From Franchisee to Franchisor
Being a franchisee exposes one to small business ownership, entrepreneurial and management skills, and puts you out in the business world, surrounded by other businesses, mentors, suppliers, and customers. From this experience, an idea may spark in you to become a franchisor of a business concept, or someone else may give you such a tip.
If you decide to try and flip from bring a franchisee to becoming a franchisor, or attempt to do both simultaneously, here are some pointers to consider.
Non-Compete Agreement with Current Franchisor
First, it is important to examine any non-compete clause you have with your current franchisor to determine if your proposed franchise venture would run afoul of the terms of your non-compete. And, commonly, “in-term non-compete agreements,” in effect during the term of your franchise agreement, will be more broad than a post-term non-compete that only takes effect after you have left the franchisor.
Practically speaking, you would want to avoid starting a venture in an adversarial way with a current franchisor, and it may be wholly unneeded. In fact, your current franchisor may be a strategic ally worth cultivating in a win-win situation. For example, if you are a franchisee for a franchisor with a highly seasonal business, and you come up with a complimentary franchise concept that peaks at a different time of year, your current franchisor may support your venture and offer it for sale to current franchisees as a co-branding opportunity.
As we discuss in further detail below, the start-up of a franchise system entails costs for such items as Trademark Registration, development of initial training materials and an Operations Manual, preparation of financial statements, and preparation and possible registration of a Franchise Disclosure Document.
In addition, these legal minimums do not bring a franchise system to life. A franchisor also needs some type of franchise advertising, sales, accounting system, operational support, and consumer marketing apparatus. All of this requires capital. So, if you are thinking of launching a franchise, it is imperative to make sure you have sufficient capital to properly launch the business.
A Working Prototype
The very nature of a successful franchise is one based upon a proven operating system. And there is no better proven operating system than a fully functioning prototype that is generating profits. To experiment on franchisees to develop a working profitable concept can lead to legal troubles and be harder to sell. A wise franchisor starts off with a successful prototype in operation.
Trademark Selection and Registration
From the public’s point of view, the very hallmark of a franchise is the particular brand name under which it operates. So, if you do not already have a federally registered trademark, you should work up a name and logo with nationwide appeal and submit it to the United States Patent and Trademark Office for registration. This process takes time so it is best to start as soon as you know what your mark will be. Failure to have a registered trademark can lead to a warning in the Franchise Disclosure Document (‘FDD”) that you will have to use to offer and sell franchises as to the risk that franchisees may have to change names.
By its very nature, a franchise is a uniform system of operation. So the second cornerstone of a franchise is an Operations Manual that contains the system.
Indeed, one of the items that the FTC Franchise Rule requires be included in the FDD is the Table of Contents and page count of an Operations Manual. So drafting of a Manual makes a good early step for a business owner because it is not only required, but allows you to fine tune your system of operations as you see it come to life in writing. And, since you should have a working prototype before considering franchising, you have an actual model to work from to make it easier to reduce the system to a written Manual.
Develop an Initial Training Program
A successful franchise concept depends upon many individual franchise owners successfully running outlets under a chosen brand name, and doing so in a consistent and quality manner. Therefore, quality training and initial training is essential to ensure a consistent delivery of services. Additionally, this is part of what attracts potential franchisees to franchising, knowing that someone is going to tell them what to do and how to do it. And, once again, the itinerary of the initial training program and a list of trainers are required to be in the franchisor’s FDD, so sufficient care should be given to this important aspect of your franchise system.
Audited Financial Statements
Under the FTC Franchise Rule, a start-up franchise system needs to only include an unaudited opening balance sheet in its FDD, if it is in its first partial or full fiscal year selling franchisees. But certain states go beyond this Rule and require audited financial statements. Audits of course require time. Therefore, it is important to consult with franchise counsel as to the financial statement requirements in the states where you intend to offer or sell franchises and make sure to have your CPA work on preparing the appropriate financial statements.
Prepare an FDD and Register
While it may seem like you are already juggling many balls, another important step is to hire a competent attorney who will work with you on the preparation and registration of your FDD. This is a step that you should not save until you have finished all the prior tasks. We generally work with our clients on timing so that everything comes together at once.
Once you have your completed FDD you can immediately begin selling in the Non-Registration States. Then there are other states that require a “notice filing.” There may be up to a one-month delay in your ability to sell in these states. Finally, some states are what we call “registration states.” These are states that review your FDD filing and may issue comment letters asking for changes to certain text.
Taking the first steps to launch a franchise is an exciting time. You may be developing a brand and brand name that will become a part of American culture. There are many details to attend to, from training, financial statements, and legal requirements. Hopefully, this article has given you a good overview of some of the first steps to take to launch a franchise.
Carl Khalil is a Partner in the law firm of Carl Khalil and Sada Sheldon, PLC. He has 17 years of franchise law experience and previously worked as Corporate Counsel for Jackson Hewitt and Liberty Tax Service. During his tenure at Liberty Tax Service, it grew from 35 offices to nearly 4000 offices and 100+ Area Developers.
Sada Sheldon is a Partner in the law firm of Carl Khalil & Sada Sheldon, PLC in Virginia Beach, Virginia, a nationwide franchise and trademark practice. She is admitted to the State Bars of both California and Virginia. She is a member of the ABA Forum on Franchising.