Franchise Lawyer Blog

Like many people over the age of twentysomething, I have stumbled clumsily into the arena of social media: Twitter, Facebook and other social networking sites and vehicles. Our teenage children have effortlessly adopted multiple forms of interpersonal communication, so much so that an actual phone call has become rare. Information is exchanged via Facebook, text messaging and Instant Messaging. There are signs that the same migration of the flow of information will happen in the world of commerce.
I recently read a piece in Franchise Times by Gini Dietrich of Arment Dietrich Public Relations that offered some advice on social media in franchising from B.J. Emerson of Tasti D-Lite. The discussion concerned different forms of social media and the advisability of outsourcing the use of those media. The consensus seems to be that using Twitter and Facebook, for instance, to develop business is an inevitable development that should be cautiously embraced if one intends to successfully take one's business into the 21st century. The bottom line appears to be this: the most powerful source of business leads has always been word of mouth. Social media are a concrete means of generating and directing word of mouth in a way that has never been achievable before. You have to look into it.
Mastering these tools is a very different story. Twitter is a wildly unmaneagable tool and the sense is that the entire business commmunity is still learning how to use it. Similarly, Facebook Fan Pages are being introduced by companies every day, but both this and Twitter are in an exploratory trial and error phase.
More commonly accepted methods of obtaining internet based leads, such as Google Adwords, are widely in use. I recently did a Google search under the word "Franchise." Pages upon pages of links appeared (including one for this firm), some of obvious initial use and others not so. Blind searches are a difficult way to go. You must carefully scrutinize the leads that are developed in that manner, particularly by checking out websites.
There are interesting places to go for online information and possible contacts. For example, you can look at BlueMauMau if you are a franchisee and The International Franchise Association (IFA), if you are a franchisor. The former offers information and advice in an open forum, primarily geared to franchisee cautionary tales. The IFA has long been viewed as the unoffical spokesperson for the franchisor community and is a valuable source for information, although its bias must be taken into account.
Proceeding blindly into cyberspace because everyone else is doing it is not a particularly wise business plan. What should be done is what I frequently advise clients to do when they come into my office with pre-determined legal needs. Take a step back and make a reasoned determination of what your most immediate needs are. If, for instance, you want people to find you on the internet when they are looking for a plumber, then you could invest some money on Google Adwords keyed to plumbing (plumber, leaking pipes, etc) to increase the possibility that somebody will stumble upon you. More importantly, you should revise your website so that it does not try to be too much to too many people. Accentuate your plumbing expertise. And then perhaps look into setting up a Facebook Fan Page and see if you can find a couple of satisfied customers to tout it on their Facebook. You could even open a Twitter account and start talking about plumbing and how you deal with problems that you know people have (in 140 characters or less).
Keep in mind that if you left school as long ago as I did, you will always feel like a dinosaur. Particularly if your children have rejected your "friend" requests on Facebook. But better to be a somewhat tech savvy dinosaur than an extinct one.

I attended an IFA Franchise Business Network meeting this morning, attended by various franchise professionals, franchisees, franchisors and regulators. We heard from franchise consulting companies, including brokers and matching companies, brand developers and new and established franchisors. The topic was the business forecast for 2010 and the primary speaker was Edith Wiseman of FRANdata.
The consensus presented is that the economy is in a technical recovery that is much slower to reveal itself in real terms. What that means is that the stock market and technical data such as corporate profits and GDP numbers are showing improvement, but those improvements are not being felt at the consumer/employment level. The employment numbers, which we have seen in a number of places, are sobering: when the unemployed are added to the "underemployed" (people who have taken lesser jobs just to work) and people who have stopped looking, the actual figure is 17% of Americans are affected. A recent Wall Street Journal article recently counted in the millions the number of "long term unemployed," people who have been out of work for over a year. The unemployment numbers are a huge drag on any calculation of consumer spending and consumer sentiment.
Lending has also suffered a negative effect whose roots are now deep and will take some time to recover from. Franchisors in attendance who once had "preferred lender" programs now say those relationships have disappeared. Franchisors are trying to create new relationships from scratch with local and regional banks. The SBA lending limit is being reduced from 90% to 75% and some banks are responding by saying they will not participate in SBA transactions any longer. All of these developments make it more difficult for potential franchisees to finance new businesses.
Ms. Wiseman's prognostications included a 2 to 4 year window of choppy economic developments, such that even if the overall trend may be positive, considerable setbacks will be felt along the way. She indicated that recent numbers show that franchising as a business model continues to show resilience in this economy, with a net increase in total units within 2009.
When those in attendance were asked how this recesssion is affecting their approach to business development, the mantra of "performance matters" was repeated. Transactions will not be entered into unless potential financial performance can be measured in real terms. In the development context, this means carefully scrutinizing potential franchisees and their financial capability if you are a franchisor, with a preference for multi-unit development deals. If you are a franchisee or someone consulting them, there is a higher demand for financial performance figures (it was reported that FDD's containing Item 19 financial performance representations increased from 18% to 35% in the last year). Potential franchisees are also looking for incentives and discounts, which some franchisors are now willing to consider.
All told, the mood in the room was sober, but not somber. People were optimistically looking for the light at the end of the tunnel and planning acordingly.

