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Franchises: Reaching for the American Dream

Lerch Early's Legal Update

The American Dream for many individuals is manifested by a desire to “be my own boss.” Turning this dream into reality may mean starting a business from scratch or buying an existing business. For an increasing number of individuals, this wish is reached through the entry into a franchise business. It is estimated that there are more than 825,000 franchise businesses in the United States across 300 business categories, including fast food, hotels, health and fitness,educational services, automotive and convenience stores and gas stations. This article provides a brief, introductory overview of the franchise business for those who may seek to become a franchisee.

What is a Franchise?

Those interested in exploring entry into a franchise business need to understand the nature and regulation of the franchise relationship. Franchises generally consist of four elements known as the (1) “grant,” (2) “marketing plan or system,” (3) “trademark” and (4) “franchise fee.” Basically, one cannot operate in a franchise system and use a franchisor’s trademark without a grant from the franchisor and an agreement to pay the franchise fee to the franchisor, usually in the form of initial franchise fees, on-going royalties and advertising fees.

Federal and State Franchise Regulation

In the United States, franchising is regulated at both the federal and state level. The Federal Trade Commission (FTC) is the federal body with jurisdiction over franchises, mandating that certain minimum disclosures be provided in the Franchise Disclosure Document (discussed below). At the state level regulation varies, with some states having little to no statutory or regulatory oversight while others regulate both pre-sale disclosures and the subsequent franchise relationship. Maryland, for example, requires that franchisors register with the Maryland Securities Commissioner and obtain advance approval of disclosures regarding the franchise before offering a franchise for sale in the state. Virginia, on the other hand, does not require pre-sale registration or disclosure, but does have a franchise relationship law limiting termination of a franchise relationship absent reasonable cause.

The Franchise Disclosure Document

The most important document for any individual looking to enter into a franchise business is the Franchise Disclosure Document or “FDD” (formerly known as Uniform Franchise Offering Circular or “UFOC”). The FDD is a document required by the FTC and is meant to set forth in plain English, without legal jargon or highly technical terms, basic information regarding the franchisor, the franchisor’s business, the franchise system and the franchise agreement. Each FDD contains the same 23 numbered items covering such areas as: the business experience of the franchisor’s directors, officers and persons with management responsibility; litigation and bankruptcy history of
the franchisor; fee structure; franchisee’s obligations; franchisor’s assistance, advertising and training; the territory; trademarks; restrictions on what the franchisee can sell; renewal, termination, transfer and dispute resolution; financial performance representations and franchisor’s financial statements. By requiring that all franchisors provide an FDD containing these identical 23 items, anyone interested in becoming a franchisee can undertake an apples-to-apples comparison prior to entering into a particular franchise relationship. For more, see “Due Diligence for the Potential Franchisee: How to Use a Franchise Disclosure Document.”

Stuart Schwager is a business and litigation attorney at Lerch, Early & Brewer in Bethesda, Maryland who provides franchise counseling and litigation representation. For more about exploring a franchise opportunity, contact Stuart at (301) 347-1271 or saschwager@lerchearly.com.

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This content is for your information only and is not intended to constitute legal advice. Please consult your attorney before acting on any information contained here.

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