Offering and selling franchises is governed by the Federal Trade Commission’s trade regulation rule entitled “Disclosure Requirements and Prohibitions Concerning Franchising; Final Rule,” 16 C.F.R. Part 436 (the “Amended FTC Rule”).  Among other things, it requires franchisors to provide prospective franchisees with a pre-sale franchise disclosure document with 23 “Items” of information (“FDD”) and imposes a 14-day waiting period before binding documents can be signed or money exchanged.  The Amended FTC Rule also prohibits franchisors from sharing any revenue or profit information (whether historical or projected) with prospective franchisees except for information contained in Item 19 of the FDD.   The FDD must be updated annually, within 120 days after the close of the franchisor’s fiscal year end, with current information as of its fiscal year end, including the franchisor’s audited, year-end financial statements.

In addition to federal law, offering and selling franchises is regulated by the franchise sales laws of 15 states: California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Oregon, Rhode Island, South Dakota, Virginia, Washington and Wisconsin (the so-called “Registration States”). These laws potentially apply to a franchise sale if the offer is made in the state, the offer is accepted in the state, the franchisee is domiciled in the state, and/or the franchised business will operate in the state.  Like the Amended FTC Rule, most states’ franchise sales laws require that the FDD be updated, and the state registration amended, after a material change occurs in the information contained in the registration.  Several states also regulate the offer and sale of franchise through their business opportunity laws: Alabama, Alaska, California, Connecticut, Florida, Georgia, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Maryland, Michigan, Nebraska, New Hampshire, North Carolina, Ohio, Oklahoma, South Carolina, South Dakota, Texas, Utah, Virginia, and Washington (the so-called “Business Opportunity States”). Several states’ business opportunity laws exclude or exempt the sale of franchises made in compliance with federal law. Certain states’ business opportunity laws, however, exempt sales only if the franchisor has a state or federal trademark registration, Other states’ business opportunity laws require either a one-time filing or annual filings to claim exemption from the business opportunity laws.

Once a franchise is sold, a different set of laws and regulations apply. These laws are commonly known as “franchise relationship laws” because they govern important aspects of the franchise relationship, such as the franchisee’s right to sell or transfer the franchise to a third party, and the franchisor’s right to terminate or refuse to renew the franchise relationship. While the franchise agreement may allow a franchisor or refuse to renew a franchise or provide a franchisor with certain remedies in the event of a franchisee’s default, franchise relationship laws may restrict a franchisor’s right to exercise certain contractual remedies, may extend applicable notice or cure periods, or may require the franchisor to compensate a franchisee if certain remedies are exercised.

California, New York and Washington impose additional registration requirements for franchise brokers or sales agents.

When you contact the franchisor, you most likely will communicate first with a franchise sales representative. This person may send you information about the franchise and ask you to complete a franchise application. If your application is approved, you may be invited to participate in a franchise “discovery day” at franchisor’s headquarters. During discovery day, you will meet the company representatives with whom you will have a relationship, and learn more about the company, its culture, and the franchise opportunity. Because you will be relying on the franchisor for support and assistance, it is important to choose a franchisor who knows both the business being franchised and how to be a good franchisor. Take all necessary steps to get to know your franchisor.

Federal law entitles you to receive a franchise disclosure document (commonly called an “FDD”) at least 14 days before you sign a binding contract or pay any consideration for the franchise. The FDD must be prepared in accordance with federal regulations. The FDD, which is broken down by “Items,” contains prescribed information about the franchisor and the franchise offering. Item 7 contains an estimate of your startup costs, which you can use as a basis for preparing your business plan and budget. Items 5 and 6 describe all fees you must pay to the franchisor, and Item 8 describes supplier restrictions, which can affect the amount you must pay for goods and services required to operate the franchise. Item 17 summarizes other key provisions of the franchise contracts, and Item 20 provides information about current franchisees and franchisees that have left the system. The FDD also contains copies of the franchisor’s standard contracts and audited financial statements. The following chart summarizes the information than can be found in the FDD: You should engage an attorney who is thoroughly familiar with franchise law to assist you in interpreting the FDD and understanding the terms of your franchise agreement.   Although a general business attorney may be able to help you with certain legal matters, such as forming an entity to operate the franchised business or negotiating a commercial lease, it is best to engage a franchise attorney who understands, and who can explain to you, the practical and legal implications of franchise agreement provisions.

While your franchise attorney is reviewing your FDD, you should continue your research by: Investigating any financial information provided by the franchisor. If the franchisor provides any earnings information regarding the franchise opportunity, Item 19 of the FDD must contain a written “financial performance representation” that supports the information provided. If the franchisor has provided you financial information that is not in Item 19 of the FDD, a violation of federal law may have occurred. Interviewing franchisees and former franchisees of the system. Item 20 of the FDD contains information about current franchisees and franchisees that have left the franchise system during the franchisor’s most recent fiscal year. You should call and speak to each franchisee and former franchisee to determine their level of satisfaction with the franchise and, where possible, the income or profit level that they have realized. Preparing a business plan to determine the amount of capital that you will need to begin operating and to operate the franchised business during the initial period. Item 7 of the FDD reflects your estimated initial investment.   Although you should use this information as a starting point, to create your own business plan, you will need to investigate actual rental, labor and other costs in the area in which you will operate the franchised business. Asking what value you will be getting from the franchise. When evaluating a particular type of business, think about what you would need if you established the business yourself, the level of risk and potential barriers to entry. Then balance that against what the franchisor brings to the table and the difficulty and cost of obtaining the same products and services as an independent operator. Consider whether you will like the business. Also important to your decision is whether operating the business fits your independent lifestyle. Do you need a certain level of income? Do you mind working nights and/or weekends? Do you like cold calling? Do you prefer to work alone?

While nothing legally prohibits a franchisor from negotiating the terms of its standard franchise agreement (and the franchise laws favor negotiation), franchisors typically are reluctant to do so. This is partially due to a fear that offering a better deal to one franchisee, if discovered by another franchisee, will affect other franchise relationships. Negotiating with one franchisee also is thought to “open the floodgate” to future requests for negotiation, with each new franchisee wanting the same or a better deal than offered to the previous franchisee. That being said, there sometimes are opportunities to negotiate the terms of the contracts and situations where certain terms should be negotiated.  We can help you to assess the likelihood that your franchisor will negotiate the terms of the contract and to identify areas where concessions are most likely to be made. Involving us in negotiations also can expedite and streamline the negotiation process.

A “franchise” is a contract where one party (the franchisor) grants the other party (the franchisee) the right to use the franchisor’s business system and to operate under the franchisor’s trademark. For federal law purposes, a “franchise” exists whenever there is a license of a trademark, a minimum payment is made either before the purchase or within the first six months of operation, and the  franchisor either promises to provide significant assistance in, or has the right to exercise significant control over, the franchisee’s entire method of operation. Many states have their own definition of a “franchise.” The term “franchise” can encompass a variety of business structures, regardless of what the parties call the relationship. Independent contractor, dealer, distributor, license, and membership agreements may be considered a “franchise” for legal purposes, depending on how they are structured.