Any person with an entrepreneurial mindset must consider countless options when deciding whether or not to start a new business. One fundamental decision that must be made at the threshold is whether to create a business from the ground up solely in the entrepreneur's vision, or invest in a developed concept that has been franchised and made available for acquisition.

Some recent articles suggest that the trends are strongly towards the franchise model, a trend that has become accelerated by the recent economic downturn. One recent FoxBusiness article analyzing franchise development points out that the sense of ownership and self-control that is so essential to the success of a "Mom and Pop" store can be duplicated to a certain extent in a franchise situation. However, there is always a tradeoff involving a loss of some control. In exchange for the business plan, name recognition and trademark that the franchisor has developed, as well as training and other support resources, the franchisee gives up a substantial portion of revenue and must subject itself to the system controls imposed by the franchisor. As that article notes, quoting the president of the IFA, “Some entrepreneurs are so independent-minded they don’t want to give up control of any aspect of the business ...For those business people, fitting into the structure of the corporate business isn’t for them." However, for those business people who can sacrifice some part of their own vision to take advantage of a system, the franchise model offers enormous cost and time savings advantages.

A recent article in Kiplinger on franchise growth and lending trends, states that from 2000 to 2008 the number of franchised restaurants grew by 20%, while the number of independent restaurants contracted by 4% over the same period. The article predicts that this trend will continue, observing that franchised businesses are "typically better positioned than mom-and-pop shops to survive downturns, benefiting from a strong brand presence, corporatewide marketing campaigns and access to advice and mentoring from the franchisor. Plus they can often offer customers -- and get from suppliers -- steeper price discounts. " That article also points out that lenders are more comfortable with franchised businesses, noting "lenders have a slight bias toward franchises...generally, bankers tend to perceive franchises as less of a risk. There’s a greater willingness to lend to them...adding that loans to franchisers also tend to be larger compared with loans made to independents."

So do these trends signal the end of the maverick entrepreneur who singlehandedly changes what we eat, wear and buy? No, of course not. Economic trends, particularly the negative ones of the past year and a half, may alter the direction many start-up businesses take in getting started. Buying an established business concept may seem like the far safer bet in a damaged economy. But there will always be those who buck the trend. This country and this economy will sometimes richly reward those who think and act for themselves, and the lure of that unique brand of success will always be there.

We have previously written on this blog concerning what individuals need to know about developing a franchise opportunity and how they can obtain that information. Here is an important opportunity for prospective franchisees or those seeking to enhance the growth of a franchise they already own.

The Manhattan Chamber of Commerce (MCC) , in conjunction with NYC Business Solutions and the U.S. Department of Commerce, will be moderating a panel discussion on "everything from A-Z about buying and growing your franchise."

Among the featured speakers in the Program, entitled "Franchising 101," will be Michael Einbinder, a partner in this firm.

Registration: NYC Business solutions website, click on Franchising 101.
Event Location: NYC Business Solutions Lower Manhattan Center, 110 Williams Street, 4th Floor, Cafe Space, New York, New York, 10038.
Workshop time: 8:00 AM to 10:00 AM, Wednesday, February 17, 2010.
For more information: Call 212-513-6472 or email Shelly Nicholas at snicholas@seedco.org.

