Q:What is the fundamental difference between franchising vs. licensing someone to operate my business in another state? I am trying avoid becoming a franchise, but I have people interested in using my business and my business model in other states.
Answer:
The line between franchising and licensing is not always a clear one. However, as you evidently know, offering a franchise subjects the offering party to FTC and state regulations, which require disclosure statements to accompany such an offering.
Most state franchise regulations allow that if a franchisor, the party offering the franchise, has complied with the FTC regulations, then the party has also complied with the state regulations. Otherwise, the regulations for franchise offerings vary by state.
If you currently have a license agreement where you license your trademark and give or exert control over the licensee's business model and get paid, generally speaking, you are probably operating a franchise and are subject to franchise regulations. These regulations do allow an exemption for a single license within certain parameters. If you state to your buyers that you are a "franchise," however, you definitely fall under the regulations.
Franchise Regulations
The purpose of the franchise regulations is to be sure that full disclosure of all information is disclosed to someone purchasing a franchise. FTC Franchise Regulations require disclosure of a great deal of information regarding the advertising, offering, licensing, contracting, sale or other promotion of a franchise. These disclosures include:
- The name of the franchisor
- Any fictitious names of the franchisor
- The trademarks of the franchisor
- The last five years of business experience of the franchisor's directors and officers
- Whether the franchisor's directors or officers have been convicted of or plead nolo contendere to any felony involving fraud during the past seven years
- Whether the franchisor's directors or officers have been a party to, settled or convicted of a civil action involving fraud during the past seven years
- Whether the franchisor's directors or officers have during the past seven years filed for bankruptcy, been adjudged bankrupt, been reorganized due to being insolvent and so on
- All terms of the franchise agreement, including how to terminate, modify and sell it
- Information on site selection, training programs, financial statements, other franchisees and so on
The disclosure statements for a franchise and their legal agreements are lengthy. You always want to have an experienced franchise attorney help when you write the franchise disclosure statements and your franchise agreement. These documents are analogous to SEC disclosure statements in complexity and magnitude. The analogy makes sense, since the franchisee is, in a sense, investing in the franchise.
"Avoiding" Becoming a Franchise
There is no clear direction about how to avoid becoming what is defined as a "franchise." Above, we've mentioned some of the regulations involved. The best approach would be to work out your business goals, what you can live with and without, your financial goals and so on and compare that to the definition of a franchise. Then discuss your business goals with your franchise attorney, making sure to consider the best way to accomplish what you have in mind while still being in compliance with the law.
Alternatively, consider expanding your own business instead of selling your model to others. If your company owns and runs all the retail stores with its employees and offices nationwide, it's probably not a franchise--it's just one company doing business in many states. By rearranging your goals and seeking investors instead of franchisees, you might find another approach that makes sense.
All answers are general in nature, not legal advice and not warranted or guaranteed. Readers are cautioned not to rely on this information. Because laws change over time and in different jurisdictions, it is imperative that you consult an attorney in your area regarding legal matters and an accountant regarding tax matters.
