Legal Requirement To Start A Franchise

Have you considered owning your own business by franchising? Getting your foot in the door takes a lot of research to make sure a business is the right fit for you financially. If you’re wondering how to start a franchise, you’ll also need to consider and understand the legal requirements laid out by federal and state governments. The legal elements of a franchise differ from state to state, but federal franchise law ensures protection for both the franchisee and franchisor. Because laws and regulations apply to all franchising efforts, you’ll be able to focus on what best fits your business wants and needs.

FranchiseOpportunities.com provides you with resources to determine which franchise best suits you by narrowing options down by price, industries, and state of operation. This takes the guesswork out of which franchises are or are not for you. Let’s discuss what a franchise is and the legal requirements necessary to start one.

What Is a Franchise?

A franchise is when an aspiring business owner purchases an established company’s business model to sell products or services provided by the franchisor using the brand’s trademark and name. This is a mutually beneficial deal, as the franchisor receives a percentage of sales as a royalty fee—this can be one-time, monthly, quarterly, or annually—and the franchisee takes the remaining profit after business expenses.

With small businesses, it is difficult to build a brand to the point of expanding beyond a local area. One of the advantages of a franchise is providing the opportunity to open businesses nationwide with an already established brand. Buying into a franchise means it is possible to start a business without the difficulties of beginning from scratch. In general, franchises reduce the risk of owning and managing a business. FranchiseOpportunities.com provides you with several options of companies to choose from within your budget and make sure you meet the requirements to be a franchise owner.

What Are Some Legal Aspects You Should Consider When Buying a Franchise?

Once you have decided you’re interested in franchising a business, it’s important to consider the legal franchise requirements. Federal and state laws govern which information franchisors need to provide to the franchisee. While franchise laws by state vary—it is important to research your state’s rules—all franchise disclosure laws determine how the two parties legally move forward with the business agreement.

The franchisor-franchisee relationship relies on two franchise legal documents: the franchise disclosure document and the franchise agreement.

You might be wondering, “Is a franchise a legal entity?” Yes, it is. Often franchises are structured as an LLC (limited liability company), S-Corporation, or C-Corporation. Of course there are exceptions to the legal structure, but each franchise is subject to laws and regulations set forth by the federal and state governments.

What Is in a Franchise Disclosure Document?

The franchise disclosure document (FDD) offers a wealth of information to educate you about the franchise you’re considering. The FDD includes the actual franchise agreement as well as other terms that the franchisee will be required to sign in addition to the disclosure section.

The document contains information on the following franchise components:

• What staff members are essential to the business.
• The history of the business and those involved.
• Any financial statements or documents necessary.
• What bankruptcy filings and litigation the franchisor has been involved in.
• The type of training available from the franchisor.
• What purchases and investments are required.
• If there are any territory rights within your area.
• Any other costs associated with franchising.

According to the Federal Trade Commission (FTC) Franchise Rule 16 CFR Parts 436 and 437, a franchisor needs to provide a prospective franchisee with the FDD “at least 14 calendar days before the prospective franchisee signs a binding agreement with, or makes any payment to, the franchisor or an affiliate in connection with the proposed franchise sale.” The 14 days start after the document has been delivered, not when it is sent. Any agreement or payment can be signed or received on the 15th day after delivery.

If you have any questions about what the document contains, you should consult with your lawyer. The following concerns can be resolved with the assistance of an attorney:

• Examining the FDD and any franchise agreements.
• Analyzing any franchise documentation.
• Negotiating the franchise agreement's terms with the franchisor.
• Putting together shareholder and/or operating agreements.
• Filing legal forms that require assistance, including real estate and equipment leases.

The FTC’s website also provides you with more detailed information regarding franchising.

The second important document to understand in the franchise process is the franchise agreement.

What Is a Franchise Agreement?

The franchise agreement is the primary document that defines the legal franchisor-franchisee relationship and lays out the terms of the purchase. A franchise agreement grants the franchisee the legal right to open and operate a franchised location. This document also determines:

• How the franchise system, including the use of trademarks and products, works.
• Any standards or procedures required for the franchisee.
• The duration of the franchise agreement.
• What payments and in what percentage should be paid to the franchisor.
• Any training, assistance, and advertising used for the business.
• A code of conduct/ethics to maintain at all times.
• The alternative dispute resolution procedures such as mediation and arbitration.

The franchisor is under no obligation to renew your contract and might change the terms when it comes time to sign another agreement. However, if you pay your royalties and do not break any rules, you will most likely be able to continue your contract with the business. Of course, this is a legally binding document and you agree to the terms and conditions upon signing. The International Franchise Association recommends carefully analyzing the agreement with a legal or financial professional before signing the document.

While franchise agreements contain significant and similar terms, it’s important to note there are different types of franchise agreement depending on the role a potential franchisee wants and their expertise within that industry.

What Are Types of Franchise Agreement?

Single-Unit Agreement

If you are a new prospective franchisee, a single-unit franchise agreement grants you the rights to open and operate a single franchise “unit.” While other contracts can be more complicated, single-unit agreements are generally the most common and simple for entrepreneurs to get started in a particular franchise.

Multi-Unit Agreement

A multi-unit franchise agreement permits a franchisee to open and operate many units with the permission of the franchisor. This agreement is typically a natural extension of a single-unit contract for some franchisees and allows them to expand their business ventures. A timeline will usually be established during which the franchisee is expected to open the units.

Area Development Agreement

The area development agreement, as opposed to the multi-unit agreement, grants the franchisee exclusive rights to develop the territory. During the contract duration, no other franchisees will be permitted to open units in that geographic region.

Master Agreement

The master agreement gives the franchisee the authority and obligation to open and operate a specific number of units in a specific territory, like an area development agreement. However, a master franchisee also has the ability to sell sub-franchises to other people in the territory. More importantly, they are responsible for the training, recruiting, and success of the other franchisees under this arrangement. Because of this role, they are entitled to fees and royalties from the territory's franchisees.

What Are the Legal Structures for Franchises?

Franchises can legally structure themselves with a few different options, which impact legal obligations and tax implications, as well as operations and profits. Choosing a beneficial structure is one of the main requirements to start a franchise to ensure your assets, profit, and stakeholders are properly taxed. It is critical to determine the right legal structure for your franchise business before you sign the franchise agreement. There are three common business structures used by franchisees:

• S-Corporation: S companies pass corporate profits, losses, and deductions to their shareholders for federal tax purposes. Shareholders are taxed at individual rates because they report their income and losses on their personal tax returns. S-Corporations avoid paying double taxation on their profits because of the way they’re structured.
• C-Corporation: A C-corporation is a type of legal structure in which the owners, or shareholders, are taxed independently of the business. A business operates, produces a profit or loss, pays taxes, and distributes profits to shareholders.
• Limited Liability Company (LLC): An LLC is a corporate structure allowed by state statute that safeguards its owners from personal accountability for the business's debts or liabilities. Notably, an LLC isn’t a taxable structure and therefore can be taxed as a sole proprietorship, C-Corporation, or S-Corporation.

Determining a legal structure should be one of the first steps in franchising. Speaking with a legal professional can help you better understand which structure best suits your needs and business.

Find the Best Franchise Opportunities

At FranchiseOpportunities.com, we collect all of the valuable information to help you develop a franchise strategy. We were founded in 1999 and have a combined experience of over 30 years of helping entrepreneurs build strong businesses. We are confident you won’t find a more qualified team to assist you in your career. Visit our website today for more information on how you can start a franchise!