Franchises May Offer Less Than Meets the Eye

November 2012

At first blush, a franchise sounds like a great business opportunity--someone else has already taken the risks associated with developing a product, establishing a market, and protecting a brand. All you have to do is find the right real estate and put up some seed money.

If you meet the initial qualification requirements (which are usually based on prior business experience and net worth), then the franchisor will send you two documents: a Franchise Disclosure Document and a Franchise Agreement. The Franchise Disclosure Document is required by the Federal Trade Commission, and the Franchise Agreement is your agreement with the franchisor. These two documents are typically very long (it is not uncommon for the Franchise Disclosure Document to be more than 100 pages), and it often helps to have the assistance of a professional in evaluating these documents both from a business and a legal standpoint.

In theory, a franchise is a glorified trademark license agreement. The "glorified" part of it means that the franchisor will place a litany of operational requirements on the franchisee; these operational requirements are typically not present in a trademark license agreement. With that said, however, often the most important asset that a franchisee has--and the reason many people are drawn to franchising--is the brand. Thus, one of the first things we look for in evaluating a franchise agreement is adequate protection of the brand. Below are some of the issues we counsel our clients to consider:

Has the franchisor registered its trademark(s) with the U.S. Patent and Trademark Office?

Is the franchisor contractually obligated to pursue infringers?

Will you be indemnified by the franchisor if it turns out that the franchisor's "brand" is an infringement of somebody else's trademark. 

In addition to the trademark issues, franchise arrangements have broader implications for intellectual property rights. A typical franchise agreement states that the franchisee has no intellectual property rights whatsoever in any of the work product or data generated by the franchise. This means that every piece of paper you generate, every computer file you create, and all of the data associated with your business will be owned by the franchisor. If you come up with an idea for a patentable improvement to the franchisor's business methods, equipment or products, these ideas will be owned by the franchisor. In other words, everything you do in terms of intellectual property inures to the benefit of the franchisor (and its other franchisees). This would not be the case with a non-franchise business in which you would typically own the intellectual property rights to all work product, data and inventions generated in connection with the business.

Turning to the business side of things, one important issue that will affect the profitability of your franchise is the scope of your territory. The franchisor will typically define your territory based on various demographic factors. The agreement may also allow the franchisor to sell directly in your territory. You will need to consider the scope of your territory in determining whether and how quickly the business is likely to become profitable. In this regard, you will also want to evaluate carefully the franchisor's published "revenue" and "net profit" figures to determine whether they include all operating expenses and also whether they are typical for your demographic area. Franchise agreements sometimes include hidden costs (such as support and/or maintenance fees) that are not included in the net profit figures. Franchises vary greatly in terms of the amount of support the franchisor is willing to offer without charge; you should ensure that the franchise agreement addresses this as well.

Lastly, from a business standpoint, we counsel our clients to look for a franchise with an established franchise history. The franchisor should be financially solvent, and management should have a proven track record. If you consider all of these factors and the franchise still looks attractive to you, then it just may be the opportunity you've been looking for.


Amicable photo of Toni

Antoinette M. Tease, P.L.L.C.