Franchise Lawyer Blog

April 14's blog suggested two ways to improve a franchisor's form franchise agreement: creating a security interest in the franchisee's assets and creating a collateral assignment of lease for the lease of franchisee's business premises.

Here are three more improvements that can be incorporated into many franchise agreements:

- Non-Competition Agreements: Every franchisor should have a non-compete contained in its franchise agreement. But the franchisor must be certain that the scope of both in-term and post-term covenants are not too broad and provide for limited duration and limited territory. The clauses should be drafted to protect the franchisor's business interests. The provision must take into account the specifics of applicable law. California, for instance, does not allow for such non-competitive restrictions. In Atlantic Bread Company v. Lupton-Smith et al., 285 Ga. 587 (2009), the Supreme Court of Georgia recently held that in-term restrictions are governed by the same strict scrutiny standard as to length and area as post-term restrictions. All limitations in the relevant jurisdictions must be identified and accounted for in the provision to the extent possible. It is generally advisable to include a “savings” clause in the non-competition provision that provides that if any part of the provision is deemed excessive, the court can limit it.

-Trade Secrets and Trademarks: It is essential that the franchisor protect its brand and other intellectual property. This is the life blood of its business. Franchise agreements should contain strong protections of trade secrets.

-The non-competition clause should assist in this by referring specifically to trade secrets;

-The franchise agreement should require that the franchisee obtain a non-disclosure agreement from all of its employees, independent contractors, agents, management, owners, etc.;

-The franchise agreement should provide a form non-disclosure agreement for the franchisee to use;

-The franchisor should develop enforcement procedures and vigorously apply them;

-The franchisor should clearly mark all trade secrets as confidential.

It is important that the franchisor monitor the use of its trademark. The franchise agreement should strictly define franchisee's permitted use of trademarks. Franchisee's use must be consistent with franchisor's plan – color, size, shape, approved advertising formats and mediums (print, tv, radio, internet); franchisee may not use a similar mark in any way; franchisee must not have created a separate internet presence using the mark if prohibited by franchisor. The franchisor should regularly review USPTO and State filings, to be certain that similar marks are not filed. If filed, the franchisor should determine if a mark is confusingly similar and oppose registration. The franchise agreement should provide that the franchisee must participate and cooperate in these endeavors.

- Insurance: In addition to requiring that franchisee obtain the types of liability insurance generally obtained by any business, the franchise agreement should also require the franchisee to obtain employment practices insurance to cover claims alleging sexual harassment and age discrimination. The franchise agreement should also require franchisees to purchase business interruption insurance, the proceeds of which should be included as part of the franchisee's gross revenues and factored into the franchisee's royalty payments to the franchisor, if royalties are calculated as a percentage of gross revenues.

An examination of the franchise agreement with which you work in light of these concepts and the ones proposed in our last entry may result in a significant improvement to the structure of the franchise agreement.

Our firm represents many franchisors. Franchisors have typically developed franchise agreements that have been tailored by time and experience to address the issues that most often arise in the development of their franchised businesses. However, even the most polished agreement can benefit from a periodic review and revision. We suggest five areas that frequently require attention in order to enhance enforcement rights, to protect against competition, to protect intellectual property and to protect against claims by third parties. The first two we will cover briefly in this entry, the next three in the entry that follows:

-Security interest in the franchisee's assets: In the event of a franchisee default, the franchisor should be able to take possession of franchisee"s assets for the purpose of selling those assets (possibly to a new franchisee) to recover monies due from the franchisee or to keep those assets to operate the unit. To ensure the right to do so, the franchisor should take a security interest in the furniture, fixtures and equipment that are used in the franchised business. This security interest can be created in the franchise agreement and can be perfected by a recorded UCC financing statement (UCC-1).

