Part 1 of this blog series addressed business issues to consider in deciding whether to franchise your business and preparations to be made before launching a franchise program. This blog assumes that you have made the decision to franchise your business and you are ready to engage a franchise attorney to assist you with the legal compliance. The first step in legal compliance is to prepare a Franchise Agreement and the Franchise Disclosure Document required by federal and state franchise laws.
The Franchise Agreement is the binding contract between the franchisor and the franchisee. You will first need to determine what entity will be the franchisor. For a number of reasons, it is often best to set up a new entity that will be the company that offers and sells franchises and supports the franchise system.
A number of business and legal decisions need to be made by you about the structure of the franchise in order for your franchise attorney to draft the franchise agreement. These decisions are often made based on your knowledge and experience about the industry of the franchise business and in consultation with financial advisors, a franchise consultant and franchise attorney, each bringing different perspectives. At this stage, the franchise attorneys at Huck Bouma prepare a Franchise Agreement Preparation Questionnaire for our new franchisor clients to complete.
Decisions you must make include what fees will be charged (initial franchise fee, ongoing royalty fees, advertising fund contributions and other fees), whether a protected territory will be granted and what size it should be, what the length of the initial franchise term will be as well as requirements for renewal, what franchisor assistance and training you will agree to provide, purchasing requirements for the franchise business, and what operational requirements should be addressed in the franchise agreement (many more will be addressed in the operations manual). Other decisions to be made include the conditions for selling or transferring the franchise business, the grounds for termination of the franchise and how disputes between the franchisor and the franchisee will be resolved.
Once the Franchise Agreement is prepared, the Franchise Disclosure Document must be drafted. At this stage, the franchise attorneys at Huck Bouma prepare a second questionnaire for our new franchisor clients to complete which covers information needed for the Franchise Disclosure Document. When drafting this document, we must follow the format and disclosure requirements set forth in 16 CFR Part 436 – Disclosure Requirements and Prohibitions Concerning Franchising, known as the Amended FTC Rule. These federal disclosure rules are enforced by the Federal Trade Commission and apply to the offering of franchises anywhere in the United States.
There are 23 sections in the Franchise Disclosure Document (referred to as Items) in which the franchisor must address very specific disclosure requirements set forth in the Amended FTC Rule. The Franchise Disclosure Document provides information necessary for an investor to make a decision on whether to purchase the franchise. Generally, the documents includes information about the franchisor (its history, management and financial condition), the franchise system and its franchisees, the initial and ongoing costs involved in purchasing and operating a franchise business, and the terms and conditions that govern the franchise relationship.
In addition to federal disclosure requirements, the state franchise regulators have issued guidelines that we must follow in preparing the Franchise Disclosure Document so that the document will be in a form that will be acceptable to the regulators in the franchise registration states where you want to register your franchise. The franchise regulators will review your Franchise Disclosure Document as part of the franchise registration process. These guidelines are the North American Securities Administrators Association, Inc. (“NASAA”) 2008 Franchise Registration and Disclosure Guidelines. These guidelines are consistent with the federal disclosure requirements but impose some additional disclosures and registration requirements. NASAA has also issued commentaries on Financial Performance Representation and on disclosure of Multi-Units which supplement these guidelines.
Part 3 of this blog series will address registration of the franchise offering in the states that have franchise registration and disclosure laws.