The Legal Know-How You Need to Franchise Your Business
Franchising is an accelerated growth strategy that has been successfully deployed time-and-time again. Naturally, entrepreneurs wonder, how do i franchise my business?
The short answer from a legal perspective is that franchises can only be offered and sold in the United States by providing a prospect with a copy of a legal document known as a franchise disclosure document (the “FDD”).
At Waldrop & Colvin, we are business minded attorneys and our focus is on empowering clients with the legal know-how they need to launch and grow their business.
Franchising is one of the tools at our disposal.
The goal of this post is to help you understand the basic legal requirements to start a franchise. Understanding franchise laws, rules, and regulations is essential for business owners who want to avoid pitfalls and plan for the future.
Quick Jump
Success in franchising does not occur by happenstance.
A business must be suitable for franchising, and franchisors must develop and execute systems and processes that work and are easy to replicate.
An overview of the Basic Legal Requirements to Start a Franchise
There are five main legal steps in the process of becoming a “franchisor” and selling franchise opportunities:
- Develop the legal document set:
- Draft the Franchise Disclosure Document (“FDD”)
- Draft the Franchise Agreement
- draft Contracts To engage clients, vendors and suppliers.
- Document the Business “know-how” for training and operation
- Obtain state approval
- Registration in registration states
- Filing in one-time and annual filing states
- Exemption in Business Opportunity States
- Comply with disclosure requirements
- Comply with advertising laws
- Disclose the FDD
- Provide a completed franchise agreement
- observe waiting periods
- preserve documents
- Maintain the legal documents on an annual basis
- Obtain an annual audit of your financial records
- Prepare Annual Renewals within 120 days of fiscal year end
- Prepare post-effective amendments as needed
- Maintain registration and filing status
- Fulfill legal obligations to franchisees
- Provide training and pre-opening assistance
- Provide ongoing assistance
- Resolve disputes
- Protect the brand
There are many best practices to observe along the way. For example, does your business have a federally registered trademark? If not, ensuring the feasibility of registration and applying for registration should occur at the early stages of the process.
Develop the Legal Documents
The FDD is the primary legal document required to franchise. All franchisors must have an FDD before they can legally offer or sell any franchise. Period.
The FDD contains a series of disclosures designed to inform prospective buyers about the franchisor and the individuals in charge of the franchisor. The disclosures cover 23 specific areas and include specific disclosures as required by the federal Franchise Rule (16 CFR Parts 436 and 437).
These disclosures cover many business issues, financial issues, and legal issues. All contracts that govern the franchise relationship will need to be drafted and included in the FDD.
The Process of Creating the FDD
The FDD is a large and complex legal document. The mere thought of drafting an FDD can be a daunting task.
The process works best when would be franchisors pair up directly with franchise attorneys because franchise law is a complex and niche are of the law packed with nuanced legal requirements established by a web of federal and state laws, rules and regulations.
Simply put, a great deal of information is required to prepare a high-quality disclosure document that accurately reflects the company’s business model and systems, while also mitigating against risk.
Typically a franchise attorney will gather information through a combination of meetings and questionnaires to ensure the FDD accurately reflects the company’s business model and system. A collaboration between business and legal is necessary so that the attorney can understand the clients risk tolerance and draft legal provisions aligned with the company’s business strategy.
Business leads must also develop certain items and programs designed to teach others how to replicate the franchisors systems and processes. Business elements of starting a franchise are discussed in more detail below.
