What You Need to Know Before Starting a Franchise

It has been a tough year for small businesses. Across the country, millions of small businesses have temporarily closed their doors due to the COVID-19 pandemic. Even now, as the pandemic eases and operations begin to pick back up, many small businesses report that they are struggling to fill open positions.

But business owners are resilient and creative. Despite the difficulties of the past year, most businesses expect to survive the pandemic, and interest in starting a new business remains high. Many aspiring business owners are interested in becoming franchise owners. In this uncertain economic climate, starting a franchise offers several benefits over other paths to business ownership. Starting a new nonfranchised business is riskier than franchising, can require more upfront capital, and does not provide the network of training and support often available to franchisees.

Franchising, like any business, requires planning, preparation, and paperwork. The documents involved in starting a franchise include the franchise agreement, the franchise disclosure document, an operations manual, and financial documents. An experienced business lawyer can help educate prospective franchisees about their rights and responsibilities as spelled out in these documents and provide other valuable services to would-be franchise owners.

The Franchising Industry Is a Pillar of the US Economy

A franchise is a type of joint venture in which the business owner (the franchisor) grants the right to an individual or group of individuals (the franchisee(s)) to do business under the franchisor’s name and system. The franchisee pays an ongoing royalty—and usually an initial franchise fee—for the rights to use the franchisor’s trade name, products and services, logo, branding, and operating methods.

When you think of a franchise business, the first thing that comes to mind may be a fast-food restaurant. While chains such as McDonald’s, KFC, Burger King, and Subway are among the top franchises, many businesses fall into the franchise category.

According to the International Franchise Association, there are more than 773,000 locally owned franchise establishments across the United States. In addition to the restaurant industry, franchising is prevalent in many other industries, from storage and warehousing to real estate and lodging. In 2019, franchising supported nearly 8.4 million jobs, generated $787.5 billion in economic output, and contributed 3 percent of the gross domestic product.

In a recent survey of aspiring business owners by Franchise Insights, nearly two-thirds indicated an interest in buying a franchise compared to less than one-third interested in purchasing an existing business and approximately one-half who were interested in starting a new business from scratch. As companies adjusted to shifts in consumer demand during the pandemic, interest in franchising grew significantly in the areas of home services, senior care and healthcare, cleaning and maintenance, computer and internet, and automotive, according to data from Franchise Insights.

Funding and access to credit are significant barriers to starting a new business in 2021. Some franchises offer in-house financing; others have strategic relationships with lenders that view the franchise brand’s referrals more favorably than an independent business owner who is just starting.

Legal Documents Needed to Start a Franchise

Franchising is a contractual relationship between the franchisor and the franchisee. Franchisors are responsible for providing prospective franchisees with legal documents that comply with federal and state franchising requirements. The two primary legal documents are the franchise agreement and the franchise disclosure document (FDD). Along with legal documents, the franchisor also provides operating manuals, training programs, marketing initiatives, and other related documents.

Franchise Disclosure Document

Franchisors are required by law to give an FDD to prospective franchisees. The FDD includes twenty-three disclosure items about the franchisor and the business, including information about the following topics:

  • business experience
  • bankruptcy and litigation history
  • franchise fees
  • required investments
  • financing
  • financial statements, including information about operations, the balance sheet, and cash flow
  • responsibilities of the franchisor and franchisee     
  • territorial rights
  • intellectual-property
  • contact information of other franchisees in the system

Franchise Agreement

This document is a binding agreement between the franchisor and franchisee. It details the business relationship between the two parties and explains the rights and obligations of each. Franchise agreements vary depending on the franchise but should address the following areas:

  • the area or territory granted to the franchisee
  • trademark use and restrictions
  • duration of the agreement
  • conditions for terminating, transferring and renewing the agreement
  • any restrictions placed on the goods or services offered
  • noncompete covenants
  • the method of resolving disputes between the parties
  • the training and support the franchisor will provide
  • tax issues

Operations Manual

The franchisee receives the franchise operations manual after signing the franchise agreement. Although not technically a legal document, it provides detailed information about the specifications and standards that franchisees must meet and the procedures they must follow in their operation of the franchised business. In the past, operations manuals were large, printed documents, but there has been a move toward interactive, cloud-based documents.

An operations manual typically addresses the following topics and information:

  • training and other personnel topics
  • standards and requirements for day-to-day procedures
  • payroll and accounting
  • customer service
  • marketing and business development
  • brand
  • approved suppliers and vendors
  • inventory requirements

We Can Help

Investing in a franchise can be a great business opportunity. But before you sign a franchise agreement and invest any money, you should closely review all documents with help from a qualified business lawyer. Give us a call today to set up a meeting so we can help you successfully form and operate your new franchise business.

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