-Collateral Assignment of Lease: In the event of franchisee"s default under its lease for its business premises, the lease should provide that the franchisor has the right, but not the obligation, to assume the lease without having to pay any consideration to landlord, cure any defaults or replenish the security deposit. These latter conditions are sometimes difficult to extract from a landlord, but the assignment right is imperative. In order to protect itself in this manner, the franchisor should require a Collateral Assignment of Lease that is entered into simultaneously with the franchisee"s lease. This will allow the franchisor to enforce its rights upon default without requiring the cooperation of the franchisee or consent of the landlord.

Our next blog entry will cover non-competition agreements, trade secrets and trademarks, and Insurance.

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.

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.

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.

We attended the 32nd Annual American Bar Association Forum on Franchising in Toronto last week. The opening session featured Greg Nathan, a psychologist and franchising expert, who examined the psychological dynamics of the franchisor/franchisee relationship. At one point, he posted a franchisee mood monitor: how do franchisees feel about their relationship with their franchisor and their franchisors' attitude towards marketing, support and business in general?

As is so often the case with psychology, many of the observations seemed obvious: of course franchisees are happier when they are respected and treated fairly. But if it is so obvious, why did Nathan report widespread dissatisfaction among franchisees in terms of their perception of their franchisors' treatment of them? Why do these concepts of respect and fairness get confused in their translation into the marketplace?

Because economics, or economic perceptions, interfere. Apparently, many franchisors believe that decisions that make sense according to the bottom line are acceptable even if they make people unhappy. There is a prevailing attitude of "It's just business, nothing personal." And the franchisors' assumption is that franchisees understand that. The question was asked of franchisors: does it matter if your franchisees are happy or mad? Some thought it didn't. Business is business. But the statistics Nathan presented strongly suggested otherwise.

Nathan suggested that everything is personal. Even decisions that make perfect financial sense can be deeply resented. It becomes essential that franchisors step away from the bottom line and examine the long term effects of short term business decisions. Nathan suggested that the construction of a healthy system might, at times, require decisions that aren't optimum from a short term economic perspective.

Growth of a system depends on satisfied franchisees. That satisfaction must become a measured economic metric for a system to succeed. Why? Because a system is an organic thing, whose growth is dependent on the overall health of the body. Nothing slows growth more than bad word of mouth from established franchisees. Does this require blatant pandering to the moods of the rank and file? No, it requires common sense. You must convince your franchisees that decisions are for the mutual good, even if they require short term financial pain. You must also sometimes be prepared to weather difficult times as a franchisor, if the immediate short term solution is going to turn your franchisees against you.

We wrote a blog entry several months ago about the negative impact the global recession is having on franchise growth. Recent stories appearing across the country continue to confirm this trend. The IFA SmartBrief provides a story from Minnesota confirming continued difficulties in individual franchisees obtaining credit and reiterating the IFA's prediction, mentioned in our May blog, that overall franchise growth would show a negative 1.2% number for this year. As the first buds of economic recovery continue to appear, we will keep track of that number to see if it turns back to a positive growth number any time soon.

Last fall we wrote a blog that commented that franchisors were finding ways to help their franchisees through these difficult times by providing financing or assisting in obtaining financiing, or forgiving past due royalties and other fees, all in the interest of continuing the viability of the system. Recent economic trends may be causing some franchisors to pull back on that generosity. The Wall Street Journal reports that Papa John's is scaling back on its financial support to its franchisees, which had included a reduction in royalties and fees. With the recent decline in cheese costs, the franchisor and franchisees are seeing an increase in profits, enabling the system to move forward in a more conventional manner. Some writers have cautioned that recent economic good news could be illusory and to the extent that Papa John's move is based on a change in commodity prices, that could change again tomorrow. But others see this story as further evidence of an overall stabilizing in the marketplace.

Credit Crunch:

This topic has been previously discussed by us and is still a hot topic of discussion.

As today's Orlando Sentinel notes:

"Usually, a downturn increases interest in franchises as people laid off from corporate jobs try opening their own restaurants, convenience stores and child-care centers.

This time, though, the tight credit market has made it difficult for would-be business owners to find financing, something that's "really wreaking havoc on the sale of franchises," said Alisa Harrison, a spokeswoman for the International Franchising Association."

