Who Supervises Franchise Legislation?
Franchising is regulated by the U.S. Federal Trade Commission (FTC) and by various State agencies. The Federal Trade Commission franchise rule applies everywhere in the United States, whereas the state’s franchise law generally applies only when:
- the offer or sale of a franchise is made in the state; or
- the franchised business will be located in the state; or
- the franchisee is a resident of the state.
According to Federal law and under the FTC Franchise Rule, there are three elements required for a franchise viz. Trademark, Significant Control or Assistance, Required Payment.
Trademark: The franchisee has the right to distribute goods and services that bears the franchisor’s trademark, service mark, trade name, logo and other commercial symbol used for transaction.
Significant Control or Assistance: The franchisor has notable control of, or provides significance to the franchisee’s method of operation, which usually includes:
- approval of the site
- requirements for site design or appearance
- designated hours of operation
- specified production techniques
- required accounting practices
- required participation in promotional campaigns
- training programs
- providing an operations manual
Required Payment: To buy or own a Franchise, the franchisee needs to pay the franchisor { or an affiliate of the franchisor) at a minimum of US$500 either before (or within 6 months after) opening the business. The required payment includes any payments the franchise makes to the franchisor to get the right of a franchisee. It would include franchise fees, royalties, and training fees, payment for services, and payments from the sales of products (unless reasonable amounts are sold at bona fide wholesale prices).
If these three elements are present, the relationship will be a “franchisee” for purposes of the FTC Franchise Rule.
On the other hand, state law definitions of franchises vary, but they all work on a common theme. In 12 states, the 3 elements of the legal definition of a “franchise” are:
Marketing Plan: The franchisee is granted the right to engage in the business of offering, selling or distributing goods or services under a marketing plan or system substantially prescribed by the franchisor.
Association with Trademark: The operation of the franchisee’s business is substantially associated with the franchisor’s trademark, trade name, service mark, etc.
Required Fee: The franchisee is required to pay a fee, directly or indirectly.
Types of Franchise Laws
There are generally three categories of law regulating franchises: disclosure laws, registration laws, and related laws.
Disclosure Law: Disclosure law regulates the following things:
- required pre-sale disclosures;
- prohibited franchise sales practices; and
- mandatory cooling-off period before franchise sales
Registration laws: Registration laws requires the following things:
- registration of the franchise;
- registration of franchise salespersons; and
- registration of franchise advertising
Relationship laws govern certain aspects of the relationship between franchisor and franchisee, such as:
- grounds for terminating a franchise;
- notice and cure periods before termination;
- grounds for not renewing a franchise; and
- Equal treatment of franchisees.
Types of Violation of Franchise Laws
There are certain common types of violations of franchise laws that every franchisee should know and try to avoid to ensure smooth business operations. The franchises laws violation includes:
- Offering or selling an unregistered franchise
- Failing to provide a UFOC on time
- Failing to provide all required disclosures in the UFOC
- Making misrepresentations to franchisee prospects
- Improperly terminating or not renewing a franchise
Penalties for Violating Franchise Laws
Governmental penalties for violating franchise laws can include:
- fines
- permanent bans on engaging in franchising
- freezing of assets
- money damages for victims
- Jail sentences
These penalties can be applied to the franchisor, and to its officers, directors, and managers who formulate, direct or control the franchisor’s activities. The violation of state franchise laws is typically treated under the statutes as either a fraudulent and deceptive trade practice, or a misdemeanor, or a felony.
In some states, a franchisee who has been harmed by the franchisor’s conduct can be awarded money damages (including punitive damages and attorneys’ fees), or cancellation of the franchise agreement and reimbursement of all fees paid to the franchisor.
Before you choose any franchise system, you should think about how much money you want to invest, your abilities, and your goals. Be honest with yourself. The following checklist can help ensure you meet certain requirements in order to own a franchise:
Investment
- How much money do you want to invest?
- How much money can you afford to lose?
