Paddle as the water comes in
There’s a saying that goes, “Paddle when the water comes in. It means seize the opportunity when it comes. These days, we’re seeing a lot of fast-growing businesses with brilliant ideas and entrepreneurial savvy. But even the fastest-growing businesses have a problem. It’s the question of scaling. We’ve seen too many examples of businesses that think they’re in the water and need to paddle, only to find themselves out of business because they expanded too quickly and recklessly. One option to consider is franchising.
In the U.S., we’re breaking records every day.
The overall output of U.S. franchise businesses is said to be close to $889 billion in 2015. That’s a huge jump from 2010’s output of $699 billion. So what is it about franchising that makes so many people choose it as a way to expand their business?
The biggest advantage is that you don’t need to raise capital to expand your business. Capital is probably the biggest concern when expanding a business. Even if your existing business is doing well, it’s rare to have enough cash on hand to start a new business.
However, as a franchisor, you don’t have to worry about capital when you expand your business through franchising. The franchisee, not the franchisor, is responsible for most of the initial startup capital for the new business.
In addition, the franchisee’s name appears on many of the documents required to start a business, including the lease for the new location, and the franchisor is solely responsible for the working capital and wages of the franchisee’s employees.
That’s not the only benefit of franchising.
Many business owners say that one of the most necessary and difficult things to do when scaling a business is to find a manager they can trust with their new venture. Business owners want to find a manager who has a sense of “ownership”. But on the flip side, managers are vocal about how little motivation they have to take ownership. It doesn’t matter how much money you spend expanding your business, if you don’t have the right managers to manage it, it’s a foregone conclusion.
But with franchising, the situation is different. Franchisors invest their own capital to prepare their franchisees. There’s no greater motivation than that, and since franchisees are part-owners of the business, you don’t have to force ownership – they’ll take the initiative to research and work on increasing sales and saving money without anyone telling them to.
If you don’t get started on the right foot with the law, you could be in big trouble.
But even with all of these benefits, franchising can be a big mistake if it’s not done right and in compliance with the law. So, as a franchisor, what are some of the things you need to be aware of when starting a franchise? Many business owners think that a franchise is simply a contract between a franchisor and a franchisee. That’s right. A franchise is a contract between the franchisor and the franchisee. But it’s not a typical contract where the parties are free to promise whatever they want, it’s a contract that’s regulated by a set of laws.
Franchise agreements are first regulated by the U.S. federal government.
The Federal Trade Commission requires franchisors who want to expand their business through franchising to provide prospective franchisees who want to enter into a franchise agreement with materials that detail the franchisor’s business information. This is called the Franchise Disclosure Document (FDD). The FDD must be delivered to prospective franchisees at least 14 days before a contract is signed. The Franchise Disclosure Document has 23 sections and must include information about the franchisor’s business experience/history, patents held, litigation history, bankruptcy history, franchise fees, goods and services that the franchisor restricts the sale of, and the franchisor’s sales history.
You’re not done preparing your disclosure statement.
Once you’ve prepared and delivered your franchise disclosure statement to prospective franchisees, your obligations don’t end there. In 14 states, franchisors are required to register their franchise disclosure statements with the state. In addition, registered franchise disclosures must be updated at least once a year. There are many other federal and state regulations that govern franchise agreements.
While there are many ways to expand a growing business, franchising certainly has its own advantages. However, if you don’t understand the regulations surrounding franchising, you could end up losing money. In severe cases, a court may even invalidate the entire agreement with the franchisor, and order the franchisor to compensate the franchisee for all the money spent to open the franchise. Therefore, if you are interested in franchising, it is highly recommended that you consult with an attorney experienced in franchise law.
If you have any further questions about the content of the column, or if there are any legal issues you would like our readers to know about, please don’t hesitate to contact us at mail@songlawfirm.com. I will incorporate them into my next column.