Attendees will learn about domestic and international franchise opportunities and be provided with guidance to help determine for themselves if a franchise is right for them. The discussion is also intended to help understand the financing requirements of buying a franchise and discover free resources to help launch and grow a franchise. The distinguished panel includes a successful franchisee, financial professional, attorney, accountant, franchise consultant, U.S. Department of Commerce Director, NYC Business Solutions Lower Manhattan Center Director, and the MCC President.

Tuesday's New York Times (January 19, 2010), provided an obituary of Glen W. Bell, the founder of the now enormous Taco Bell franchised restaurant chain. The obituary tells the story, inspiring in this current economic climate, of Mr. Bell's invention of the crispy-shell taco and the growth of the original Taco Tia restaurant to the 5600 unit Taco Bell franchise chain currently operated by Yum! Brands.
Mr. Bell is credited with introducing mainstream America to Mexican food, an idea that seems obvious now but was undoubtedly revolutionary when he thought of it. At the time, the late 1940's, he was competing with a number of fledgling fast food chains in what The Times describes as an "emerging Southern California car culture." One of those competitors was a hamburger stand only a few miles away that was run by two brothers named McDonald. Mr. Bell recognized that he needed a hook, something to distinguish himself from the pack, and he found it in the taco. He altered the design of the traditional taco from a soft shell to a crispy shell to make it easier to sell (and eat). The rest, as they say, is history.
Mr. Bell, who served in the Marines in the Pacific in World War II, obviously did not lack for nerve, trying to sell a completely untested food in a largely untested format. But that kind of innovation has been at the heart of nearly every successful franchise concept. You have to differentiate yourself from the competition. Doing so takes nerve, because to provide something truly innovative, it has to be something that has not been done quite that way before. And no one knows how or if that is going to work.

The New York Times hosts a small business blog, which today addresses the unique set of difficulties created by entry into the restaurant business. As the writer, a former restaurant entrepeneur, notes, "...restaurants require an enormous amount of focus and the ability to coordinate a seemingly infinite number of details, many of which must be expressed as ratios and monitored constantly in order to run a successful establishment." And yet restaurants are uniquely popular as small business start-ups in general and franchise opportunities in particular.
Why? Because a successful restaurant is a magical place, vibrant, electric, humming. The coolness factor cannot be overestimated. To stand at the door greeting eager patrons to a sold out restaurant is the closest business environment there is to starring in a hit broadway play. The creative element of providing the decor, style and menu of the establishment enables the entrepeneur to take particular and personal ownership of the business.
And yet the first response that a new franchisee will likely get to the news that he or she is opening a restaurant is a cautionary tale about how most restaurants fail. However, there has been some documented writing on that subject that dismisses that assumption as an urban legend. According to actual research, restaurants, including franchised restaurants, fail at a rate that is no higher than the failure rate for new businesses in general. Generally speaking, restaurants appear to fail at a rate of 25% in the first year and 60% over the first three years. While these hardly appear to be encouraging franchise survival rates, those rates are consistent with the survival rates of start-up businesses in general.
From the point of view of the franchisee and those counselling him or her, it is essential to recognize the risks to starting a new business. Everyone has to go in with their eyes open and with as much protection as their attorneys can provide. However, there may not be anything more to fear to entry into the restaurant business, which may make the allure of success in that field even more enticing.