The Contents of the FDD
The federal Franchise Rule establishes criteria for disclosures under the 23 separate areas of disclosure (known as “Items”). The quality and content of disclosures will vary by franchise offer, but all FDD’s must include the disclosures specified under the Franchise Rule. The Items are broken down as follows:
- The Franchisor and Any Parents, Predecessors and Affiliates
- Business Experience
- Litigation
- Bankruptcy
- Initial Fees
- Other Fees
- Estimated Initial Investment
- Restrictions on Sources of Products and Services
- Franchisee’s Obligations
- Financing
- Franchisor’s Assistance, Advertising, Computer Systems and Training
- Territory
- Trademarks
- Patents, Copyrights and Proprietary Information
- Obligation to Participate in the Actual Operation of the Franchise Business
- Restrictions on What the Franchisee May Sell
- Renewal, Termination, Transfer and Dispute Resolution
- Public Figures
- Financial Performance Representations
- Outlets and Franchisee Information
- Financial Statements
- Contracts
- Receipts
The specific issues that must be addressed under each item (and in some cases the format of disclosure) are established by the text of the Franchise Rule. The extent of disclosure requirements are extensive. You can learn more by reading the rule itself or explore our site for an overview of federal franchise laws.
The Franchise Agreement
The primary contract between the franchisor and the franchisee is referred to as the Franchise Agreement.
The franchise agreement will govern the franchise relationship and will touch on many issues. There is no one-sized-fits all approach to developing a franchise agreement. There are many items to consider as these contracts should be tailored to the business and designed endure the test of time.
Other Contracts
The franchise agreement is the main contract governing the relationship, but often times it is not the only contract. For example, a franchisor may develop contracts restricting the activities of owners or employees outside the franchise agreement, may extend financing, or may mandate contracts with certain vendors or affiliates. A form copy of each contract will need to be developed and included in the FDD.
Business Elements Contained in the FDD
Many entrepreneurs choose to purchase a franchised business over building their own brand because they want a “business in a box”. For emerging franchisors, they must reduce systems, processes, and procedures to writing. Simply put, they have to share the know-how.
Generally speaking, successful franchise concepts are easy to replicate and can be manageable by people from different backgrounds with different skill sets. It all starts with reducing this know-how to writing through training programs, manuals, and franchisee resources.
Training and Support
Franchisors provide initial and ongoing training and materials to their franchisees. Initial training typically involves a formal training program, which may be in person at the franchisors facility, on-site at the franchised business, virtual – or a combination. As the franchisor grows, industries shift, and trends emerge, the are often other ongoing training requirements.
Initial and ongoing franchisee training is essential, but support is not limited to initial or ongoing training.
When you develop a franchise system, you will need to consider the degree of control you will exercise over the various aspects of each franchised business from site selection and build-out into operations.
The support and control aspects are integrated in various ways into the FDD and franchise agreement. For example, the training schedule is included in the FDD, along with a description of certain initial and ongoing responsibilities of the franchisor.
The Operations Manual
Policies and procedures are not included in the FDD or franchise agreement. Instead, the business “know-how” is reserved for the manual where it can be kept confidential. Franchisors must develop an operations manual before franchising. The table of contents is typically included in the FDD.
Some franchisors choose to share their operations manual before franchise agreements are signed, but most reserve until a contract is in place. Regardless, the operations manual should not be shared without some form of non-disclosure obligation in place.
Protecting Intellectual Property
Protecting the brand name is essential in franchising. In the United States, this is largely accomplished by obtaining a federally registered trademark. If a business name cannot be protected, it is likely unwise to license the name for others to use. Not all brand names are suitable for trademark registration.
Franchising with a protected name is essential and failing to do so can be a very costly mistake. No franchisor wants to be forced to rebrand an entire franchise system.
Issue the FDD
Franchising can begin immediately with the “Issuance” of their first franchise disclosure document.
The Issuance date is specified on the cover page of each disclosure document. By assigning an Issuance date, the drafting party (typically the franchise attorney) is asserting that the contents are in substantial compliance with the federal Franchise Rule.
In many state, a franchise can be offered and sold simply by disclosing the FDD to a prospective buyer.
However, prospective franchisors must understand that franchising is regulated on both the federal and state level in certain states. These states that regulate franchising specifically (as opposed to generally through laws applicable to all businesses) are referred to as registration states or filing states.
The degree of regulation will depend on several factors.
