Financing Your Small Business

Franchising

Franchising is a well-known means of expanding your business while transferring operational responsibilities to franchisees. The originating company, known as the franchisor, builds its brand under one or more trademarks or designs, documents a proprietary delivery system for its product or service, and develops a training program for its prospective franchisees. The franchisor generates income by the payment of franchise fees and an ongoing royalty.

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Most companies should not undertake a franchise strategy until the business system is fully established and successfully operating in at least one location.

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The Federal Trade Commission (FTC) defines a franchise using three components: (1) the franchisee's goods and services are offered and sold under the franchisor's trademarks; (2) the franchisee is required to make a minimum payment of $500 to the franchisor; and, (3) the franchisor exercises significant control over or provides significant assistance to the franchisee's method of operation. The states have variations on the defi­
nition of a franchise, and you must comply with the laws of each state where you are selling franchises.

From a legal standpoint, the franchisor, through counsel, prepares a fran­chise disclosure document and franchise agreement. The franchise disclosure document, known as the Uniform Franchise Offering Circular (UFOC), is similar to a PPM. You can obtain a copy of the UFOC and other informa­tion pertaining to franchise registration from the North American Securities Administrators Association website at Www. nasaa. org. From the main menu pull down chart, navigate to the corporation finance page and click the UFOC link on the left. The UFOC requires audited financial statements of the franchisor, so it is best to organize your accounting systems from the start to be ready for the eventual audit.

Unlike licensing, franchises are regulated by the states to varying degrees and by the FTC at the federal level. The FTC prescribes certain minimum disclosure standards and the states may require differing amounts of addi­tional disclosures. At present, fifteen states regulate the offer and sale of franchises. In those states, the franchise must be cleared by the state before offers or sales can be made. Once your franchise is launched, there are ongoing state compliance issues that must be addressed and monitored very carefully.

Many franchisors choose to grant area franchise arrangements where, for example, multiple territories or whole states are granted to certain fran­chisee's subject to certain performance standards, such as opening a certain number of units per year. International franchise operations are another way to expand a domestic franchise network.

Franchisors may charge an up-front franchise fee in addition to a royalty payment, and perhaps a cooperative advertising fee as well. The entire process of designing and marketing a viable franchise and properly docu­menting its legal requirements is a substantial undertaking. There are com­panies, such as Www. ifranchise. com, that provide consulting services for franchises, and resource websites, such as Www. franchise. com, that provide information on franchising requirements. You should also visit the website of the International Franchise Association at Www. franchise. org.

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