Denver Colorado Franchise Attorney Martin A. Mansfield, Jr.

Creating Franchise Systems and Selling Franchises

Overview:

If you have a business that can be turned into a standardized business format and then replicated in different territories and locations, you probably have a franchisable business.  You, the franchisor, would sell to franchisees who will run the franchised business as their own local operation in the different locales. 

The franchisor-franchisee relationship is expressed in a Franchise Agreement that binds both parties.  The details of running the franchise are set forth by the franchisor in what is known as a Confidential Operating Manual. 

Due to numerous abuses by franchisors in the early days of franchising, many states and the Federal Trade Commission (FTC) considered regulation to be essential to protect prospective franchisees from buying a franchise without adequate disclosures by the franchisor of certain specific aspects of the offered franchise. So, a number of states have franchise regulations and the FTC has promulgated regulations through what is known as the FTC Franchise Rule (or FTC Rule).

Therefore, before you can offer or sell any franchises, you must provide potential buyers a Franchise Disclosure Document (FDD) mandated throughout the U.S. by the FTC.  Many individual states have additional legal requirements.

The FTC considers an offered business to be a franchise if it involves (i) a trademark license to the franchisee, (ii) payment of a fee over $500 to the franchisor, and (iii) significant ongoing control or assistance by the franchisor over the franchisee.    

Colorado has no franchise-specific laws or regulations and is an excellent state for a franchisor to be located. Only the FTC Rule need be complied with. 

Representation by an attorney experienced in franchise law is essential, because compliance with franchise laws is intricate and failure to comply even on technical matters will negatively impact your ability as the franchisor to continue offering and selling franchises. 

Your Prototype:

Every franchise needs a solid foundation.  The primary foundation is the business format that is licensed to franchisees.  Typically this format is an actual operating business that has flourished for the potential franchisor for some time and proven itself by its own track record.  The format of this business is the franchise prototype.  Hopefully the prototype is observably successful to any outsider, because in the initial franchise development stage the prototype is the primary operation by which prospective franchisees can evaluate the value of the franchised business.  The better developed the prototype the more easily a franchise system can be launched and grown.

Your Experience:

Your prototype is more than just its business format.  Your hard work and creativity in making it a success is the driving force behind its success.  Any sensible prospective franchisee will want to feel assured that following not only your prototype but also your experience will increase the chances for their own success.
 

Your Trademark:

Franchise systems are almost always identified by a distinctive trademark.  If you are already using a trademark when we begin work on your franchise system, I will evaluate the trademark to see if all is in order from the franchising standpoint.  If you do not have a trademark, then I will assist you to create one.  Ideally we will obtain federal registration for your trademark if it does not have that status when we first meet.

Federal registration results in a U.S. Registered Trademark.  These are the trademarks that are permitted to use the distinctive circle R symbol.  More than that, these trademarks have specific legal rights under U.S. law that applies in every State without needed to file for state trademark registration.  Over my years of practice it has long since become clear that a U.S. Registered Trademark is a must have for a successful franchise.  The FTC agrees and requires a damaging disclaimer to be put in the FDD if the franchisor does not have a federally registered mark.  You will definitely lose franchise sales without one.

One reason the trademark is so important is that your franchise agreement will license the use of your trademark to the franchisees.  The trademark license is one of the three elements of a franchise.  You will want to be as sure as possible that you have a legally protected trademark you can defend.

Several states with "business opportunity" laws require a federally registered trademark in order for a franchisor to be exempt from compliance with their business opportunity laws.  Without one, the franchisor must in most cases avoid these states.

The U.S. Trademark application should be filed as soon as possible, since it usually takes 9-12 months to obtain federal registration.  

Your Replication Formula and Training:

The entrepreneur with a successful prototype and solid experience running it needs to then be able to package it for others to run and train them in the needed practices and policies.  This is easier said than done.  You know without even thinking how most of the important aspects of your prototype run.  What you must now do is rethink all these aspects so as to be able to train capable franchisees to implement the format and operations of your prototype at their own location.  You will also have to devise methods for ongoing contact with franchisees.

The training program is disclosed in the FDD and prospective franchisees will want to see a reasonable training program in place.

We will discuss the needed elements for a reasonable training program as part of the franchise creation process. 

Working with your Franchise Attorney:

A relationship as complicated as the franchise relationship must be properly defined and established in written documentation binding on all parties involved.  And, the legally required disclosures must also be completely and properly put into documented form.  Having been an active franchise attorney since 1988, I will give you the quality of representation you need to accomplish these goals.  

Your Franchising Business Entity:

One of the first things we must decide is if you should form a separate legal entity for your franchising business as distinguished from your prototype business.  If the answer here is yes, then we must determine the optimal business format.

Usually the answer is yes, because this separates the financials of your franchising business from your other business aspects.  This simplifies the presentation of financials in the FDD and keeps your other financials confidential.

In almost all cases you will be choosing between a corporation (and if it should be a Sub S corporation) and a Limited Liability Company (LLC).  We will discuss this.  You will want to discuss this with your accountant because many of the decision factors concern taxation.  A basic outline of the factors is elsewhere in this site.   

Your Franchise Agreement:

The franchise agreement is the cornerstone of every franchise relationship.  It sets forth the dimensions of the franchise license, establishes the financial obligations, provides for the time period of the initial franchise license and renewals of the franchise agreement, lists each parties' obligations, describes the Confidential Operating Manual, protects the confidentiality and proprietary items (including the trademark) of the franchisor, specifies what can cause a franchisee termination and what the consequences are, lays out the procedure and requirements for a sale of the franchisee's franchise as well as of the franchise system itself by the franchisor, and many other critical matters.  Franchise agreements contain so many needed topics that they are always quite lengthy and technical.  Once an agreement is signed by a given franchisee, neither party can force a change to it due to changing circumstances, so we will have to work closely to look down the road of the franchise system growth and anticipate problems that might have to be solved by reference to the franchise agreement.  We also have to make sure that the franchise agreement is fair to both sides, creates a "win-win" relationship, and does not read in a fashion that discourages suitable prospects from signing.

We may have additional agreements related to the franchise agreement itself.  For example, we will typically require all persons involved in buying the franchise to personally guaranty and accept the franchise agreement even if the franchise is purchased by them in corporate or some other entity form.  We will also have all employees of the franchisee (and your own employees) sign a legally enforceable confidentiality agreement.  We may want to allow regional developers to put up or sell multiple units and prepare a regional development agreement (this is in addition to my basic franchise creation package).

Although the FTC does not regulate the contents of the franchise agreement, certain states do.  We will vary the agreement to comply with a particular state's law to be used in that state only.  

Your Franchise Disclosure Document:

Federal law requires specific disclosures in the Franchise Disclosure Document (FDD) to be made to prospective franchisees as part of any offering of a franchise.  Certain states have their own franchise regulation laws which add to the required disclosures.  Putting together a legally sufficient FDD requires a great deal of experience and attention to detail.  The FTC has released over 500 pages of explanation, text of regulations and compliance guide pages for the FDD, and the franchise regulation states have released their own instructions.  Although all FDD's follow a prescribed format, each FDD must be customized from start to finish for each franchisor.  

The FDD has mandatory exhibits in addition to the body of the FDD itself. This accounts for much of the length of FDD documents.  One of the most important exhibits consists of the franchisor's financial statements.  The first calendar year only requires an unaudited balance sheet (unless the franchisor already has its financials audited).  The second year's balance sheet must be audited by an independent certified public accountant, and after that the balance sheet, profit and loss, and statement of cash flows must be audited.

Your Confidential Operating Manual: 

This is where you set forth the daily nuts and bolts of running the franchise as well as proprietary matters needed by the franchisee to run the franchise.  I can help you structure this document, but in the end it must be prepared by you or a technical writer we retain to assist you.  This document must never contradict the franchise agreement itself, but apart from that can be changed over and over again, and the franchise agreement I draft for you will make this changing nature part of the agreement.  So, you can begin with a bare bones manual if necessary and expand upon it over time without having to modify your franchise agreement.

Your Sales and Marketing Process:

The actual means by which franchises are sold and marketed is regulated by federal and state law.  Therefore I will work with you and your sales staff if any to ensure that these legal requirements are followed.

A critical component of your franchise marketing will be your franchise web site and possibly related social media marketing.  You may already have a web site for your foundational business that acts as your prototype so one option is to add franchising information to that site.  You may also consider creating a separate web site for the franchise system and recruiting franchisees (although these days must be aware of search engine policies on cross-linking these sites).  You can include information about your foundational business in your franchise web site.  

Ongoing Legal Matters:

As the system grows, there will be a stream of various legal matters, large and small, that have to be taken care of.  For example, a franchisee might wish to sell his franchise and you will have to deal with the approval process.  Or, a dispute might arise that should be worked out without resort to litigation.  So, our working relationship will be ongoing to take care of these matters.

Avoiding Franchise Status if Desired:

You might wonder if you can expand in a manner similar to franchising but not be burdened by all the laws applicable to franchising.  You can, if the offered business does not contain all three of the legal elements discussed above and if you do not call it a franchise. However, the resulting business may be found to be a business opportunity.

The FTC regulates business opportunities through its Business Opportunity Rule.  Compliance with this rule is easier than compliance with its Franchise Rule.  Many states, though, regulate business opportunities in a manner more onerous than that for franchises.  I can analyze your situation for you and advise you on the most likely legal definition of your operation and the available options for modifying your operation in order to avoid both franchise and business opportunity regulation.

Perhaps the most common method of avoiding definition as a franchise is to not license your trademark for use by the other party or allow it to be used or associated with their business in any way.  This has to be complete.  Your trademark must not be associated with the licensed business in any way.  In some states, however, this will not in and of itself avoid business opportunity status.  This is the business opportunity trap.  Business opportunities are considered generally disreputable by state regulators, so state business opportunity regulations can be more severe than franchise regulations. You would not want to take pains to avoid being a franchise and then be considered a business opportunity in those states.

A common misconception is that franchise status can be avoided by calling the relationship a "license". Although a license need not be a franchise, if it contains the elements of a franchise then it is a franchise, regardless of what it is called.  And, again, such a license can end up being a business opportunity.

Although franchise regulations cause inconvenience and expense, the franchise model is well defined and well understood by the public.  People want to buy franchises.  So if your business model is a good one, franchising probably offers you a greater chance for success than mere licensing or offering a business opportunity.  And the use and promotion of your trademark in a franchise system adds considerably to public awareness of the franchised businesses over having all the "licensees" use their own names.

My Fees:

I charge a flat fee of $9800 for all services in connection with launching your franchise system.  This includes the franchise agreement and a non-state-specific FDD that complies with the FTC Rule and the time working together to formulate the franchise system structure, operations, policies and requirements.  This is quite a time consuming process for both of us, and you can expect it to take 1-2 months depending on how many complexities we encounter.  I think you will find this fee to be reasonable and moderate given the services that you will receive.  You may also find it to be substantially less than the fee charged by other firms.  My practice efficiencies permit me to offer a high quality work product and spend considerable time with my clients for a lower fee than less efficient practices.  

This does not include state-specific concerns, such as registering in a franchise regulation state, changing the FDD for a particular regulation state or changing the franchise agreement for a particular regulation state.  

Nor does this include the trademark services apart from the initial advice, although I offer trademark services for low legal fees 

Certain related agreements, such as those for franchisee lease addendums and software licenses, and those related to area developers, are also not included in the flat fee.  

I don't charge you fees until we are ready to begin work, so you can call me at the number at the bottom of this page and go over the basics with me without concern over incurring a fee.  Also, if you want, you can Contact me by email from this Web site.