Let’s say that you’ve decided to grow your business by franchising. Your business is successful and some customers are asking how they can clone your business in their hometowns. What are the first steps that you need to take to franchise your business?
First, consider your likelihood of success. Do you have the type of business that lends itself to franchising? Does the business have some feature that clearly distinguishes itself from the competition? Companies in fast foods, hotels, auto services, education, real estate brokerages, business services, gyms and many others run successful franchise operations. These are businesses that have a need for managers in a variety of locations who know and can service their local communities. The business itself should be one that can be cloned. It should be one that can be described in an operating manual and in which qualified people can be trained to run essentially the same business at different locations. Also, the economics of the business must allow both the franchisor and the franchisees to be profitable.
As with any business, launching a successful franchise business requires market research and planning. One aspect of this planning is looking at competitive franchise offerings. What characteristics will your franchise system have that will make it likely to succeed and meet or beat the competition? How will it accomplish that goal? Once the plan is written, who will write the operations manual and who will prepare a course of training for new franchisees?
Federal trademark registration
Next, you should have a strong brand identity. Franchising is one way to develop a brand. The company’s principal trademark is an important component of its brand. A local business that decides to expand by franchising should immediately look into applying for federal registration of its trademark. Federal registration in the U.S. Patent and Trademark Office gives the trademark owner national protection. For a company that sells franchises, federal trademark registration also exempts the offering from the requirement in some states to register the offering under the state’s business opportunities law.
Applying for federal trademark registration should be one of the very first steps a prospective franchisor should take. The reason is simple. It commonly takes a year or longer to obtain federal trademark registration. In fact, because trademark registration protects all trademark users, not just franchisors, applying for trademark registration is often a good business decision whether you decide to franchise or not.
Legal entity structure of franchise
Legal entity structure is another consideration. Many franchisors set up a new limited liability company or corporation to be the entity that sells franchises and operates the franchise system. This entity can have the same owner or owners as the original business or it can have different ownership. For example, new investors can help the franchise company grow without taking an interest in the original business. The original business will typically own the trademark and license it to the franchise company. This structure shields the company-owned operation from the liabilities of the franchise business and vice versa.
The approach of forming a separate company to be the franchisor also has the benefit of allowing the original business to keep its finances confidential. Franchisors in the U.S. are required to disclose their financial statements. In most cases, the franchisor need not disclose the financials of an affiliated company. Also, forming a new company avoids the need to prepare financial statements of past years. A newly-formed franchisor can prepare an audit of its opening balance sheet in its first franchise disclosure document. An audit of the opening balance sheet is far less expensive than an audit of an entire year or more of operations.
Franchise agreement and disclosure document
Finally, before even one franchise can be sold, the company must prepare a form of franchise agreement and a franchise disclosure document. The agreement is the contractual basis of the ongoing relationship between the franchisor and the franchisee. The disclosure document describes the franchise offering in plain language. It includes the franchise agreement, the audited financial statements and much more.
A franchisor offering or selling franchises anywhere in the U.S. must prepare a franchise disclosure document in accordance with the detailed requirements of the Federal Trade Commission’s trade regulation rule on franchising. The franchisor must deliver this disclosure document to each prospective franchisee before the prospective franchisee signs an agreement or pays a fee to the franchisor.
In several states, the franchisor must register its franchise offering before the franchisor can offer or sell franchises in the state. These states include California, Illinois, Maryland, New York and others. In some states, franchisors must also file franchise sales materials before they are used.
What experts will you need to set up your franchise system?
You will certainly need the help of a certified public accountant to prepare audited financials. And you will need the help of a qualified attorney to draft the franchise agreement, the franchise disclosure document and related documents, and to handle the registrations and exemption filings under the state franchise and business opportunity laws. Your attorney can also assist you in forming the franchise company and in evaluating your trademark and applying for trademark registration.
Should you engage a consultant to help in preparing your franchise offering? A consultant can help in a number of areas, like assessing the market, writing the manual and preparing a marketing plan. Stay away from consultants who offer to prepare a draft franchise agreement and disclosure document. It may be more costly to have your lawyer review the documents prepared by a franchise consultant than to draft the documents himself.
How long does the franchising process take?
The process of preparing to offer franchises in the U.S. is likely to take at least two months and probably longer, especially in those states that require franchise registration. For many companies, the process is worthwhile. When franchising succeeds, the results can be impressive.