- Are you purchasing the franchise alone or with partners?
- Do you need financing? Where’s it coming from?
- What’s your credit rating? Credit score?
- Do you have savings or additional income to live on while you start your business?
Capability & skills
- Does the franchise require technical experience or special training or education?
- What special skill set can you bring to a business, and, specifically, to this business?
- What experience do you have as a business owner or manager?
Your Ultimate Business Objective
Write down your reasons for buying a particular franchise:
- Do you need a specific annual income?
- Are you interested in pursuing a particular field?
- Are you interested in retail sales or performing a service?
- How many hours can you work? How many are you willing to work?
- Do you intend to operate the business yourself or hire a manager?
- Will franchise ownership be your primary source of income or a supplement to your current income?
- Do you get bored easily? Are you in this for the long-term?
- Would you like to own several outlets?
Apart from knowing Franchise legislation and legal requirement, you should also investigate franchisor and business to make sure you are investing in the right franchisee.
Get The All-Important Disclosure Document
Before you invest in any franchise system, get a copy of the franchisor’s disclosure document. Under the Franchise Rule, which is enforced by the FTC, you must receive the document at least 14 days before you are asked to sign any contract or pay any money to the franchisor or an affiliate of the franchisor.
You have the right to ask for—and get—a copy of the disclosure document once the franchisor has received your application and agreed to consider it. Indeed, you may want to get a copy of the franchisor’s disclosure document before incurring any expenses to investigate the franchise offering.
The franchisor may give you a copy of its disclosure document on paper, via email, through a web page, or on a disc. The cover of the disclosure document should have information about its availability in other formats. Make sure you have a copy of the document in a format that is convenient for you and keep a copy for reference.
Check Franchisor’s Background
Before investing money, you need to know how long the franchisor has been in business, likely competition, and any special laws that pertain to the industry, like any license or permit requirements. This will help you understand the costs and risks you are likely to take on if you purchase and operate the franchise.
Read the entire disclosure document. Be upfront about asking for explanations, clarifications, and answers to your questions before you invest.
Analyze the Business Background
Identify the executives of the franchise system. Pay attention to their general business backgrounds, their experience in managing a franchise system, and how long they’ve been with the company.
Litigation History
Whether the franchisor or any of its executive officers have been convicted of felonies involving fraud, violations of franchise law, or unfair or deceptive practices law, or are subject to any state or federal injunctions involving similar misconduct. It also says whether the franchisor or any of its executives have been held liable for—or settled civil actions involving—the franchise relationship.
A number of claims against the franchisor may indicate that it has not performed according to its agreements, or, at the very least, that franchisees have been dissatisfied with its performance.
This section also should say whether the franchisor has sued any of its franchisees during the last year, a disclosure that may indicate common types of problems in the franchise system.
Calculate Initial and Ongoing Costs
Here, you need to know the costs involved in starting and operating a franchise, including deposits or franchise fees that may be non-refundable, and costs for initial inventory, signs, equipment, leases, or rentals. It also explains ongoing costs, like royalties and advertising fees. You also need to ask the franchisor about:
- continuing royalty payments
- advertising payments, both to local and national advertising funds
- grand opening or other initial business promotions
- business or operating licenses
- product or service supply costs
- real estate and leasehold improvements
- discretionary equipment, such as a computer system or a security system
- training
- legal fees
- financial and accounting advice
- insurance
- the costs of compliance with local ordinances, such as zoning, waste removal, and fire and other safety codes
- health insurance
- employee salaries and benefits
Starting your business may take several months. Estimate your operating expenses for the first year and your personal living expenses for up to two years. Compare your estimates with what other franchisees have paid and with competing franchise systems. You may be able to get a better deal with another franchisor. An accountant can help you evaluate this information.
You should be familiar with standard and state’s franchise legislation and legal requirement to ensure your franchise business is running within the law requirements and help you avoiding any legal violation.
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