The Federal Franchise Law and the franchise rules and regulations issued by the Federal Trade Commission govern a franchisor’s distribution and obligations in the disclosure of their [...]
Franchising is a vital part of the American economy both for entrepreneurs and for the work force. Many entrepreneurs across the country (and the world) have been massively successful opening and growing franchised businesses.
Unfortunately, there is often confusion surrounding some of the basic definitions and terminology. What exactly is a franchise? Is it the same thing as a “chain”? How does a franchise differ from a business opportunity or a business license? These are all important questions that business owners must understand before they start the franchising process.
The most fundamental distinction we need to make is between franchising and licensing. Franchise and license aren’t synonyms, and the distinctions are crucial. The name you choose to use doesn’t define a business arrangement. Rather, the arrangement determines what name is correct.
Let’s look at what exactly makes a franchise and how it differs from a license.
The Federal Trade Commission regulates franchise disclosures through the Franchise Rule (“The Rule”). The Rule defines a “franchise” as a business arrangement that has the following broadly-interpreted elements:
☑ A common trademark or commercial symbol,
☑ Payment of $500 or more during the first six months of the relationship,
☑ Significant control or significant assistance.
To fall within the legal definition of a franchise, the business arrangement has to meet all three of these elements.
This element includes registered trademarks like names (e.g. McDonald’s or Nike) and logos (e.g. the Arches or the Swoosh), as well as trade names, service marks, and other symbols that indicate a common origin or enterprise. A common symbol could even exist where the phrase “Part of the Acme Business Group” is used in marketing materials.
Generally, if a name or logo is a part of the arrangement, the trademark element will be satisfied.
A franchise fee of $500 or more is sufficient, but, because the elements are interpreted broadly, all of the following payments count toward the $500 threshold:
In short, because the amount is so low and includes many different purchases, this element will be satisfied in most cases.
This element is usually the determining factor of whether or not an arrangement meets the definition of franchise. It broadly considers the power and dependency dynamic between the buyer and seller.
“Significant control” hinges on whether the seller has the right to direct the buyer in how to operate the business or provides services and components that are essential to the operation of the franchised business. Indicators include an operations manual, the use of financial reporting procedures, or mandatory sales or management training.
If a buyer wouldn’t be able to operate the business without the seller’s systems, training, or services, the reliance factor will likely be satisfied.
If you’re business arrangement does, in fact, fall within the franchise definition, The Rule requires you, the franchisor, to prepare a comprehensive Franchise Disclosure Document (FDD) for any potential franchisees.
If you sell a franchise but fail to provide the required disclosures and follow the other rules, you could be personally liable for the franchise buyer’s expenses and damages.
When the upfront costs of franchising are prohibitive or the franchise model is just not what the business owner wants to implement, a business licensing arrangement is possible.
You can avoid creating a franchise by eliminating at least one of the elements of a franchise. There are other very limited exemptions to The Rule that I am not describing here because they rarely apply.
The easiest franchise element to remove is the common trademark element. Rather than permitting licensees to use your company name, each licensee would select a separate name.
An element that business owners can consider removing is significant assistance or control.
Rather than require the buyer use specific systems, provide financial reporting, or meet requirements of any of the other things identified above, a business license can provide, but not require:
The licensee can be required to pay a recurring fee, but there cannot be any requirement that the licensee follow the training, use the equipment, market or operate the business in a particular way, make a specific level of sales, attend meetings, or do anything else according to your process.
Moreover, you can’t provide the licensee with customers or any essential services.
There is always a danger that a licensee will go astray and do business in a way that harms the goodwill associated with your business and the trademark. Therefore, any trademark license should have protections for the mark, including the right to terminate the license if the licensor (you) discovers the mark has been harmed by the licensee.
The legal landscape isn’t all wide open green pastures when it comes to licensing a business. In many cases, a licensing arrangement will fall within the definition of “business opportunity,” which is regulated by the FTC, as well as by many states, Florida included.
The FTC’s definition of business opportunity is broad, and the state-level definitions are likely to vary. For example, a business opportunity according to the FTC has the following elements:
The Florida law modifies the FTC definition in a few ways. First, it limits the definition by adding a $500 threshold to the buyer’s payment, bringing the definition in line with the franchise definition. It, then, expands the definition by adding a seller’s promise of a sales or marketing program as another basis.
It is important to note that the FTC rule must be satisfied if the business arrangement meets the FTC definition of business opportunity, even if the arrangement doesn’t meet the state-level definition.
Additionally, because the state-level rules vary, you must satisfy the rule of each state in which you plan to offer or sell a business opportunity as well!
The good news, though, is that even if a business licensing arrangement falls within the definition of a business opportunity, the disclosure obligations are much less onerous than for a franchise. The disclosures are generally shorter and less comprehensive, do not require financial statements, and are a lot less time-consuming (read: expensive) to prepare.
One aspect of the business opportunity laws to be careful about is that they sometimes require specific provisions in the contract between the seller and the buyer. Florida has these requirements, and a buyer is able to rescind (undo) any contract that does not contain these provisions.
Franchising to expand your business must be accomplished carefully to avoid running afoul of franchise disclosure laws. At the end of the day, business owners must remember that whether or not a business arrangement is a franchise, a license, or a business opportunity depends on the arrangement, not the name.
Once required disclosures are provided, a properly structured franchising arrangement can lead to successful growth of an already successful business.
Licensing and business opportunities are also a viable option for business owners. They, too, must be dealt with carefully as your business owners have to comply with both FTC and state laws.
Here at Alexander Abramson our attorneys have advised businesses and business professionals for over 25 years on ways to grow their businesses. We focus exclusively on business-related legal matters including business franchising, business opportunities, and business licensing development and disclosures.
Whether you’re looking to expand your business through franchising or licensing, we can help ensure that you do so safely with sound legal advice, proper disclosure documentation, and a comprehensive franchise or licensing agreement.
Our staff strives to create a wonderful client-experience by actively listening and maintaining open lines of communication, consistently meeting deadlines, and being upfront about our pricing and services.
Don’t trust the legal needs of your business to an attorney that can’t or won’t offer you the best service possible.
Fill out the form below to get exclusive information sent directly to your inbox!