Are you thinking about franchising your business? Well, there is a lot you will need to figure out then, especially the legal requirements to franchise your own business.
Different states can have different rules for franchising a business, but there are certain common legal steps that all business owners who are interested in franchising must follow.
What are these? Let us explore in this comprehensive guide!
What Does Franchising Mean?
Franchising is a type of business model in which business owners (franchisors) systematize their business operations in order to sell their brand units to individuals (franchisees).
For this, a franchisor creates a uniform process and also a legal structure to grant the right to the franchisees to run one or more units of their business smoothly.
Franchisors provide the franchises with some level of support, training, and other resources to ensure success.
There are some legal documents, such as the franchise disclosure document (FDD), franchise agreement, etc., that the franchisee must sign to run their franchise legally.
So, what are the legal requirements to franchise your own business? Keep reading to find out!
What Are the Legal Requirements to Franchise Your Own Business?
Franchising occurs when there is a written agreement for:
- the seller to exert some level of control or provide certain assistance.
- the buyer to use the sellers trademark.
- the buyer to pay for the association.
There are esentially five major legal documents that the business owner needs in order to start franchising and these are:
1. Legal Document Set
The first and foremost document that is required to legally start franchising is Franchise Disclosure Document (FDD). An FDD contains “23 items” that are designed to inform the prospects about the franchisor. The FDD must be prepared under strict compliance with FTC rules.
In fact, a total of 15 states compulsorily require the franchisor to register FDD with the state. And in some states, you are not even allowed to start franchising before you have registered the FDD and have informed the state about the same.
The FDD contains extensive information about your business and is divided into three sections: cover page, table of contents, and 23 items, including:
- Key persons: This includes the identity and also information of the key executives and management personnel involved in the business.
- The franchisor: This shows for how long you have been in the business, any specific laws pertaining to your industry, license or permit requirements, likely competition, etc.
- Bankruptcy: If you or any of your executives have ever filed for bankruptcy, you must disclose this here.
- Litigation history: Shows litigation involving your company, customers, or other franchisees. It also shows allegations or disclosure of fraud, violations of franchise laws, etc.
- Initial franchise fee: You need to show the list of costs for starting and operating the franchise here. This section also discloses the ongoing advertising and marketing fees, non-refundable fees, etc.
- Restrictions: This includes the restrictions that the franchisees are bound to, including using the brand’s name, relationship with suppliers, etc., to maintain the integrity of the brand.
- Training: Includes the training program the franchisees must attend before beginning operations.
- Obligations: This section covers the obligations and restrictions for both you and the franchise to operate smoothly.
- Financing: Shows any financing help you may or may not provide the franchisee.
- Financial performance: This reveals the financial performance of your business. However, this is optional, and you may choose not to disclose your company’s financials.
- Financial statements: This reveals your financial status, including audited financials, so that the franchisee can determine whether or not your business is profitable.
- Current franchisee contacts: This section includes the contact information of your current franchisees so that the potential franchisee can talk with them and get more information about the viability of your business.
2. The Franchise Agreement
A franchise agreement is a very crucial legal document as it acts as a binding contract between you and the franchisee. This document contains the obligations and legal rights of both parties and helps in protecting the integrity of the trademark and franchise system.
This is also the first legal document that you send to the potential franchise and should be clear and crisp. A franchise agreement contains the following information:
- Initial and ongoing franchise fees
- Franchise territory protections (if applicable)
- Specifications for equipment, supplies, and inventory
- The terms of the agreement and conditions for its renewal
- Timelines for opening the franchise for business
- Rules for the transfer of the franchise to a third party
- Post-termination obligations
- Any conditions for termination of the agreement
- Non-compete covenants
- Minimum sales requirements (if applicable)
- How disputes will be resolved, including methods such as mediation and arbitration
3. State Approval
The next important legal step in starting your franchise business is getting state approval. As mentioned, the FDD is a federal requirement applicable to all states and territories.
However, some states impose additional requirements. Depending on the state you live in, you might be required to include state-specific information in your FDD.
States are usually referred to as “registration states,” “non-registration states,” “business opportunity states,” and “filing states.” We have shared more information about this in the below section.