Its vital that franchisor’s and their sales teams understand when and where they can offer a franchise. Typically, a franchise attorney will prepare a state-by-state list where it is okay or not okay to offer and sale franchises.
The Cost to Develop An Initial FDD
The cost to develop and issue a FDD will vary based on your business and the law firm you select.
There is no set price to develop an FDD, but this legal service is typically offered for a flat fee. Our research and experience suggests the price is typically between $15,000 and $35,000 to develop an FDD, but your mileage may vary depending on the size, experience, and location of the firm.
At Waldrop & Colvin, we work with business leads to franchise on their schedule and budget. Not all clients know on Day 1 that they want to franchise. Further, not all clients have the budget to pay for the FDD in one lump-sum payment.
In some cases, we take on a fractional general counsel role for a reasonably monthly rate and work with the client to develop the document set on a schedule. In other cases, we charge a flat-rate. We do our best to keep fees low relative to the experience and level of service we provide. Our goal is to create long term business relationships, while helping you do the same.
Regardless of who you choose to work with, the key to successfully developing an FDD is to work with a franchise focused law firm.
You should be wary of non-attorneys offering to prepare an FDD. The FDD is the primary legal document used to offer franchises and it contains the contracts that will govern your 5, 10, or 20 year business relationship with franchisees.
Non-attorneys are not permitted to prepare legal documents for third parties. Unfortunately, it happens often in franchising and the results can be disastrous.
Franchise trading partners may offer great referrals, but should not prepare documents directly. You should have several consults and decide on an attorney who is a good fit for your immediate and ongoing business legal needs.
Obtain State Approval
The FDD is a federal requirement. That means the FDD is required in all states and jurisdictions of the United States.
There is no federal review or approval process. Instead, review and approval occurs at the state level.
What is Required to Sell Franchises in Certain States?
If you are located in a state where franchising is regulated or you want to do business in a state that regulates franchises, you will need to take steps to obtain state approval.
Franchisor’s must ensure that they have any necessary state approval before offering to sell any franchise. The FDD is a federal requirement applicable to all states and territories, but federal requirements are supplemented by state laws, rules, and regulations.
This requires a state-by-state determination and should be considered while the FDD is being drafted, because additional disclosures are required in certain states. Further, addendums may be required to supersede portions of the disclosure document or franchise agreement that are inconsistent with state laws designed to protect residents of those states.
Which States Regulate Franchising?
States are often referred to as “non-registration states”, “registration states”, “filing states”, or “business opportunity states”. A business cannot legally franchise until complying with federal franchise law and any applicable state law. Franchise attorneys can file the franchise documents and file any renewal applications.
Click here to learn more about franchise laws by state.
We also offer a 10,000 foot view of the registration process in the franchise law section of our website.
The Cost of State Registration
Each regulating state imposes fees in exchange for operating within their state. The frequency and amount depends on state law.
In addition to the initial fees, some states charge for renewals and amendments.
Initial Registration Fees
Registration and filing often requires the submission of forms and payment of fees. These requirements are imposed at the state level and can change from time-to-time. States typically impose an initial fee, a renewal fee, and an amendment fee. Initial fees are posted to the right.
There is an additional $100 fee for applying online through the NASAA EFD. This fee is well worth it as it reduces time between filing, receiving, and responding to regulator comments.
The attorney who prepares and issues the FDD can assist in this process, or you can retain new counsel. We file for clients on a fixed fee, hourly basis, or as part of a flat fee monthly engagement for franchise legal support.
Current state franchise initial filing fees are listed here.
Renewal Fees
Renewal filing and registration fees are typically cheaper than the initial filing fees, but that is not the case in all states. Further, an application is typically considered an initial application if the registration lapses for any period of time or the renewal is not otherwise timely filed. Because of the audit requirements, renewal can be a tricky part of franchising.
Uniform Franchise Registration Forms
The registration process often requires submission of certain forms, along with a copy of the franchise disclosure document.
The following forms are standardized, but some states utilize their own forms.
