Franchise Lawyer Blog

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.
.

Posted by Terrence M. Dunn | Permalink | Email This Post

Posted In: Franchise Development

Bookmark:

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.

Posted by Terrence M. Dunn | Permalink | Email This Post

Posted In: Franchise Development

Bookmark:

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.

Posted by Terrence M. Dunn | Permalink | Email This Post

Posted In: Franchise Development

Bookmark:

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."

Posted by Terrence M. Dunn | Permalink | Email This Post

Posted In: Franchise Development

Bookmark:

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.

Posted by Terrence M. Dunn | Permalink | Email This Post

Posted In: Franchise Development

Bookmark:

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.

Posted by Julianne Cowan Lusthaus | Permalink | Email This Post

Posted In: Franchise Development

Bookmark:

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.

Posted by Terrence M. Dunn | Permalink | Email This Post

Posted In: Franchise Development

Bookmark:

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.

Posted by Terrence M. Dunn | Permalink | Email This Post

Posted In: Franchise Development

Bookmark:

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.

Posted by Terrence M. Dunn | Permalink | Email This Post

Posted In: Franchise Development

Bookmark:

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

Posted by Einbinder & Dunn | Permalink | Email This Post

Posted In: Franchise Development

Bookmark:

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.

Posted by Terrence M. Dunn | Permalink | Email This Post

Posted In: Franchise Development

Bookmark:

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.

Posted by Terrence M. Dunn | Permalink | Email This Post

Posted In: Franchise Development

Bookmark:

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.

Posted by Michael Einbinder | Permalink | Email This Post

Posted In: Franchise Development

Bookmark:

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.

Posted by Terrence M. Dunn | Permalink | Email This Post

Posted In: Franchise Development

Bookmark: