1. What are the top legal issues that people who are considering the purchase of a franchise need to know?
Prospective franchisees need to know and analyze many issues with a given franchise opportunity. Among the most important tasks is a thorough analysis of the franchisor’s Franchise Disclosure Document (“FDD”), which includes the proposed franchise agreement with the franchisor and other related documents. Franchisors are obligated to disclose a mountain of specific information in their FDD, which makes it a valuable tool for prospective franchisees. The FDD must be provided to a prospective franchisee by the franchisor before any commitment can be made to purchase or money is exchanged in purchasing a franchise.
Prospective franchisees often want to know first how much money they can make with a franchise. The Federal Trade Commission has specific rules about what a franchisor may and may not say about potential earnings and how this information can be presented in the FDD. Another primary concern prospective franchisees have is the cost of getting into business. A franchisor must disclose in its FDD all “initial fees” and “other fees” payable to the franchisor, e.g., franchise fee, royalty fees, brand development fees, audit fees, late payment fees, transfer fees, marketing fees, etc. The franchisor is also required to disclose if and under what conditions the “initial fees” are refundable. A franchisor’s FDD must also include an estimate of the total upfront investment for a franchisee to get into business, as well as an estimate of expenses that will likely be incurred during the “initial period” of operations (typically three months).
Prospective franchisees, with the help of their attorney, should also analyze the franchise agreement and related documents attached to the FDD. The franchise agreement sets out the working relationship between the franchisor and franchisee, including the rights of a party to terminate the relationship, the duration of the relationship, and issues about resolving disputes.
2. Under what circumstances should someone consult an attorney before buying a franchise?
Professional fees should be an expected part of the initial investment in any new business. As examples, a prospective franchisee should review any financial information with an accountant, and it may be a good idea to engage the services of a real estate agent when it comes to finding a negotiating a location for the business. An attorney plays a critical role for prospective franchisees in many ways, a few of which include interpreting the FDD and franchise agreement, forming a business entity to operate the franchise (for liability protection), preparing documents to govern the relationship between franchisee business partners, assisting with obtaining any necessary state and local permits and licenses to operate the franchise, and assisting with reviewing and negotiating real estate leases. In order to keep costs down, it is helpful for prospective franchisees to do their due diligence and to decide if they have a genuine passion for the business.
3. How have the laws pertaining to franchising changed over the years?
In 2007, the Federal Trade Commission overhauled the franchisor disclosure requirements. These changes were the most dramatic changes in these rules since they were enacted in 1978. The changes were made in an effort to make information disclosed by franchisors more practical and accurate in use by prospective franchisees. Also to be noted is that in addition to the FDD requirements, several states have their own registration requirements that must be addressed in any FDD.