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Expanding Your Business Through Franchising
By Andrew D.
Simons
Suppose you own a successful
restaurant. Business has been steadily improving
and your best customers keep telling you that you should open
another store. Maybe they even offer to invest in the venture
because they love your food so much. You would like to expand
but are not sure how to do it. You have heard about other
operators that have franchised their concepts and made millions.
You wonder “why not me?”
However, you are not sure
whether your business is right for franchising or what is
involved in such an undertaking. This article discusses the
general concept of franchising to give business owners a
framework for evaluating whether franchising is right for them
and offers some alternatives to franchising that provide for
business expansion without the cost or commitment required by
franchising.
Should I
Franchise My Business?
There is no doubt that
franchising offers business owners a vehicle to quickly expand
their businesses and increase market share without a major capital
investment. Multiple stores give franchisors more buying power
and increases efficiencies in advertising and operations.
Sometimes, franchisors also profit from selling goods, services
or supplies to the franchisees that are used in the business.
Franchisees generally build and operate their stores with their
own money and then pay the business owner a royalty on the
franchisee’s sales. Franchisees sign up because they like the
concept and get a “turn-key” system complete with training and
support.
Franchising is not for
everyone, however, and you should carefully evaluate your
options before proceeding.
The threshold questions are “Is
someone interested in replicating my business?" and "If so, will
they be able to do it?” Businesses with limited brand
awareness may have trouble attracting desirable franchisees.
In addition, businesses that
are highly dependent on the skills of the business owner or
certain employees are not good candidates for franchising.
Successful franchise operations
have distinct procedures and processes for all important phases
of the business operation that can be readily “exported” or
easily learned by someone else with experience in the field.
A detailed operations manual, for example, is a minimum
requirement.
Another important consideration
is the profitability of the business. Ideally, franchisees
would like to net ten to twenty percent of their gross revenue,
after paying a royalty to the franchisor. If a business does
not have an established track record of profitability, it is not
likely to attract potential investors and selling the brand
based on its “potential” is ill advised.
How to
Franchise
If franchising or otherwise
expanding your business is of interest, you should be familiar
with both the state and federal laws that govern franchising.
Basically, these laws provide that any business relationship
that has each of the following characteristics shall be deemed a
franchise:
- A right is granted to the
franchisee to engage in the business of offering, selling or
distributing goods or services;
- The right to engage in
the business is granted under a marketing plan or system
prescribed in substantial part by the franchisor;
- The operation of the
franchisee’s business is substantially associated with the
franchisor’s trademark, service mark, trade name, logo or
other unique characteristics; and
- The franchisee is required
to pay, directly or indirectly, a franchisee fee or other
charge.
In California, the consequence
of being a franchise is that you must “register” with the
California Department of Corporations before promoting,
soliciting or entering into any agreement for the franchised
concept. You may need to register in other states as well if
you plan to expand outside of California.
Registration involves
preparation of a comprehensive disclosure document called a
Franchise Disclosure Document (FDD) that provides
detailed information about your business, the prospective
business relationship, the investment required and other
information that is helpful to a prospective franchisee in
evaluating whether to invest.
The FDD must then be delivered
to the prospective franchisee at your first “face to face”
meeting and at least ten business days before you sign any
agreement. Failure to comply with these laws could render any
franchise or other related agreement unenforceable and subject
you to a claim from State and Federal regulators as well as the
franchisee.
Alternatives
If franchising is not for you
but you want to expand, there are alternatives to franchising
that maybe better suited for your situation. Some of these
alternatives are as follows:
- Joint Venture.
You can form a separate corporation or other entity with
outside investors for the purpose of opening and operating
additional units. Provided you do not charge the new entity a
royalty or other fee for use of the trademarks of the
business, and only receive payments based on your ownership
interest, the arrangement is not a franchise and registration
is not required. The investors can also manage the operations
of the new entity.
- Limited Partnerships.
You can form a limited partnership in which you act as the
general partner and the investors act as passive limited
partners. This arrangement can be structured in a way that
avoids triggering franchise laws. Unlike a joint venture
company, however, under this arrangement the investors cannot
play an active role in the operations of the business.
- License. You
can grant a license to use your name and trademarks but agree
not to assert control over the licensee’s business plan or
operations. If you are willing to allow your investors to
devise their own business plan and system, this structure
presents a viable alternative to franchising.
- Other Alternatives.
There are other alternatives to franchising that are outside
the scope of this article. Prospective franchisors should
exercise caution in using any alternative, however, because
the consequences of entering into a “sham” transaction, that
is later determined to be a franchise, are significant.
Conclusion
If you are ready to grow your
business there are many ways to do it. If your growth strategy
involves leveraging the skills and resources of third parties
you should consider franchising, and at a minimum, be aware of
the laws that govern franchising so that you do not
inadvertently violate those laws. Most successful business
owners that want to expand their businesses are able to do so.
The issue is finding the right structure for the particular
situation.
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Drew Simons is a partner
at Reicker, Pfau, Pyle & McRoy and specializes in business
and franchise law. He can be contacted at
dsimons@rppmh.com.
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