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WHAT TO LOOK FOR WHEN BUYING A FRANCHISE
If you are considering franchising your business, or purchasing a franchise, there are red flags to look out for.
Here are my ten red flags for franchises:
1. Long Term: Franchise terms should not exceed ten years. I've seen them be as long as 25 years. Who wants to be tied to anything for that long. Franchise agreements are nearly impossible for a franchisee to get out of, so you want to make sure you're not stuck for life.
2. Large Closings: If a large number of franchises have gone out of business within the first three years that's an indication that the franchisor's business model may not be sound.
3. Franchisor is a Chameleon: If the franchisor has been in the same location, with the same leadership team, and has changed names three times in the last decade, that's a red flag. That franchise may be in trouble.
4. Salesman Says LISTEN, DON'T READ: If a salesperson tells you to listen to what he tells you and to ignore the language in the franchise agreement, RUN. The franchise agreement will be enforced, and no one will care what the salesperson told you.
5. Crazy "Cause" Clause: A franchisor can shut down a franchisee's business for "cause." This is one of the most important provisions in the franchise agreement that franchisee's gloss over thinking it never happens. It happens, ALOT! So make sure the franchisor has a good reason if they are going to step in and take your franchise away. And, make sure there is a reasonable cure period, which allows any deficiencies to be fixed before termination occurs.
6. Non-Exclusive Territory: Franchisees assume that any territory granted to them is exclusive. It may not be.
7. Franchisor is Competition: Franchisor's don't compete with franchisees in a perfect world. But, the world is not perfect. Search for any provision in the franchise agreement that allows the franchisor to compete with its franchisees.
8. FDD & Franchise Agreement Don't Match: The law requires the FDD to explain the franchise agreement to potential franchisees in a language they understand. However, this does not always happen. Sometimes, the FDD and the franchise agreement and the FDD do not match, fooling some that rely too heavily on the FDD.
9. Up-Front Fees: Up-front fees are paid regardless of the success of the franchisee. Royalties are only paid when the franchisee's make money. You want the franchisee invested in your business.
10. Pending Litigation: If there is a lot of litigation (or quasi-litigation) between the franchisor and franchisees, or the franchisors and vendors, or franchisors and their employees, have a lawyer pull up those cases to see what is alleged.
Ahaji Amos is patent and trademark attorney with 17 years of experience in intellectual property litigation and prosecution at Ahaji Amos, PLLC, a law firm that represents startup and small businesses in all matters including patent prosecution, trademark prosecution, copyrights, trade secrets, oppositions, cancelations, equity funding and commercial litigation. Ahaji Amos, PLLC is dedicated to representing entrepreneurs, inventors, and innovators.
This article is for information and advertising purposes and does not constitute legal advice. No attorney-client relationship is formed in the absence of a fully written and executed engagement agreement between Ahaji Amos, PLLC and its clients. Ahaji Amos can be reached at ahaji@ahajiamos.com. More information can be found at https://ahajiamos.com.
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From Food Truck Guy to Franshisor
Creating a franchise is not as difficult as you think.
My goal as an attorney is not solely to keep clients out of trouble and minimize risk. I try to help clients see and experience their full potential. I recently met two guys who own and operate a food truck business. I'll refer to them as the food truck guys. When I met them, they explained that they had four food trucks in operation in the city in which they both live, and were excited because they had just accepted a deal with an investor that would expand the company to another city.
The investor had proposed to run and operate four additional trucks in another city, using the same truck design, logo, business model, and products. The food truck guys would teach the investor how to run the business, provide information on where to purchase supplies, and allow him to design his truck, uniforms, and advertising materials the same as the food truck guys had done. The investor would expand the brand presence from one coast to the other. And, he would provide all of the capital needed for the expansion. This was something that the food truck guys had dreamed of, but couldn't bring to fruition because of a lack of capital and infrastructure. What the food truck guys saw as an exciting new opportunity set off my alarm bells.
So, you are franchising? That's great! Blank stare. "Uh, No. He's going to own the truck; he just wants to use our name and truck design." Is he paying you a royalty? "He wants to be a partner." How much of a partner? "He's talking about half." Half! "We'll, he's putting up the money for the extra trucks." Are you going to license your trademarks to him? "Yes. But, we haven't filed for them yet." What's to stop him from just running the new trucks without you?
