Franchise Lawyer Blog

Depending upon your source of information, we are headed into a recession or a depression or even a catastrophic cessation of all business activities. By any definition, things do not look promising and we are looking at a new economic landscape. The question arises as to how that will affect franchising. People will tell you that franchising is counter-cyclical, that it continues to thrive during a downturn in the general economy. We have touched on this before, but let’s try to approach the question with numbers.

The equity markets are searching for a bottom after a historically precipitous decline. However, let’s take a look at a small part of the equity market, a selection of U.S. publicly traded franchisors referred to as the Rosenberg Center Franchise 50 Index, developed by the University of New Hampshire’s Rosenberg International Center of Franchising.

The index tracks the performance of the top 50 U.S. franchisors. These 50 franchisors represent 98% of the market capitalization of public companies engaged in business format franchising. Using a similar model as the S&P 500, the performance of those franchisors has been tracked and charted. In the 2nd quarter 2008, the RCF50 was down 4.4%, compared to the S&P 500 being down 3.2%. For the first half 2008, the RCF50 was down 12% and the S&P 500 was down 12.8%. Not much of a difference there. However, for the years 2000-2008, the RCF50 is up 59.6%, while the S&P 500 is down 8.2%. These numbers suggest that franchising has historically outpaced the general economy, but is suffering similarly in this recent downturn.

A quick review of various franchise related websites finds a similar set of statistics being advanced by those who support the franchising concept. These statistics consistently support the notion that franchised businesses are more growth oriented and survive at a higher rate than non-franchised businesses. For instance, a US Department of Commerce study is quoted on more than one site as showing that from 1971 to 1997, less than 5% of franchised businesses close each year, while those same websites cite a US SBA Study looking at the period 1978 to 1998, which found that 62% of non-franchised businesses close within the first 6 years of their opening.

It is difficult to independently verify those statistics and they are dated in any event. But if those trends are true, than someone looking to get into business in an unfriendly economic environment would be wise to look at franchised concepts rather than inventing his own. The question remains whether the current economic environment is so toxic that any business venture, be it franchised or self-invented, will find it impossible to thrive.

In the current economy, questions arise more than ever about how to finance the purchase of a franchise. In fact, many people think that it simply will not be possible to borrow money for the purchase of a franchise. While it is true that it may be more difficult and that lenders are being more careful about lending money, there are some ways a franchisor can improve the ability of a prospective or existing franchisee to get financing.

Franchisors should be aware that some lenders are paying greater attention to the information contained in the franchise disclosure document ("FDD"). Therefore, when preparing an FDD, a franchisor should take into account the necessity of prospective franchisees to obtain financing.

For instance, more lenders are looking for information that might be provided in Item 19 of the FDD. Such information is known as financial performance representations. Not surprisingly, lenders may want to know about the earnings and earning potential of units in the franchise system. Of course, a lot of factors must be considered when a franchisor decides whether to provide Item 19 information and if so, what specific information to provide. But one of those factors should be that franchisees are going to require financing and if so, some lenders may expect and require such economic data.

Also, lenders may want assurance that the franchisor will provide the franchisee with the necessary training to succeed. One of the great things about buying a franchise is that a franchise is supposed to be a “turn-key” business. That is, a franchisor is supposed to provide a franchisee with all of the knowledge and skills necessary to operate the franchise. When deciding whether to lend to a prospective franchisee, lenders are more and more interested in assessing the type and extent of training the franchisor is going to provide. Therefore, when providing information in Item 11 concerning the franchisor’s obligations, a franchisor should take care to ensure that sufficient detail is provided about the training program. This way, lenders will be able to ascertain whether a franchisee without any experience may be provided with the tools necessary to succeed.

While financing for the purchase of a franchise is harder to come by these days, it is possible for a prudent franchisor, with attention to detail, to increase a prospective franchisee’s ability to obtain such financing.

Contributed by Julianne Cowan Lusthaus

There are many individuals running successful small businesses who decide that franchising their concept is the best way to grow. With the assistance of franchise counsel and sometimes business consultants, they develop a business model and create the appropriate franchising documentation; registering their franchise disclosure document (“FDD”) where necessary. At this point they enter into the most crucial phase of franchise development: identifying and attracting the right people to become franchisees of their new systems.

At this stage, many franchisors find that there is an art to finding the right match. We spoke to a new franchisor that this firm represents, Jason Puleio, about his franchise concept, The Barker Lounge, a dog daycare center and boarding facility offering full service dog care in large, “cage-free,” climate-controlled facilities. The Barker Lounge plans to have 4 or 5 franchises developed this year.