Everyone seems to be proclaiming that the recession is over and the light has appeared at the end of the tunnel. Certainly the stock market has priced a recovery into current equity trading. But in the world outside of Wall Street, an economic rebirth will only be measured by two standards: jobs and credit. We have previously discussed the impact of credit trends on franchise growth.Job growth is not a meaningful yardstick in terms of directly measuring franchising trends, but credit developments certainly are. Franchise growth depends on a dramatic improvement in the credit markets.
The International Franchise Association's Smartbrief recently urged its franchisor readership to call and write their Senators "to build momentum to pass S. 2869 early in 2010." The IFA writes that "Sens. Mary Landrieu, D-La., and Olympia Snowe, R-Maine, recently introduced S. 2869, the Small Business Job Creation and Access to Capital Act. President Obama and SBA Administrator Karen Mills have indicated strong support to extend SBA provisions of the American Recovery and Reinvestment Act and increase the maximum loan limits from $2 million to $5 million." To read more on this, see the IFA website.
The expansion of this program is being accompanied by President Obama's attempts to pressure the banking industry to give "third and fourth looks" to loan applications for small businesses that had been prevously rejected. The Wall Street Journal reports that many banks are assuring the President that second-look programs will be implemented immediately or are already in place. Additionally, the article reports that several large banks are increasing their targets for small business lending for the coming year, including Bank of America, JP Morgan Chase and Wells Fargo.
However, talk is cheap. Despite the assurances, the Journal goes on to report that since April, Bank of America's outstanding small business loans have decreased 5%, or $2.2 billion, while JP Morgan and Wells Fargo have also decreased small business lending by billions of dollars. This contraction occurred while these institutions were receiving huge injections of public funding.
Only time will tell if the banking industry will hold up its end of the bargain and what the net effect of any increased lending efforts will be. As of now, the flow of credit to the small business world has not improved.

We attended the International Council of Shopping Centers (ICSC) convention here in New York at the Hilton this week. The ICSC hosts the primary retail real estate conventions in the country, principally in New York City in December and Las Vegas in May.
Why or how does this affect the franchising community? A short walk through the convention floor makes it impossible not to make the connection. A notice board alerts everyone to the the IFA's (International Franchise Association) presentation that afternoon on how "Franchises Offer New Uses for Retail Space." By the way, the IFA is planning to release its own prognostication of the immediate economic future on December 16. You may want to visit the IFA website at that time to see what that admittedly optimistic organization sees in your future.
On a tour of the booths we immediately encounter GE Capital franchisee finance, then Arby 's franchise opportunities, Dunkin' Brands, Yum Brands, Rita's, Red Robin, Subway and on and on. All franchisors looking for sites for their franchisees. You cannot host a retail real estate gathering without talking about franchised opportunities. Retail real estate growth depends on business growth and business is seeing the opportunities presented by the franchise model and the durability offered by that model. As a result, those of us working in franchising are grateful for our real estate experience and looking to make it work to our franchise clients' benefit.
The mood at the convention was one of somewhat forced conviviality. Speakers at the conference were describing a somewhat optimistic tone in terms of consumer spending. However, the real estate market's rebound may take longer than the consumer's. On the selling side, it is not a strong market and many feel the real estate downturn has not yet found its bottom. One of the largest presenters, General Growth Properties, is just emerging from bankruptcy. While no one at the convention was conceding the heretical view that it has become a buyer's market, there is still a real sense that vacancies abound and deals can be had. There is even a growing market for discount brokers and developers picking up and marketing excess space.
A franchisor, franchisee or multi-unit developer who is looking for affordable locations might have found the convention's rather extravagent entry price ($650) worth it. The convention presents a wealth of information concerning available locations for the industries that have traditionally been at the heart of franchisiing, retail and restaurants. They meet again in Las Vegas in May and there are numerous other smaller meetings. Check out the ICSC website referred to above.

We have previously written about state efforts to obtain franchisor financial information, specifically efforts by the New York State Department of Taxation and Finance to require annual information returns from franchisors. The purpose of this would be to determine if franchisees are not providing completely accurate information for the purpose of fixing sales taxes and state income taxes.

A recent piece in the Law Journal Newsletters Franchising Business & Law Alert, written by Dirk Giseburt, Rochelle Spandorf and Jaymee Castrillo, reports that the State of California has now initiated efforts through its California Franchise Tax Board (FTB) to require California franchisees to begin withholding 7% of all lease and royalty payments to out-of-state franchisors that exceed $1500 per calendar year. The stated goal is to require out-of-state franchisors to become qualified to do business in the State of California, which carries with it the obligation to file State income tax returns. Apparently, some organizations, such as the IFA, are questioning the FTB's authority to impose such a withholding requirement. The inquiry into applicability in a particular instance would focus on two theories, first, that royalties and the like represent California source income; and second that a franchisor has established a business situs in California when its intangible assets are used in a California business, in this case, the asset being the franchise license.