SBA Lending:

We have writtten previously about franchising and Small Business Administration lending. The subject is touched upon again in the June/July issue of Franchise Times. In a section called "Dollar Signs," the magazine notes that while SBA lending has increased since the beginning of the year, nevertheless the total for this year (20,997 loans) remains at half of the number approved at the same time a year ago. The IFA is predicting that franchise lending will decline 40 percent this year, which will cost the country 50,000 jobs and $5 billion dollars in economic activity. A recent survey suggests that three-quarters of lenders believe that they will ulitmately increase lending as a result of stimulus policies, so a guarded optimism may not be misplaced.

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A potential client called the other day and described a potential business venture to me. He said that he wanted to structure it as a license rather than "getting involved in all of the complications of franchising."

As an aside, we have written on the topic of franchising vs. licensing previously.

Recently, the American Bar Association's Forum on Franchising's Listserv, which we have discussed before , featured a long chain of emails on the same subject, during which many opinions were offered as to what defines a license and a franchise, as well as the gray area between them, and whether those definitions can be manipulated to one's benefit.

However, one writer offered the clearest bit of advice. He suggested that his esteemed colleagues, being lawyers, were focusing on the legalities of the situation to the exclusion of everything else, including good business sense. He proposed that the proper approach is to look at the business being contemplated and decide what is the best model for its expansion. Forget the law, don't even talk to your lawyer unless he is able to not miss the forest for the trees. When that business model is clearly established, then apply the tests to determine whether or not it needs to be structured as a licensing arrangement or a franchise system.

More often than not, the situation will call for a franchise model. This is because the three prong tests that we have discussed before identify three elements that most successful business models will want to include. The three prong test identifies (i) a fee as a condition for entry into the business; (ii) the use of a trademark; and (iii) a marketing plan or system. It's sometimes hard to imagine how to license a trademark, while properly protecting your rights by controlling its use, without qualifying oneself as a franchise.

But if the model calls for a franchise, we tell our clients not to look for a way around it but rather to embrace it. As franchise regulation evolves and the models become more refined, it continues to establish itself as an extremely efficient means of exponentially expanding the number of units of a particular business.
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A quick follow up:

Demonstrating that we know a trend when we see one, the most recent IFA Smartbrief received today refers to more articles concerning the ebb and flow in franchising caused by this economic climate. The flow is caused by the human tide of employees and business developers that have been jettisoned by the conventional economy. The ebb is caused by the increasingly constrained credit markets, which are making it difficult for businesses to get the financing needed to start-up or survive.

Our last entry discussed these topics. Today's IFA Smartbrief refers to an article in the Orlando Sentinel that examines the local economy in Florida and finds that many people who have been left unemployed by corporate downsizing are looking to make new careers through franchising. As we noted in our last blog, this need for immediate employment is creating a trend towards business-format franchises and other low cost to entry franchises that will provide immediate returns.

The Smartbrief also refers to an article in The Boston Globe that reports on developments in Massachusetts with similar observations: people forging ahead with business development in the franchising space, concentrating their efforts on the grassroots level, finding local trends that are cost conscious in a way that appeals to local wallets.

However, both articles make reference to the credit crunch. The Orlando Sentinel notes that FRANdata reports a 27% decline in franchise borrowing over the past few months, undoubtedly because of the lack of available credit. This trend could make it impossible for even the most savvy, driven business visionary to get her idea off the ground.

We have written previously about the unusual position that the franchising model may end up occupying in this recession. We have suggested that franchising may not be affected as severely by the recession and that franchising may offer opportunities to those forced out of areas of the more conventional economy.

We posited in all of those earlier writings that only time would tell. Our recent issue of IFA Smartbrief, the informative newsletter of the International Franchising Association, contains a couple of stories that suggest that these views are beginning to gain traction, albeit with some nuances.

The May 26 issue of the IFA Smartbrief refers to an article in The Palm Beach Post that paints a guardedly optimistic picture of franchising prospects in a recessionary economy. The article states that franchising has always grown in prior recessions, based upon the flow of laid off personnel from traditional jobs who decide to start their own businesses. The author cautiously notes that this recession is different in that it comes accompanied by a severe credit crunch, which makes it difficult to finance a new business enterprise. In fact, the IFA itself has measured a 1.2% decline in franchises in 2009 so far, the first decline in recorded history. However, a 1.2% decline in an economy that has retracted as much as this one may be viewed as a positive.

The IFA Smartbrief also highlights a recent article from The Charlotte Observer in a similar vein, which makes some observations on the flight of down-sized refugees from the corporate world into entrepreneurial small business. The article makes a somewhat grimmer assessment of this trend. It notes a severe contraction in six figure jobs and observes that while the Kauffman Foundation Study finds a national increase in new businesses, much of this growth is in lower income franchises, such as child care and retail services, suggesting that people are creating jobs out of necessity, rather than finding great business opportunities.

We recommend you to the Smartbrief (contact ifa@smartbrief.com) for actual hard news about how franchises and franchising is faring in this economy. With respect to our earlier writings, there does appear to be a shift in emphasis towards franchising, but entry may be harder than forecast because of the credit crunch. Moreover, the desperation of unemployment may be driving people to lower cost to entry and lower income franchising opportunities.

We have written extensively on the role the franchising model can play in a recessionary economic environment, most recently on January 22. While there is some evidence that franchising is a viable alternative model in uncharted economic waters, there are also significant risks.

Although we have previously offered some evidence that franchising business models are weathering the storm better than the market as a whole, it is too early to draw any final conclusions.

To continue the discussion, we refer you to a piece in that vein recently posted on MSNBC.com, titled "When Career Turns Down, Franchising is an Option," by Eve Tahmincioglu, which discusses how "some laid-off workers turn to franchising."

In this country we have a national compulsion to rank things. If one enters "top ten" into a Google search, the first five entries that come up are top ten (i) urinals; (ii)shirts to get arrested in; (iii) time wasting websites; (iv) chemistry videos; and (v) books. The list is endless after that. So why not rank franchise systems? Entepeneur has done just that, featured today on AOL Small Business.
As it turns out, ranking franchises makes a lot more sense and is infinitely more informative than ranking urinals or chemistry videos. Entrepeneur has been featuring its Franchise 500, a registered trademark, for thirty years. An examination of the current list and the historical trends tells you a great deal about the successes and failures of the franchise concept as a whole, as well as how it works within particular industries. The rankings are established based upon financial strength, stability, growth rate and size.
This year's top twenty is dominated by fast food and fast casual dining (Taco Bell, Arby's, Dairy Queen, KFC, Baskin Robbins, Papa John's, Pizza Hut, Sonic, McDonalds and Subway), cleaning (Jani-Pro and Jani King), tax services (Liberty Tax and Instant Tax), hospitality (Intercontinental Hotels and Super 8) and assorted other industries (Ace Hardware, Super K convenience stores, Jiffy Lube and UPS/MailBoxes Etc.)
Running down the list, there are franchise systems for every business you can think of, and a few that probably would not have occurred to you: several tanning companies, wheelchair ramps (American Ramp Systems at 412), spray-on truck bed liners (Line-X Corp at 419) and pet waste removal (DoodyCalls at 452).
We are pleased to note the appearance of two systems with whom we have worked recently:
(i) Sir Grout Franchising LLC at 499, which was featured on this blog previously. Sir Grout's appearance is noteworthy because this is their first year of operation, an unusual characteristic for a top 500 entry. Sir Grout sells franchises in the business of grout sealing and restoration; and (ii) Four Seasons Marketing Corp., appearing at # 365, a company selling franchises in the business of selling sunrooms, windows, conservatories, solariums, patio rooms, deck enclosures, patio covers and pergolas, retractable awnings and greenhouses.
Entrepeneur is not the only publication to rank franchises. A quick search finds FranchiseBusinessReview, a website, which offers top 50 rankings in three categories (large systems, midsized systems and under 50 units).
Any prospective franchisee or established franchisor can learn something from these lists. Taking into account the fact that they are necessarily subjective by nature and skewed in favor of whatever measurement standards are being applied, they nevertheless can be useful when viewed year over year in terms of examining what types of franchises are finding traction in the nation as a whole.

Some Points to Consider Before Signing a Franchise Agreement

Many of our blog commentaries address franchisor concerns. We also represent franchisees. We offer these observations to that constituency concerning the most crucial step in forming that relationship.

When buying a franchise, it is important to review the franchise agreement with an attorney, preferably one with experience in franchising. This is true regardless of whether the terms of the franchise agreement are ultimately negotiated. It is imperative that you understand the parameters of your relationship with the franchisor. Prospective franchisees sometimes focus only on the products and/or services they will be selling and the fees they will be paying the franchisor. They often do not fully review and understand the terms of the franchise agreement or their future relationship with the franchisor. This can result in dissatisfaction to the franchisee and cause substantial investment losses.

For instance, when purchasing a franchise, you may have the right to operate the franchise for a certain term such as five or ten years. But what happens at the end of that term? Does the franchise agreement provide you with a “right to renew”? And if so, what does that really mean? Are there conditions attached to the right to renew? Will you have to sign a new form of franchise agreement? Can that agreement contain new and increased fees? In what other ways may it differ from your initial agreement with the franchisor? If you are not allowed to renew the agreement, what happens to the value of your business? Will you receive any benefit from the years of operating your business? It is important to fully understand what will happen to your business and investment at the end of the term of the agreement.

Another point to consider is whether you will have the right to terminate the franchise agreement. Prospective franchisees often assume that if the business is not successful, the franchisee can simply close the doors and walk away as it would be able to do with an independent business. However, that is rarely the case in franchising. If the franchisee stops operating the franchise before the end of the term, he or she may be liable to the franchisor for its damages arising from the premature termination of the franchise agreement. Be sure to understand whether and on what grounds you have the right to terminate the agreement.

It is true that one of the benefits to buying a franchise is that the franchisee is buying into a proven system with a known name. Presumably, the franchisor has created a system and worked out the kinks before franchising the business. However, the franchise agreement is likely to provide the franchisor with the right to maintain control of the system. That control may include the right to require you to make modifications to your franchised business during the term of the agreement. These modifications can be quite costly and may include changes in equipment, computers, even changes to the brand name which may require new signs, new uniforms, new office supplies, and the like. While these modifications may ultimately benefit the system, you will be required to implement these changes at a time and cost determined by the franchisor without regard to your situation. It is important to realize that these unlimited costs may be imposed by the franchisor at any time during the franchise relationship.

These are just a few of the contract terms you should review with your attorney prior to purchasing a franchise. Buying a franchise can be a wonderful opportunity for owning a business with a proven brand and concept. Just be sure to understand the entirety of your relationship with the franchisor so that you ensure that the opportunity is right for you.

Our firm has always been extensively involved in real estate, so this week I walked up 6th Avenue in Manhattan to the New York Hilton to visit the annual New York Conference of the International Council of Shopping Centers ("ICSC"), the premier retail real estate organization in the United States. The ICSC Conference is where commercial landlords, including most of the major mall owners and real estate developers in the country, gather to make deals. The conference also attracts potential tenants of all shapes and sizes, including (and here's the connection to our blog) many franchisors. In fact, a walk around the countless booths brought me face to face with many of the nation's major franchising companies: Burger King and Dunkin' Donuts, among others. There are also a host of lenders, brand experts and other advisors looking to provide assistance to prospective retail tenants.
The tone at this function could not be described as somber; this is, after all, a room full of salesmen (and saleswomen). However, the crowd seemed a little thinner than at prior events, with the occasional booth operator standing forlornly alone with no one to talk to. Various speakers gave the bad news, retail chain store sales have fallen a record 2.7% year over year in November. With this morning's Wall Street Journal announcing that the World Bank predicts an unprecedented global recession, it wasn't hard to detect a panicky note in the air, a more strident tone in the hub bub of conversation.
What does this mean for franchising? Well, obviously this worldwide slowdown is going to have a negative effect on just about everyone. Franchisors and their franchisees will have to adjust to reduced demand, tightened credit, rising costs and everything else that goes with it.
But within the real estate context the news from this conference is that attractive real estate deals can be made. It is a buyer's market for premium locations. A franchise system that is weathering this storm and cautiously thinking about expansion will be able to find attractive sites at prices that are significantly more affordable than they were even a few months ago. And those prices will probably be reduced even further as demand continues to weaken. A franchisee who secures a long term location at this point will be paying prices that a few years from now, when (not if) things turn around, will look like the deal of this new century.