You must note that you cannot start franchising legally unless you comply with federal franchise law or any other law specific to your state.
4. Complying With Disclosure Requirements
After obtaining the necessary state approval, the next step is the disclosure of the FDD.
Disclosure of the FDD involves providing the document to the potential franchise, obtaining signing acknowledgment from them, and offering them a waiting period of 14 days to digest the document.
As per federal law, the 14-day waiting period is mandatory, and it must occur before:
- You collect any fee from the franchisee.
- Any agreement can be executed by the franchisee.
This is how you calculate the 14-day waiting period:
It might look simple at first, but the 14-day period is actually 16 16-day period. This is because the day on which you provide the FDD and the day on which the franchise agreement is signed do not count under the 14-day period. This leaves you with a 16-day waiting period.
If any additional changes are made to the FDD, then the waiting period might extend for upto 7 more days.
5. Maintaining Legal Documents
As per the Federal Franchise Rule, the franchisor must update the FDD with current information as an ongoing legal requirement.
So in some states, the FDD must be updated each year at a minimum. And the update must be made within 120 days of the end of the business fiscal year-end.
You might also be required to make periodic updates whenever any changes occur in your franchise system.
The franchise laws can also vary from state to state. You can look at the section below for more information.
Since the process is a bit complicated, take help from attorneys with disclosing prospects, preparing contracts, calculating waiting periods, maintaining FDD, and more.
Franchise Laws at the State Level
Apart from the basic necessary legal documents mentioned in above, different states may require some additional legal documents for filing for franchises.
There are certain states that require the franchisor to register their FDD along with other franchise information on an annual basis. So here’s a list of all the franchise registration states:
- North Dakota
- New York
- Rhode Island
- South Dakota
Franchisors who wish to offer franchises for sale in these states must follow the initial registration requirements, pay the filing fees, and also renew their registration on an annual basis in compliance with state law.
Filing States & Business Opportunity
Some states have “Business opportunity laws” that regulate the sale of business in those states. Business opportunities and franchises are different; some states, in certain situations, might require franchises to register before they can sell franchises.
Now, some of these states might require annual filing, while others may require a single filing or even none if the franchisor uses the trademark registered with their brand.
For example, if a franchisor operating in Louisiana or Georgia does not have a trademark registered with the federal government, then they need to file documents with the state compulsorily.
The requirement for the same can vary greatly depending on the state; it’s best to hire a franchise lawyer for proper assistance and guidance for the same.
Here’s a list of states with business opportunity laws:
- South Carolina
- North Carolina
List of States That Do Not Require Registration:
So here’s a list of states that do not require registeration:
- District of Columbia
- New Jersey
- New Hampshire
- New Mexico
- West Virginia
Franchising is a great way to expand your business and boost your revenue. However, the legal requirements to franchise your own business could be a lot to take in.
The best way to start your franchise business legally is by hiring a franchise attorney lawyer.
This will ensure that everything goes smoothly and also within the legal limits.
How long does it take to start a franchise?
A lot of factors, such as your state laws, business structure, how well-defined the business’s processes and systems are, etc., will define how long it will take to start your franchise business. However, a reasonable estimate for the same should be three to six months.
Is applying for trademark important in franchising?
Yes, applying for a trademark is a must before you start franchising. Trademark protects your business name, logo, and tagline from getting stolen by someone else. So franchisors can apply for a trademark through the United States Patent and Trademark Office (USPTO).
Should I hire an attorney for franchising my business?
Yes, franchising is not an easy task and involves a lot of legalities, such as forming the FDD, registering with the state government, drafting the franchise agreement, etc., so you must hire a franchise attorney at all costs.
How can I ensure smooth operations of all my franchise locations?
Once you franchise your business and find a handful of franchises, you will start to worry about how you are going to handle them. Well, there is a lot of franchise management software for different things, such as:
- Franchise billing softwares
- Franchise analytics softwares
- Franchise compliance softwares
- Franchise accounting softwares
- Franchise mapping softwares, etc.
So you can use the needed software to manage the operations of all your franchises smoothly with these.