ASK THE EXPERTS

QASK A LEGAL EXPERT As a franchisee, what should I have in my legal tool kit before embarking on a new franchise opportunity?

AMOST FRANCHISEES GET A CRASH COURSE in franchise law as a fringe benefit of purchasing a franchise. Counsel will gleefully dissect the franchise disclosure document (FDD), advise on the finer elements of the franchise agreement, and pontificate on the meaning of “material facts,” the duty of good faith, and the right of rescission. Here, I will dive deeper and provide franchisees with a useful tool kit of core principles that govern the relationship between franchisors and franchisees.

Is it a franchise?

Promoters will go to great lengths to assert that their business is not a franchise in order to avoid the costs of franchise compliance and issuing FDDs. However, any business which, under a written agreement, grants a person the right to conduct a business, using the other person’s trademark, and in which the other person exercises significant control over the business or provides significant assistance, is a franchise. Substance trumps form, and the courts will find a franchise if these elements exist.

Piecemeal disclosure is no disclosure

An FDD must be delivered in one document, at one time. For example, franchisors cannot provide pro forma income statements in one meeting, the franchise agreement in another, and then the investment costs in another, even if the prospective franchisee receives, in the aggregate, all information required by law.

Strike one, you’re out

A franchisor’s failure to disclose in its FDD financial statements from the most recently completed fiscal year in audited or review engagement format (subject to a 180-day grace period), is fatal to the FDD and can entitle a franchisee to a two-year rescission period commencing on the date of the franchise agreement. Notice to reader and internally prepared financial statements are a critical deficiency. Failure of a franchisor to have two of its officers and directors sign and date the FDD certificate (unless there is only one officer and director) is also a critical deficiency which will invalidate the FDD and open the two-year rescission window.

Keep the faith

Franchisors owe franchisees a duty of good faith and fair dealing in the performance and enforcement of the franchise agreement. In exercising discretion, a franchisor must consider the franchisee’s interests, but is not required to put those ahead of the franchise as a whole. Franchisors must act in good faith, absent ulterior motive, and in a commercially reasonable manner.

Please release me

Franchisees cannot be asked to contract out of, or release a franchisor, from its statutory obligations. The law protects franchisees by invalidating any purported waiver or release by a franchisee of these rights. For example, an agreement by a franchisee to waive a franchisor’s disclosure obligations, or release the franchisor from any rescission claim, is invalid. The exception to this rule is where a franchisee agrees to release known statutory claims against the franchisor (e.g., a rescission claim), for valuable consideration, and with the oversight of lawyers.

(No) right of renewal

Once the term and all renewal terms in a franchise agreement have expired, the franchisor has no implied, or good faith obligation, to renew the agreement. The courts will not read into a contract terms that do not exist. Franchisees must ensure that their agreement contains meaningful renewal rights in their favour or risk losing the right to continue to operate their franchise.

Ch, ch, changin’

Franchises are constantly evolving, and franchisors must often make key changes to their business model. Franchisors must consider whether (i) such changes are permitted under the agreement; (ii) the changes would be so impactful as to undermine the benefit of the contract; and

No ‘cookie-cutter’ FDDs

Franchisors can no longer issue “generic,” one-size-fitsall FDDs. These must be tailored to the specific opportunity. Costs must reflect the format (new build, turnkey, conversion, kiosk, etc.), and the franchisor must disclose site information, revenue information, and, if it is a head tenant, lease information pertinent to the site. Failure to do so can result in a deficient FDD. Franchisors can, however, supplement the original, properly prepared FDD with statements of material change to disclose new information (such as a head lease, sublease, and costs) arising after the original FDD is provided.

Richard Leblanc

Partner

Miller Thomson LLP

rleblanc@millerthomson.com

(iii) the imposition of the changes breaches the duty of good faith. The courts have reviewed this question and while a franchisor must consider the best interests of the system as a whole, it is not required to guarantee any benefit or level of profit to its franchisees when making system changes in good faith for legitimate business reasons.

To compete, or not to compete

Non-competition covenants are often unenforceable as being in restraint of trade and contrary to the public interest. The party enforcing the clause must justify that it is reasonable in time and scope, and protects a valid business interest. Restrictive covenants that are vaguely drafted, are overly broad in scope, or contain material errors, will be voided by the courts. And, if the franchisor does not have a legitimate business interest to protect in the restricted territory (including the lack of any intention to expand their business to that territory), the courts may strike the clause as unenforceable.

QASK A FRANCHISE EXPERT What are some of the most common franchising myths?

ASOME PEOPLE HAVE PRECONCEIVED NOTIONS when it comes to franchising and how it can be a vehicle for their success. Often, these perceptions are based on inaccurate and erroneous information.

Here, we’ll examine six of the more prevalent myths regarding franchising.