A few blogs ago we spoke about Jason Puleio's The Barker Lounge, a dog day care franchise. In that blog entry we identified how Jason has had success in developing his franchise system by focusing on entering into agreements with individuals who are a good match for the system and the business. That inquiry led us to look at another one of our franchisor clients, Sir Grout, a business that provides grout and tile cleaning and restoration services.
Since the issuance of their first UFOC in October of last year, Sir Grout has sold six franchises, taking a deliberate approach to laying the groundwork for a franchise system. Another large franchise deal is in the works. Jeff Gill, one of the two principals (Tom Lindberg is the other) says that most of the franchises so far have come from previous acquaintances and word of mouth, built upon the business reputations of the two principals. They have taken a careful and economic approach to marketing, with a focus on developing their website and finding advantageous placement on other franchise oriented websites.
The franchises they have established have succeeded, which supports their growing reputation and builds on the word of mouth support. Jeff says this success is because they have adhered to their carefully developed business model and training practices that were defined in their UFOC (now FDD). In fact, says Jeff, "Every time someone has slipped a little, we have been able to pinpoint where they are struggling at the point where they deviated from the business model." Jeff says one key component is the availability of the principals. They have always made it a priority to be responsive to franchisee problems.
Jeff notes that the economic downturn has not impacted them as much as some other franchise systems, because they present a low cost alternative to home improvement. "We're a good alternative to a major home repair," says Jeff, "Our service gets you a bathroom that looks like new, as opposed to the huge expense of a new bathrooom."
The principals also place a priority on advertising, which they see as crucial to building confidence in the system. They require their franchisees to spend a minimum and encourage them to do more. In this business, says Jeff, "the more advertising you do, the more you make." However, conscious of the fact that they are a low cost franchising option, they look for inexpensive advertising options, so that they can increase the exposure without increasing the costs. For instance, by investing in an SEO specialist, they have gotten all of their franchisees placement on the first page of a Google search.
In difficult economic times, the recipe for success seems to always include personal attention to the franchisor-franchisee relationship and a focus on keeping costs down without sacrificing quality. It has worked for Sir Grout. We will be examining the success and struggles of other systems as we continue to analyze what works and what doesn't in this volatile economic landscape.

On October 22, Julie Cowan Lusthaus wrote a piece on this blog about franchisors helping their franchisees obtain financing in this difficult credit market. In the past couple of weeks, as the credit markets have tightened to the point where they are frozen, it seems as if no one is talking about anything else in the franchising world.
The Franchise Times November/December issue features an article on the steps franchisors are taking to work in a frozen credit market; it also features another piece on the credit contraction, which provides some tips on how to ride it out.
A recent article in NuWire Investor discusses how Domino's is offering short term financial credit solutions to its franchisees. Papa John's is featured in Nation's Restaurant News attempting to ease the economic pressures on its franchisees by cutting the price of cheese and trying other short term credit assistance.
Some franchise systems have still found it possible to finance their operations and even acheive expansion, proving that that there are still some businesses, at least for now, that may lay claim to the elusive title of being "recession-proof." Great Clips, Inc. just announced plans for 300 new salons through 2009, aided by $14 million in new financing. The AOL Money and Finance story reporting that development notes that franchises remain a viable source of business development and job opportunity in a turbulent employment market.
We will keep an eye on financial developments as they unfold in the economy as a whole and as they resonate throughout the franchising space. Although there is no question that tightening credit availability will negatively impact on many franchised businesses, all franchisees theoretically belong to a community of businesses with shared needs, hopefully supported by a franchisor with a mutual interest in seeing each of them succeed. That offers many more prospects for support than would be available to the independent business owner.

