What steps do you need to take to franchise your business?
Start with the right business
First, consider whether you have the type of business that lends itself to franchising:
- Does the business have features that clearly distinguish it from the competition? What characteristics will make your franchise system likely to succeed and meet or beat the competition?
- Does the business need managers in a variety of locations who know and can service their local communities?
- Can the business be cloned? In other words, can it be described in an operating manual? Can qualified people be trained to run essentially the same business at different locations?
- Can this be done in a way that allows both the franchisor and the franchisees to be profitable?
Federal trademark registration
Next, you should have a strong brand identity. The company’s principal trademark is an important component of its brand. If you are even thinking of franchising the business, you should look into applying for federal registration of the company’s principal trademark. Federal registration in the U.S. Patent and Trademark Office gives the trademark owner national protection. For a company that sells franchises, federal trademark registration also exempts the offering from the requirement in some states to register the offering under the state’s business opportunities law.
Applying for federal trademark registration should be one of the very first steps a prospective franchisor should take. The reason is simple. It commonly takes a year or longer to obtain federal trademark registration. In fact, because trademark registration protects all trademark users, not just franchisors, applying for trademark registration is often a good business decision whether you decide to franchise or not.
Legal entity structure of franchise
Legal entity structure is another consideration. Many franchisors set up a new limited liability company or corporation to be the entity that sells franchises and manages the franchise system. This entity can have the same owner or owners as the original business or it can have different ownership. For example, new investors can help the franchise company grow without taking an interest in the company-owned operation. The operating company can own the trademark and license it to the franchise company. This structure shields the operating company from the liabilities of the franchise business and vice versa.
The approach of forming a separate company to be the franchisor also has the benefit of allowing the original business to keep its finances confidential. Franchisors in the U.S. are required to disclose their financial statements. In most cases, the franchisor need not disclose the financials of an affiliated company. In fact, it can simply prepare an opening balance sheet for its first franchise offering. In New York, the opening balance sheet of even a new franchisor must be audited.
Franchise agreement and disclosure document
Finally, before even one franchise can be sold, the company must prepare a form of franchise agreement and a franchise disclosure document. The agreement is the contractual basis of the ongoing relationship between the franchisor and the franchisee.
The disclosure document describes the franchise offering in plain language. It includes the franchise agreement, the audited financial statements and much more. It must comply with the detailed requirements of the Federal Trade Commission’s trade regulation rule on franchising. The franchisor must deliver this disclosure document to each prospective franchisee before the prospective franchisee signs an agreement or pays a fee to the franchisor.
In several states, the franchisor must register its franchise offering before the franchisor can offer or sell franchises in the state. These states include California, Illinois, Maryland, New York and others. In some states, franchisors must also file franchise sales materials before they are used.
How long does the franchising process take?
The process of preparing to offer franchises in the U.S. is likely to take at least two months and probably longer, especially in those states that require franchise registration.
