Registration and Filings
There is no federal franchise registration or filing requirement. However, 14 states do require franchisors to register or file their franchise offerings with the state:
Business opportunity laws
About half of the states have business opportunity laws. The Federal Trade Commission also regulates the sale of business opportunities, but its definition of a business opportunity is narrow. The business opportunity laws generally require disclosures and some require registration.
In many cases, franchises are exempt from the business opportunity laws. Many of those laws contain exemptions for franchise offerings made in compliance with the FTC Rule. Another common exemption is for the grant of rights relating to a federally registered trademark. And usually, larger investments are excluded from coverage.
Even with these exemptions, though, certain states will require a filing. Florida, for example, requires each franchisor to submit a simple exemption filing each year. In Connecticut, an offer of a franchise without a federal trademark registration will constitute an offer of a business opportunity unless some other exemption or exclusion applies. If the franchisor does have a registered trademark, Connecticut requires a simple exemption filing. Texas requires franchisors to submit a one-time business opportunity exemption filing regardless of whether the franchisor’s trademark is registered.
Franchisors commonly include franchise sales information on their websites. Advertisements and brochures advertising the franchise offering must be filed in advance of their use in California, Maryland, Minnesota, New York, North Dakota, Rhode Island, South Dakota and Washington.
Under federal law, franchisors are required to deliver the franchise disclosure document (FDD) to each prospective franchisee at least 14 days before the prospective franchisee pays any money or signs an agreement.
New York requires franchisors to wait 10 business days, which may be more than 14 days. New York requires earlier disclosure if the franchisor actually meets with the prospect to discuss the sale of a franchise at an earlier date.
You should keep careful records of the dates you deliver the FDD to your prospects. The last two pages of the FDD are duplicate copies of an acknowledgment of receipt. The prospect should sign and date this receipt, and you should keep each signed receipt on file to prove the date of disclosure if necessary.
Financial Performance Representations
When selling franchises, franchisors have to be especially careful not to make any representations about the chances of success or the level of revenues or profits that a franchisee can make.
Item 19 of the FDD deals with financial performance representations, which used to be called earnings claims. You are not required to make financial performance representations in the FDD. But if you don’t, then you are making it tougher to sell franchises. The first thing a prospective franchisee usually wants to know is how much money he or she can make. What do you say to a prospect who asks how much he or she can earn? You can refer that prospect to existing franchisees, who are free to discuss their own numbers. But that doesn’t work for a new franchisor who has not yet sold any franchises.
You can make financial performance representations to prospective franchisees, but only if you’ve included those representations in Item 19 of the disclosure document. If you do provide information to a prospect regarding financial performance, the disclosure must follow the detailed requirements of Item 19.
Annual audits and renewals; material changes
After launching a franchise system, a franchisor must keep its FDD and its state registrations current. Each year, the franchisor must prepare new audited financials and include them in the updated FDD, which must show financials for the last three years. State franchise registrations remain in effect for a period of one year and must be renewed from year to year.
The tables in Item 20 of the FDD showing franchise sales, transfers and other information also need to show a running three-year window, and the lists of franchisees in the exhibits to the FDD need to be updated from year to year.
Once you have franchisees in your system, you will want to exercise quality control. Each franchisee represents your brand and should maintain your quality standards. This requires monitoring and frequent communication with franchisees.
Communication is key also if you find that you need to make a system-wide change in your franchise. You may need to make such changes, for example, in order to respond to competition or other market conditions. Because you are dealing with independent franchise owners rather than employees, changes require planning.
Contract management also becomes important. You’ll want to keep close track not only of compliance, but also renewal and expiration dates. You are also likely to have an evolving franchise agreement, so agreements signed in different years might have different provisions.
The ultimate sanction a franchisor can impose is to terminate or refuse to renew the franchise agreement. Terminations and litigation that sometimes results from termination must be disclosed in the FDD, which can dampen future franchise sales. The best way to avoid terminations is to select excellent franchisees at the outset.
The best systems start with a good business model. They communicate well with franchisees, imparting the need for quality control, but also listening to what the franchisees say about changes in the marketplace. These are the ingredients that go into system growth and successful franchise systems.