1. I can’t be in that business if I don’t know anything about it

Good news: you don’t have to. One of the greatest advantages of starting a franchise is that you’re provided with training and ongoing support. Essentially, this negates the requirement of having experience in specific industries and systems or past business ownership. Typically, franchisors are looking for candidates with the right transferable skills. You may not have worked in a particular industry before, but if you’re diligent, patient, and willing to learn, you have many of the qualities required to thrive as a franchisee. If you restrict your options to only things that you’re already good at, you shut down a universe of possibilities.

2. I can’t be creative in a franchise because the franchisor will dictate everything

Franchisors provide the framework but as a franchisee, often you manage, market, and promote your business. You’re in charge, and the flexibility and creativity are achieved by how you choose to run and elevate a proven process.

There’s plenty of room for your ideas. You might be amazed to know how many product and service innovations have come from franchisees, not the parent company.

3. I can’t afford a franchise

Although some people think that investing in a franchise is too expensive, it’s important to point out that there are numerous opportunities available to fit a wide variety of budgets. Generally, the expenses for starting and running a franchise won’t be much different from other business models and the franchise’s fees come with plenty of value and benefits that other start-ups wouldn’t provide. With so many diverse franchise possibilities out there, you have the ability to invest at your comfort level.

Moreover, there are various funding options and programs in place for potential and existing franchise owners to help you get closer to fulfilling your business ownership dreams.

4. Franchisors get rich at my expense through royalties

Franchisors do indeed earn money through partnering with franchisees and vice versa. Each franchisee must assess the value of what they’re receiving in return for paying a percentage of their revenue. Consider what franchisors provide for that royalty: experience, support,

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Gary Eisler

Career ownership coach

The Entrepreneur’s Source

geisler@esourcecoach.com

TUTORIAL 1: THE FUNDAMENTALS OF FRANCHISING WHAT IS A FRANCHISE?

FRANCHISING IS A BUSINESS RELATIONSHIP where a franchisor (a company or individual who owns the franchise system) grants a franchisee (a company or person who contracts to use the franchise system) the licence to use the franchisor’s trademark, brand, and operating system for an initial fee (franchise fee). In return, the franchisee provides a share of the income back to the franchisor (a royalty). The licence is contractual and is usually for a fixed period of time, often five, 10, or 20 years. The franchisor selects candidates to become strategic partners in implementing the business plan and selling products and services to the franchisor’s customers using the franchisor’s proven business model and/or their proprietary products. A franchise system has policies and procedures in place so as to create consistency from one franchise location to the other.

As a growth strategy, it provides franchisors with the ability to gain market share by increasing their points of distribution. Increased points of distribution result in greater exposure and brand awareness. Franchisors are able to grow and have committed individuals operating and driving the location. From a franchisee perspective, it allows the franchisee to get into business with support, a brand name, and a proven business model. This helps to reduce the risks involved with getting into business.

It has become a part of almost every industry. Although people most often think of fast food when they think of franchising, it’s also found in many other sectors including retail, commercial and residential services, automotive, business services, real estate, and lodging.

There are several things that one must understand about a franchise. You’re not buying the franchise. Instead, you’re acquiring a licence to operate a franchise. You don’t own the name, but instead have a licence to use the name. You don’t own the business model, but instead have the rights to use the business model for a period of time. It’s a little like being a tenant and renting. You don’t own the space you’re renting, but instead have the use of the space for a period of time.

Uniformity is a fundamental principal to the success of a franchise. There must be consistency from franchise to franchise within a given business. By having the same product in similar outlets, with consistent levels of service, the franchise is able to build confidence in the mind of the customer, and this drives people to the brand. Customers gravitate to what they know, what’s familiar, and what they trust. The uniformity is often created through operating standards and procedures that are clearly documented in operation manuals. Franchisees are required to follow an operating system, use the same suppliers of product, and take the same training. The system, suppliers, and training are all designed to create a consistent experience to the end user of the product or service, and thus create an expectation and impression in the mind of the customer.

The uniformity is enforced through a franchise licence. This licence gives you the right to use the brand and operating system. The licence also comes with obligations, to follow the operating standards and systems, as clearly defined in the business model. If you fail to follow the standards, you may lose your licence. With compliance to the system, it drives the market and enhances your investment. When you first look at a franchise agreement, it may seem controlling and one-sided in favour of the franchisor. This is normal, and is required to allow

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FRANCHISING PROVIDES NUMEROUS BENEFITS:

✔ An established brand and proven business model ✔ Mass purchasing power ✔ Co-operative advertising ✔ Operational support and training ✔ Research and development, marketing new products and services ✔ Access to financing and site selection

HALLMARKS OF A STRONG FRANCHISE INCLUDE:

✔ Strong leadership ✔ Participative management with Franchise

Advisory Councils enhancing communication ✔ Continuous training ✔ Evolving brand development ✔ Continuous improvement to the operating system ✔ A positive corporate culture

TUTORIAL 2: THE FUNDAMENTALS OF FRANCHISING

INTRO TO FRANCHISE FEE FUNDAMENTALS

FRANCHISE FEES ARE TYPICALLY PAID for the use of the franchisor’s trademark, brand, and operating system. There’s usually a one-time initial franchise fee, as well as an ongoing fee, called a royalty. The ongoing royalty may be a flat monthly or weekly fee, or a percentage of the gross sales from the business. In addition, most franchise companies charge a fee for an advertising fund where the advertising dollars of the franchisees are pooled together to allow for franchisees to share the costs of national or regional advertising. By pooling the advertising dollars together, they’re able to afford advertising that wouldn’t have been affordable otherwise.

