[Franchise Law] What to look for in a franchise agreement

Hello, this is Song Dong Ho. “Entrepreneurship is the answer!” is the cry of many economists, because we are living in an era of uncertainty. Youth unemployment is rising day by day. It’s reaching new highs every year. And it’s not just young people who are looking for work. The aging population is also looking for work in retirement. It’s hard to compete with young people who are looking for jobs. You have to find a new way. That’s why many people turn to starting a business. “I’ve been living under someone else’s paycheck for decades, so now I can live with the boss.” But starting a business is not easy. You don’t just suddenly have the aptitude and talent for entrepreneurship after a lifetime of building walls. In fact, in South Korea in 2016, an average of about 3,000 people became self-employed every day, while 2,000 small businesses closed every day, meaning that for every three people who started a business, two went out of business. Besides, I don’t have the money to start a business, I’ve been working hard for decades to save money to feed my children and family. I want to start a business, but I don’t have the experience. Many people choose to start a franchise as an answer to this problem.

Franchising is a huge business in the United States. There are currently about 550,000 franchised businesses in operation across the United States, and they generate about $800 billion in revenue annually. About 35% of all retailers in the US are franchises, and they employ nearly 7 million people. That’s a lot of business. Recently, Korean companies have also been actively entering the US franchise business. BBQ, a chicken restaurant that recently opened a franchise on 32nd Street in Manhattan, New York City, has announced a bold ambition to open 10,000 franchises in the U.S. by 2020. Paris Baguette, a famous Korean bakery, also announced that it is challenging the “franchise myth” in the US. Since entering the U.S. in 2005, Paris Baguette has operated exclusively as a franchisee, but in 2016, the company opened its 46th U.S. store and first franchisee. The company also announced plans to open 350 franchises and restaurants across the U.S. by 2020. Is this a trend? We’ve been getting a lot of questions about franchising at our law firm lately, so today we’re going to talk about some important things you should know if you’re interested in franchising.

First, you need a legal understanding of franchising. In the United States, a franchise is a contract between a franchisor and a franchisee, and the basic framework of the contract is as follows: 1) the franchisee is granted the right to sell goods and services that are associated with the franchisor’s trademarks; 2) the franchisor must actively assist and be involved in the operation or management of the franchisee’s business; and 3) the franchisee must pay the franchisor a franchise fee in return.

The Federal Trade Commission requires franchisors to provide a Franchise Disclosure Document (FDD) to people interested in a franchise agreement at least 14 days before the franchise agreement is signed. The FDD is a document that contains important business information about the franchisor. The disclosures are very comprehensive and detailed, including the franchisor’s business experience and history, patents held, litigation history, bankruptcy history, franchise fees, products and services that the franchisor restricts the sale of, franchisee obligations, operating policies and education/training policies, franchisor sales performance, and distance restrictions from other franchisees. Why do we require this disclosure? The reason is simple. To protect the franchisee’s interests. If a franchisee were to enter into a franchise agreement without this information, the risk to the franchisee would be too great, and the relationship between the franchisor and franchisee could become a classic power struggle.

Also, franchising is regulated differently in each state, so it’s important to understand the franchise laws of the state you want to open a franchise in. For example, in New Jersey, a franchisor cannot terminate a franchise agreement with a franchisee without good cause, which can include the franchisee going bankrupt/going out of business on their own/being criminally prosecuted in connection with the operation of the franchise/not fulfilling their obligations under the franchise agreement.

Second, you need to have an accurate understanding of the costs involved in opening a franchise. “I thought I only had to pay the franchise fee and construction costs when I started a franchise,” is a common complaint among franchisees. Depending on the franchisor, there are many other expenses that the franchisee must bear in addition to the franchise fee and construction costs. Let’s take Subway, a sandwich franchise that many Koreans are interested in. Subway’s franchise fee is $15,000 anywhere in the United States. However, in addition to that, franchisees have to pay for interior construction costs, equipment purchase costs, transportation costs, signage costs, insurance costs, business training costs, and advertising costs. The amount of franchise fees varies greatly by region. According to Subway, the total cost to the franchisee, including the franchise fee and ancillary costs, can range from a low of $115,000 to a high of $260,000 depending on the location. Therefore, it is necessary to thoroughly analyze the contract and the costs to be borne by each franchisor.

As with any business, there is no guarantee of 100% success in franchising, but it has been said that if you get burned out, go for it. The same goes for franchising. It is clear that a proper understanding and analysis of a franchise will increase the chances of success. Therefore, if you are interested in franchising, I strongly recommend that you consult with an attorney experienced in franchise law.

If you have any further questions about the content of this column, or if there are any legal issues you would like our readers to know about, please do not hesitate to contact us at 마시고mail@songlawfirm.com. I will incorporate them into my next column.

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