As in New York, these fledgling regulations are still being tested. Franchisors and franchisees are well advised to refer to their accountants and franchise counsel for an up to date assessment of current applications, so that they are continually making informed decisions as to whether or not to provide different types of reporting under consideration.

New York's Department of Taxation and Finance has extended the original September 21 compliance deadline and reportedly is changing the rule to make it less burdensome. The available 90 day extensions now extend until December 20, 2009.

As we have explored on this blog previously, there has been endless discussion during this economic downturn concerning the effect current economic conditions will have on the franchising model. That discussion continues unabated, as evidenced by the following entries found through the briefest of internet searches:

A franchise fix for the recession blues? - BNET

Franchise leader says industry can lift economy - Fox Business

Fewer small business jobs lost in October - CNNmoney.com

Lackluster economy creates prime tenant market. - Franchising World.

The Franchise Decision - WSJ.com

The accepted wisdom on franchise growth is that the most valuable resource, people, is in ample supply in the marketplace. The second most valuable resource, real estate, has become more affordable, opening the door to small business devolopment. The equation goes like this: recently downsized capable business person with entrepeneurial bent cannot find a job and so creates a new business by acquiring a franchise, with the help of affordable rents.
The clouds on the horizon for this sunny view arise when one considers an enormously stingy credit environment and sharply reduced consumer spending.
There is no question that franchising presents some business opportunities that would otherwise never materialize in this economic environment. And in the long run, franchsing as a model seems destined to occupy a larger and larger segment of the US economy. Buying into an established system and brand increases the odds of success exponentially in an economic environment that moves faster and faster. However, there is also no question that people are spending less money: on eating out, clothes, electronics, almost anything you can think of. Until consumer confidence returns in full, this softness in spending is going to slow nearly every segment of the economy, and franchised businesses will fare no different.

At least one study reveals that in 2007, over 45% of franchisors included arbitration as the method for dispute resolution in their franchise agreements. Arbitration can provide the parties to a dispute with substantial benefits. Arbitration is touted as a method for resolving disputes more efficiently than litigation, saving both money and time. In addition, arbitration provides the parties with the ability to control the process and to obtain an unappealable resolution.

Unfortunately, the process of arbitration does not always result in the hoped for benefits. Costs skyrocket with the addition of arbitrator fees and administrative fees. Arbitration often results in what may be perceived as an “arbitrary” determination; the oft-heard reputation of arbitrators to cut the baby in half. Also, with limited discovery and procedural safeguards, the parties can be left with a feeling that they did not have their day in court.

But arbitration does not necessarily have to result in such dissatisfaction (although, no doubt, any losing party is likely to be dissatisfied regardless of whether the claim was arbitrated or litigated). The parties should remember that arbitration is a creature of contract and the process can be tailored to the parties' satisfaction. They can contract for certain discovery or discovery limits. They can contract to limit the arbitrator’s discretion. And, the parties can decide which administrative organization to use (if any) thereby possibly substantially reducing their costs.

If the parties to a franchise agreement consider all options and variations in the course of drafting the arbitration provision, the parties will have far greater control over the dispute resolution process. This will presumably result in a more favorably received method for resolution.

Julianne Cowan Lusthaus

At the ABA Annual Forum on Franchising in Toronto this past week, several of the presentations touched on the subject of mediation, specifically as a dispute resolution method stated in the franchise agreement. The concept was discussed in what was for me a surprisingly positive light. I have never thought much about the concept of contractually induced mediation. If it is phrased as mandatory it seems unproductive conceptually. Parties are less likely to agree to anything if they are forced to the table at the expense of other remedies. If it is not mandatory, it seems like a toothless concept. If the parties could voluntarily agree to resolve their dispute, they wouldn't be having a dispute in the first place. But one of the presentations at the Forum introduced statistics that suggested that parties are more likely to resolve a dispute if they enter into mediation first, to a surprisingly high degree.

Which leads me to a question. Do you think mediation works? Do you use it in your franchise agreements? If so, do you phrase it as a mandatory requirement to the initial exclusion of all other remedies? If not, how do you introduce it?

This query is an experiment of sorts. I have never offered a survey type question on this blog before. It you do respond, via our contacts page, I will provide to you a summary overview of the other information I receive in response.