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.

Even in an economic environment as troubling and uncertain as the current one, the only way for a business to survive is to grow. For many smaller businesses, asking how to grow inevitably leads to an inquiry into the possibility of franchising.

So, is your business right for franchising? The answer is not always apparent, in part because success as an individual business does not guaranty success as a franchise model. There are many reputable sources of useful information regarding the viability of franchising, such as the Web site of the International Franchise Association, a large membership organization consisting primarily of franchisors. You should also refer to the Web site for this law firm.

When asking whether your business can be franchised, important things to consider are the following:
• Is your brand known? Successful franchises are built upon unique and readily recognized brands. If your brand is not already well known, you will need to make it well known as soon as possible.
• Has your business concept been tested and proven? Many entrepreneurs come to us with a concept but no established business. It is very difficult to franchise a mere concept. It is essential that at least one version of your business model is up and running before your can meaningfully consider franchising.
• Do you have a system that is replicable and that can be taught? For your business to become a successful franchise system, you must be able to teach franchisees how to operate the business in a manner that will work in various environments.
• Do you have the people to help you get your franchise off the ground? You must remember that running a franchise system is different from running your business as just a business. You will need expertise in marketing, building brand awareness, and sales. Many aspiring franchisors do not realize that even after the franchise plan is in place, it still has to be sold to the public.

We will discuss the viability of franchising a business further in entries to follow, offering actual practical case studies of successful franchising ventures.

What are franchisees supposed to do when a franchisor goes out of business?

Given the current state of the economy, a number of franchisors are either filing or contemplating petitions in bankruptcy or simply ceasing operations (see this Blog's entry of July 30). There are many reasons why this is happening, but the common result is that this event can be devastating for future franchisees. Franchisees are left without any support, having paid thousands of dollars in franchise fees and royalties and getting nothing in return.

The lack of operational support may be most devastating. Franchisees who rely on the franchisor for menu choices, inventory, even scheduling of appointments, may find themselves out of business. When a franchisor simply disappears, the only choice may be to have the franchisees band together in a cooperative arrangment to fund support.

Among other questions, however, is whether or not the franchisees can continue to use the franchisor's trademark. A more sophisticated approach is necessary when the franchisor is a larger company which liquidates in an orderly fashion and whose assets, including the extant franchise agreements and trademarks, are actually sold to a new owner. In that instance, franchisees may choose to look for a white knight with whom they can chart the course of their ongoing business.

Wednesday's Wall Street Journal article, "Dining Chains Shut Doors" by Jeffrey McCracken and Janet Adamy, discusses the Chapter 7 bankruptcy liquidation filing of Plano, Texas-based Metromedia Restaurant Group, the parent company of Bennigan's and Steak and Ale. Although the 138 franchisee-owned Bennigan's sites were not included in the filing and apparently intend to remain open, they will be doing so initially without a franchisor or franchise system support. Those franchisees will also be trying to succeed in an environment that has already proven to be glutted with mid-priced, sitdown restaurants. The Ground Round chain went through a similar experience several years ago; ultimately the franchisor was acquired by a cooperative of existing franchisees.

What the future holds in store for Bennigan's cannot be known at this point, but the bankruptcy is a painful indication of the Darwinian survival process that is evolving in the fiercely competitive franchise restaurant landscape. That does not mean that all franchised restaurants are a bad bet in this environment. Only time will tell if the economy is driving a broad move away from eating out, or simply to restaurants that offer cheaper, fast food meals. The latter concept could bode well for the franchisors of those concepts. We will examine how the more nimble franchisors are adjusting to the environment and look at some of those concepts in coming posts.