Franchises are excellent ways to start a business.  The logo and trademark may have instant recognition.  Proven business practices become available.  Franchisees often participate in regional marketing at a much smaller cost per business than they would incur if they were competing for a market segment on their own.  On the other hand, franchise agreements often run for 10 years and may not be renewed if there are problems.  In the end, becoming a franchisee is a long-term decision that should be carefully considered.