- Form A: Uniform Franchise Registration Application
- Form B: Franchisor’s Costs and Sources of Funds
- Form C: Uniform Franchise Consent to Service of Process
- Form D: Franchise Seller Disclosure Form
- Form E: Affidavit of Compliance
- Form F: Guarantee of Performance
Comply With Disclosure Requirements
A franchise offering can only be made through disclosure of the FDD after obtaining any necessary state approval. Disclosure of the FDD requires providing the entirety of the document, obtaining signing acknowledgment of its receipt, and observing a waiting period for the prospect to digest the document.
Federal law mandates a 14-day waiting period, which must occur before: (i) any fee can be collected by the franchisor and (ii) any agreement can be executed by the franchisee. Although it may seem straight forward at first-glance, it is important to know how to calculate this waiting period.
The 14-day waiting period is actually a 16-day period. This is because the day the FDD is provided and the day the franchise agreement is signed do not count towards the 14-day waiting period. This creates a 16 day minimum period between receipt of the FDD and forming a franchisee | franchisor relationship.
There is also an additional 7-day waiting period if certain changes are made to the franchise agreement. Again, the date of disclosure and the date of execution are not considered in calculating the waiting period.
Franchisors can negotiate business and legal terms for the franchise
There is no legal prohibition on the franchisor and franchisee agreeing to negotiate the terms of the franchise agreement. In fact, in Virginia the franchisee must have a fair opportunity to try to negotiate the terms. It is common for franchisors to negotiate certain business and legal terms. Often the franchisors own terms will change over time as the franchise system evolves.
However, like many areas of franchising, the implications of negotiating changes can be nuanced and are not obvious to the average person. For example, California imposes additional disclosure requirements if favorable terms are granted, including disclosure of those deal terms to future prospective buyers. Likewise, pricing discounts often must be disclosed in future iterations of the disclosure document.
Negotiating terms is one of the areas where a skilled franchise attorney is essential for guidance and compliance. The cost of non-compliance can be severe and may jeopardize the entire franchise business.
Maintain The Legal Document Set
The federal Franchise Rule imposes an ongoing legal obligation to update the FDD with current information. Essentially, disclosures must be current and accurate. At minimum, the FDD must be updated each year, within 120 days of the end of the business fiscal year end.
Periodic updates are also required when certain changes occur in the franchise system or when there are certain developments with the franchise business parties.
Regulating states also impose their own requirements, which may require a supplemental filing and subsequent approval before resuming franchise sales. The period of time between a change occurring and state approval is often referred to as a black-out period.
The process of franchising and maintaining best practices may seem complicated, but it is more easily managed when business and legal work together. Attorneys help with disclosing prospects, calculating waiting periods, preparing contracts, maintaining the FDD, and filing the proper paperwork so Franchisors can lawfully conduct business in the states they desire.
The annual renewals also provide an opportunity to continually improve the document set, systems, and processes.
Fulfill Legal Obligations to Franchisees And Trading Partners
The legal framework for the franchise relationship is governed primarily by the franchise agreement, but the best contracts are rarely looked at. From our perspective, franchisors should consider their disclosure documents and franchise agreements as shields to protect the franchise system, not as swords to hurt other entrepreneurs.
The best way to keep these contracts locked in a safe, is to deliver on your promises, comply with your obligations, and strive to exceed expectations. You cannot please everyone, but it is vital that you work hard to create happy successful franchisees. This is particularly important when launching a new franchise.
You may find that it is easiest to grow close to your company locations, because you can provide better support at a lower cost. Or, you may swing for the fences and launch nationally. Regardless, franchisors must appreciate the investment and trust that franchisees place in their franchisor, and they must deliver on their obligations.