Based on the local success of the food truck guys, I have no doubt that the investor was going to do exactly what he proposed; i.e., use the goodwill, following, and tested business model developed by the food truck guys for his benefit. I also have no doubt that the investor had no intention of being an actual partner, i.e. to share in the losses and the profits. My guess is that once he learned the ropes, he'd disappear off the food truck guy's radar and benefit from their years of hard work.
The food truck guys failed to recognize that they were franchising without the opportunities inherent in the franchise structure for a franchisor. A franchise business is one in which the owners, or "franchisors," sell the rights to their business logos, name, and model to third parties, owned by independent, third party operators, called "franchisees." Becoming a franchisor could be extremely lucrative.
Franchisors can generate revenue from various sources.
Initial Franchise Fees. Most franchise companies require a new franchisee to pay a one-time up-front fee to become a franchisee. This fee can be as little as $10,000 to $15,000 or as high as the sky--in some cases well over $100,000. The average or typical initial franchise fee for a single unit is about $20,000 to $35,000.
Royalty Payments. A standard royalty percentage in a franchise is 5 to 6 percent of gross revenue, but could also be a set amount, say $5000 per month.
Marketing Fees. Franchises often require participation in a joint advertising or marketing fund. Participation costs 1-5% of gross sales volume.
Supply Chain Management Fees. Franchisors must control the quality of their brand. As such, they have complete control of the franchisee's supply chain. All products, supplies, tools, and sometimes real estate, must be purchased directly from the franchisor, who in turn benefits from economies of scale that are only partially passed on to the franchisor. Buying, 100,000 apples is much less expensive per unit than purchasing 100 apples. The franchisor can take his savings and split the difference with individual franchisees who could never buy at the same rate.
Leasing Fees. Many franchisors retain ownership of land or equipment used by the franchise, which is required to lease the land or equipment from the franchisor perpetually. The franchisee pays rent to the franchisor for as long as they own the franchisor, while the franchisor benefits from the increasing value of the land or equipment.
To advance from food truck owners to franchisors, the truck guys could avoid the partnership and make more money by taking the following steps:
1. Develop a Great Business Model. Figure out what works and what doesn't work for the company. Work out the kinks in distribution, marketing, supply chain, sales, advertising, etc. You should have at least a couple profitable locations (or trucks) before you consider franchising.
2. Create a Marketable Brand. Create a consistent brand that the public associates with your product or service. Use logos, taglines, colors, interior design, and words to develop a recognizable brand and image. Make sure that brand is translatable and can be replicated.
3. Own Your Brand. Protect every aspect of your brand. Colors, phrases, words, the look, and feel of your interior design and marketing, logos, and unique sounds can all be protected using intellectual property laws. Copyrights are used to protect unique expressions that are fixed in tangible media (websites, marketing pieces, manuals, books, etc.) A trademark is a word, phrase, symbol, and design that identifies and distinguishes the source of goods of one party from those of others (logo, business name, product name, trade dress). A service mark is a word, phrase, symbol, and design that identifies and distinguishes the source of a service rather than goods (business name, product name). Design patents protect ornamental, non-functional designs. Trade secrets are formed by adhering to statutory guidelines for keeping valuable information out of the public (suppliers, distributors, customer information, business model, marketing strategy and contacts).
4. Get Your Finances in Order. You will have to disclose all of your financial information to the Federal Trade Commission (FTC) to properly register as a franchisor. Make sure you have not co-mingled your business and professional finances and that you've kept clean and detailed financial records. Franchisees will want to know what to expect when they buy into your concept.
5. Develop a Franchise Model. Determine your required fees and which portions of the supply chain you as the franchisor will control. Think about and be able to articulate how you will market to potential franchisees, as well as to the consumer. Do you know what type of background, experience, and net worth will be necessary to ensure a successful independent franchise business?
6. Become a Franchisor. Complete the Franchise Disclosure Document (FDD) to register your new franchise with the FTC, and begin negotiating with each state for the right to operate your franchise in that state. Completing the FDD is a daunting process and will require an attorney.
7. Build Your Team. Build a team of professionals to operate your franchise