The Barker Lounge was recently featured in the October Franchise Times. You can find out more information about The Barker Lounge franchise system by going to the The Barker Lounge website.

Jason tells us the main component to identifying the right candidate for a franchisee is transparency – a totally honest approach. He makes the candidate aware from the start that his system is growing at a deliberate pace and that he is willing to wait for the right people. Jason provides interested parties with everything that they ask for in terms of information and guidance. And as the candidates are checking his operation out, he is simultaneously checking them out. Jason is looking for someone that is passionate about dogs, it simply won’t work otherwise. He wants franchisees who are going to love the work.

Jason says that he is breaking with convention and finding most of his interested parties in non-franchise environments. Rather than trolling the big franchise business conventions, he is meeting people through industry connections, such as pet shows and animal rescue organizations. That is where he can find the type of people who are willing to commit to Jason’s carefully developed brand of dog care.

A franchise system will ultimately succeed or fail with the quality of the franchisees running the system's operations. Jason's hands-on approach to developing his system from the ground up, with committed, passionate franchisees, describes a formula for success.

Understandably, much more attention is given to the present and future of franchising than to the past, but this entry considers (very briefly) the origins of franchises. Not the start of the practice, though, but rather the etymology of the word franchise.

In short, going backward in time, the word “franchise” comes to modern English by way of Middle English fraunchise (circa 1290), from Old French franchise (“freedom”), from franche, the feminine of franc, from Late Latin francus, meaning, simply, “free” (or “exempt”; francus is also the root of “frank”—open, honest—and, some argue, even “France” itself.)

Coming back again to the present, the meaning of “franchise” narrowed to “a particular legal privilege” in the eighteenth century… then, in 1790, to “the right to vote” (that being a particularly particular legal privilege). The meaning of franchise of “the authorization by a company to sell its products or services” dates from 1959. (It does not appear any other specific milestone in franchising was reached in that year, though the International Franchise Association was founded in 1960.)

Notably, when a business franchise arrangement comes to an end, if it is because of something inappropriate that the franchisee has done, generally we speak of the default and termination of the franchisee by the franchisor. We do not typically refer to his or her disenfranchisement, that term being reserved for the (usually unnecessary) fate that befalls one who loses the right to vote, which is most commonly the result of a failure to reregister when required… something to keep in mind this election season.

Your choice of candidate for the U.S. presidency will no doubt be made after a complex consideration of various factors. However, since we are focused on franchising in this space, let’s try to consider the election just from that perspective.

Franchising World Magazine recently published the “FranPAC Report Card.” FranPAC is the political action committee of the International Franchise Association (which also publishes Franchise World Magazine); FranPAC advertises itself as supporting “pro-franchise, pro-business” candidates. FranPAC donated to 27 candidates for the Senate—23 Republicans and 4 Democrats. FranPAC gave financial support to 83 candidates for Congress—64 Republicans, 19 Democrats. FranPAC made a donation to the National Republican Congressional Committee as well. Although FranPAC did not donate directly to either Presidential candidate, clearly it favors Republican candidates in general as the pro-business, pro-franchise candidates and presumably would favor McCain in the same manner. To the extent FranPAC’s financial activities reflect the sentiments of the franchising community as a whole, clearly there is a perception that McCain and the Republican Party will best serve the interests of the franchising community.

Others have tried to sort through the candidates’ stated views to determine who might best serve the franchising community. Blue Mau Mau, a publication primarily serving the franchisee community, analyzed how each candidate would serve the small business community. But there is no plain answer there either, as both candidates offer a litany of ideas that would serve those who might fall within that constituency.

Notably, NPR’s online publication likens the development of the Obama campaign and the Obama brand to the development of a franchise system. But Obama’s intelligent use of the grassroots business structure that forms the basis of many successful franchise systems does not necessarily mean he is naturally the best candidate for those working within the franchise industry.

The IFA went to the candidates themselves with a series of questions, some directed specifically at issues facing the franchise community. Each candidate offers specific solutions to particular problems, although the pair has a tendency to disagree on what the real issues are. Reading through this Q&A might give one a sense of how each particular candidate would address a specific issue facing a specific franchisee or franchisor. It does not give a clear indication, however, that either candidate would better serve the franchising or small business community.

Given the enormous complexities of our current financial environment, an undecided voter would be much better served examining the views of the presidential candidates on our current financial crisis generally and the solution(s) each of them proposes. One of these men will have to lead us out of this morass, and all business models are going to sink or swim together based upon how well the man ultimately elected provides that leadership.