My experience with franchising lies with the franchisor side. I was in-house counsel for several years with a business that had franchised its business. Now I am trying to apply my knowledge to the franchisee side also.
A franchisor is the one who creates the original franchise system and the franchisee buys the franchise and does the day-to-day running of the business. Think of Papa John's (for example) as the franchisor and the owner of the local store as the franchisee.
Franchising presents the ability for the franchisor increasing profits by shifting some risks onto the franchisee and the franchisee hopes to profit from a winning franchise system and reduce the risks from starting a business from scratch. Overall, franchises are a fast growing business but they do have a drawback. That drawback intertwines with the great benefit of franchising: the association with a brand name. Anything damaging the brand name damages all those associated with that brand. I have posted on this problem here and here. The prospective franchisee needs to keep this danger in mind.
Somewhat as an aside, a friend and I started listing franchises that were no longer around. The list we came up with ran like this:
Dog & SudsQuite often the failures were due to over-extension and poor capitalization of franchisees. Some franchises were regional that could not expand enough to keep the system alive. Some just did not have a product that could compete against market leaders. Some just retreated from the area. (Kenny Rogers was a nice concept but could not really compete with KFC. I used to love Popeye's Chicken but how many times a week will Hoosiers eat red beans and rice?). If you are buying a franchise take a serious look at the product being franchised. I think common-sense will help most in thinking about these overarching business issues. After all, there are very good reasons that there are no Haggis To Go Restaurants.
Arthur Treacher's Fish & Chips
Roy Rogers Chicken
Kenny Rogers Roasters
For information on business issues, I suggest a potential franchisee take a look at Entrepreneur Magazine at entrepreneur.com and Bison.com.
Legal protections exist for the potential franchisee. The Federal Trade Commission and the Indiana Secretary of State regulate the franchising process.
The federal rules on what must be disclosed can be found at 16 CFR 436.1. These disclosures must be made 10 days before paying any money or signing any franchise agreement. The FTC has a detailed overview of the franchising rule online here. The FTC summarizes the disclosure requirements here:
- names, addresses, and telephone numbers of at least 10 previous purchasers who live closest to you;
- a fully audited financial statement of the seller;
- background and experience of the business's key executives;
- cost of starting and maintaining the business; and
- the responsibilities you and the seller will have to each other once you've invested in the opportunity.
The FTC's also archives its informal opinion letters here.
Take a look at what the FTC requires in its disclosures. These touch on what I call overarching business issues and are meant to inform business decisions.
Indiana's Secretary of State regulates franchises within Indiana through its Securities Division. The Securities Division has a FAQ page here, an online database for searching out Indiana franchises here, and an online collection of state franchise forms and statements here. (A note for anyone accessing those forms and/or statements - they are in PDF format.)
Indiana's Secretary of State does not provide the depth or breadth of information available through the FTC site. However, registration with the Secretary of State can be just as important as complying with the FTC rule. I do not find any mention at the Secretary of State's site that Indiana has two statutes regulating franchises.
The Indiana Franchise Act (IC 23-2-2.5) basically follows the FTC rule. However, IC 23-2-2.5-3 has particular interest for what is exempted under Indiana law.
Sections 9 through 25 of this chapter do not apply to the offer or sale of a franchise if the franchisor either sells no more than one (1) franchise in any twenty-four (24) month period or the franchisor:The franchisor claiming the exemption must still provide the disclosure information (IC 23-2-2.5-3(c)).
(a) has a net worth:
(1) on a consolidated basis according to current financial statements certified by independent certified public accountants, of not less than five million dollars ($5,000,000); or
(2) according to current financial statements certified by independent certified public accountants of not less than one million dollars ($1,000,000) and is at least eighty percent (80%) owned by a corporation which has a net worth on a consolidated basis, according to current financial statements certified by independent certified public accountants, of not less than five million dollars ($5,000,000);
(1) had at least twenty-five (25) franchisees conducting business at all times during the five (5) year period immediately preceding the offer or sale; or
(2) conducted the business which is the subject of the franchise continuously for not less than five (5) years preceding the offer or sale;
or if any corporation which owns at least eighty percent (80%) of the franchisor has had at least twenty-five (25) franchisees conducting business at all times during the five (5) year period immediately preceding the offer or sale, or such corporation has conducted the business which is the subject of the franchise continuously for not less than five (5) years preceding the offer or sale....
Indiana's other franchise statute needs attention from both franchisors and franchisees. This statute is Indiana's Deceptive Franchise Practices Act (IC 23-2-2.7). The statute has two long lists of deceptive practices which need to be read. They are much too extensive for this post. I believe that most will find counterparts in the FTC rule but some such as the following (and which I want to point out for all) I do not recall in the FTC rule:
Requiring a franchisee to covenant not to compete with the franchisor for a period longer than three (3) years or in an area greater than the exclusive area granted by the franchise agreement or, in absence of such a provision in the agreement, an area of reasonable size, upon termination of or failure to renew the franchise.The statute allows for damages or reformation of the franchise agreement. IC 23-2-2.7-4. I should note that this statute has received little review by the Indiana appellate courts. Kahlo Jeep Chrysler Dodge of Knightstown, Inc. v. Daimler Chrysler Motors Company LLC is the most recent case I am aware of. (That opinion is in PDF format).
I will finish some odds and ends from my research on franchises. Here is an article from a New York lawyer on the pros and cons of franchising. While slanted towards New York law, the writer does provide some good insights into the business of franchising. Some websites are geared towards putting potential franchisee with franchisor with potential franchisee (and vice versa) and others are just more informational:
- Franchise Help (which bills itself as "Your global franchise connection")
- William Rosenberg Center of International Franchising. (A center at the University of New Hamsphire created by the founder of Dunkin Donuts.)
- Michael H. Seid & Associates, LLC. (Business services for franchisors).
- International Franchise Association. (Which appears close to a trade association for franchising.)
Correction: in the list above was listed Bonanza Steakhouse and Godfather's Pizza. These franchises remain in operation but not in my area. I probably ought to have googled the franchises but I did not. My only defense is that the list came out of a discussion of local franchises that were no longer operating in the area. Which does raise an interesting point about franchises: some are stubbornly regional and others are not so tied to their region. I am not aware of any Popeye's Chicken stores in my area (Anderson and Indianapolis) but I have seen commercials for them. Popeye's seemed to rise with the interest in New Orleans/Louisiana cooking. I suspect - but have not time to check this - that Popeye's remains strong south of Indiana. For franchisors and franchisees I suggest thinking long and hard about expansion with food businesses. Ethnic, regional favorites might not transfer well elsewhere regardless of the strength of the franchise system. By the way, I found Bonanza here and Godfather's Pizza here (and there is information for potential franchisors on the Godfather's site, too). Thanks to Mr. Nabors for pointing out my error in his comment.