Pre-Opening Obligations
These obligations are laid out in Item 11 of the disclosure document and should be incorporated into the franchise agreement. Common pre-opening obligations involve:
- Site Selection
- Site Construction and Buildout
- Initial Training and Support
- Assistance in Hiring and Training Employees
- Assistance in Obtaining Equipment, Signs, Fixtures, Inventory, and Supplies
Ongoing Assistance
These obligations are also laid out in Item 11 of the disclosure document and should be incorporated into the franchise agreement. Common ongoing obligations involve:
- Product Development
- Vendor and Supplier Relationships
- Ongoing Training and Support
- Advertising
- Establishing or Recommending Prices
The disclosure document and franchise agreement often provide a minimum framework, but execution requires a combination of having appropriate materials developed and accessible to franchisees and having knowledge staff accessible to answer questions that arise.
Protect the Brand
Franchisors have a duty to protect their brand. This includes obtaining and maintaining federal trademark registration and taking action against infringers.
Protecting the brand also includes ensuring systemwide conformity. This often requires a balanced approach, with consideration of many different factors as issues arise. It also starts with your screening and application process. Franchising is not for everyone.
Protecting the brand also includes ensuring that you as a franchisor provide ongoing value. We encourage franchisors to ensure they are an indispensable part of the day-to-day operation of the business. This varies by business model, but may include things like controlling phone numbers, websites, and social media accounts, providing a system wide scheduling platform and point of sales system, bringing vendor relationships with discount pricing, and serving as the supplier of proprietary items.
If you do not protect the brand, then some franchisees may feel they can do just as well without paying your ongoing royalties.
Resolve Disputes
It is a matter of when, not if, when it comes to disputes during the franchise relationship. There will be issues with non-payment or general non-compliance as the franchise system grows. Likewise, some franchisees will not see the value in your service and support.
Disputes can have systemwide impacts on franchisors both in terms of existing franchisees and the franchisors ability to attract prospective franchisees. Franchise disclosure requirements include information about disputes (but not all disputes).
It is often best for franchisors to resolve disputes with franchisees quickly and quietly. Of course, the approach will vary based on the particular facts and circumstance. Working with a franchise attorney on an ongoing basis can help stop major issues before they develop.
Partner with Franchise Legal Counsel
Partnering with a skilled franchise attorney can help turn your concept and vision into a franchise success story.
Launching a franchise system and maintaining compliance with the legal intricacies of franchise law requires a partnership between business and legal. Your business can save time, efforts, and resources by involving an attorney at the early stages of its franchise journey.
If you engage Waldrop & Colvin, our attorneys will work with you to ensure your brands disclosure documents and contracts accurately reflect the business model and place your business in a position to implement long-term goals and objectives.
In addition to preparing the legal documents, a franchise attorney can help you succeed in the business of franchising. This includes taking steps necessary for the franchise to be offered in any state where you want to conduct business and working closely with business and sales leads to reduce risk and help maintain compliance.
At Waldrop & Colvin, we offer franchise legal services tailored to your needs. Don’t leave your legal compliance to chance. We will create a plan with you and help you follow the right steps to franchise your business in compliance with all legal requirements. We offer flat rate and fixed monthly service options, to ensure you can budget for legal support.
Meet the Author
Derek A. Colvin
Derek is a graduate of Penn State Law and Old Dominion University. He started his legal career in 2009 as a prosecuting attorney before entering private practice.
Derek currently serves business clients as a partner at Waldrop & Colvin, the law department for your business. His practice focuses on SMB client legal services and franchise law.
Derek is laser-focused on delivering efficient and effective solutions for business legal needs. As a seasoned litigator and experienced business attorney set on thinking critically and communicating effectively, Derek is well-suited to advise and protect your business.
Derek often serves as outside general counsel providing transactional support for business owners. He represents SMB independent owners, as well as franchisors, and franchisees as a franchise attorney.
Primary Practice Areas: Franchising | Franchise Law (Franchisor Legal Support & Franchisee Legal Support), SMB Mergers & Acquisitions, Entity Formation and Governance, Lease Negotiations, Trademark Registration, Dispute Resolution and Civil Litigation & Outside General Counsel Support