Why do some franchise systems have franchise fees and others don’t?

The initial franchise fee can vary from $5,000 to more than $75,000. How much the initial fee is will vary depending upon the amount of training and support that’s provided to get the new franchised location up and running. In addition to the initial training and support, the initial franchise fee covers the cost of franchisee recruiting, territory analysis, site identification, grand opening launch, and some recovery of the franchise development costs. Typically, the more established and recognized the brand of the franchisor, the higher the initial fee.

Ongoing royalty fees will vary from zero per cent to 20 per cent of gross sales. The amount will vary depending upon the level of ongoing support and services that are provided by the franchisors. For example, some franchisors may provide a centralized call centre with order taking. This requires a higher cost, which is addressed with a higher royalty.

Where no royalty is charged, it’s usually built into product sales or sale of services in the form of markup or rebates on products. Typically, the more involved the franchisor is with ongoing business operations, the higher the fee.

Franchisors must make some form of revenues and profit in order to provide ongoing support and services. A royalty ensures that the franchisor has a vested interest in your success. Your success results in their success.

GLOSSARY OF TERMS

Advertising fund: A fund held by the franchisor where franchisee advertising dollars are pooled together for national and/or regional advertising. Franchise: The right to use the trademarks, know-how, and business systems of the franchisor, and to promote and market products and/or services using such trademarks, know-how, and systems. Franchisee: The company or person who contracts with the franchisor for the right to operate the franchise in return for payment of an initial fee and/or an ongoing royalty. Franchising: A way of doing business in which the franchisor gives the franchisee the right to offer, sell, or distribute goods or services identified by the franchisor’s trademark. Franchisor: The company or individual that owns or controls the trademarks and the franchise system and grants the right to operate the franchise using the trademarks, know-how, and business systems of the franchisor. Franchise system: A system of marketing and distribution in which an independent businessperson, for a fee, is granted the right to market the goods or services of the franchisor according to the established standards and practices of the franchisor. Initial franchise fee: A one-time fee paid by the franchisee to the franchisor in payment for the right to operate a franchised business (also known as an initial, upfront, or licence fee). Franchise model: A business model that has in place policies and procedures to create consistency from one franchise location to the other. Royalty: An ongoing fee paid by the franchisee to the franchisor, often calculated as a percentage of sales. Trademark: A name, symbol, or other device identifying a product or service of the franchisor that distinguishes them from similar products and services supplied by third parties.

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the franchisor to control the integrity of the brand. As a franchisee, it’s important to understand that you’re required to conform to the franchise system business model. The success of the system as a whole to build a brand is dependent upon consistency.

Although you can’t simply do what you want, strong franchise organizations value franchisee input and often create advisory groups to provide feedback and input to the franchisor to assist in the strategic direction of the company. They view the franchisee and franchisor relationship as a partnership. Franchisees are on the front lines and have strong knowledge of the needs of the customer. At McDonald’s, it was the franchisees’ input that led to the development of the Egg McMuffin® and the McFish® sandwich. Strong franchisors listen and value the input from franchisees.

Watch the Franchise Tutorials video on Franchising 101

Watch the Franchise Tutorials video on Franchise Fee Fundamentals

STUDY QUESTIONS

TUTORIAL 1

1. From a franchisee perspective, franchising benefits include:

a) allowing the franchisee to make money by collecting royalties from the franchisor b) allowing the franchisee to get into business with support, a brand name, and a proven business model from the franchisor c) transferring ownership of the franchise system to the franchisee

2. One of the fundamental principles of franchising is:

a) uniformity and consistency across all franchise locations b) a lack of consistency in customer experiences from location to location c) complete autonomy of franchise locations from the franchise system

3. Franchising only exists in the fast food industry.

True or False?

a) True b) False

4. Franchisors often don’t welcome franchisee input. True or False?

a) True b) False

TUTORIAL 2

1. Franchise fees are typically paid:

a) when first meeting with franchisors b) every year c) for the use of the franchisor’s trademark, brand, and operating system

2. Ongoing royalty fees will vary from:

a) 0 per cent to 20 per cent of gross sales b) 50 per cent to 90 per cent of gross sales c) 60 per cent to 100 per cent of gross sales

3. An advertising fund is a government funding program to assist franchisors in developing advertising materials. True or False?

a) True b) False

4. A royalty ensures that the franchisor has a vested interest in your success.

Your success results in their success.

True or False?

a) True b) False

4) b 3) b 2) a 1) b Answer Key: 4) a 3) b 2) a 1) c Answer Key: