Our lawyers at Scott Law Group have practiced franchise law for over 15 years and during such time one of the most common question surrounds the “franchiseability” of various businesses and concepts. Although the answers to these questions don’t constitute “legal advice” per se, we feel our experience in the industry gives us the ability to engage on the issue and in the conversations with clients that follow, these high level considerations are always discussed at length.
Proving the Model
Prior to entertaining the idea of franchising, most businesses will have commenced operating the business concept it seeks to franchise. In certain cases, multiple locations are opened and operating. Prior to investing in a franchise system and all this entails (discussed below), we recommend that our clients prove the concept, i.e. ensure its businesses will make a healthy profit. For some clients this means having one location that is thriving. For others it is multiple locations. Some clients wish to prove the concept in rural, urban and suburban settings before deciding to franchise and still others wish to first prove the concept in multiple cities. In all cases, it is important to prove the concept before deciding to invest the substantial amount of time and capital necessary to embrace franchising.
The System
We always discuss with prospective franchisors whether the business has a system in place and that can be effectively implemented in a franchised business. Is it a system that a prospective franchisee can learn over a reasonable training program of no more than a few weeks? The system is typically memorialized in a franchise operations manual that contains important information regarding the procedures, policies, guidelines, etc. involved in running the business, which will be enforced by the franchisor. Many prospective franchisors have a functioning system but do not have an operations manual and this is one of the important initial steps we recommend before deciding to franchise a business.
Control
Over many years practicing franchise law, our firm has advised a large number of business owners that franchising is not for them due to the loss of control, compared to the corporate model. Once you franchise your concept, you are allowing an entrepreneur to use your trademark and system to run its own business, albeit under the terms, conditions and restrictions set forth in a franchise agreement. You seek to recoup some control by way of this contract, but compared to full control of your business in the corporate model (under which a business owner may simply terminate the employment of managers at under-performing locations, close locations, open new locations in any territory, etc.) the business owner loses control when it grants a franchise. Also, due to franchise legislation for franchisees in most jurisdictions, franchisees have many significant rights which will be discussed below and in further posts. It is worth mentioning that “license models” have the lowest amount of control, since in most cases the license of a trademark combined with some attempt at control of the business being operated under such trademark (which would be contained in the written contract) would, in fact, make it a franchise. A license of the mark with no control over the business would typically qualify as a license (and outside the purview of franchise laws) which makes it at the opposite end of the control spectrum (see below) from the corporate model.
Spectrum of Control
Less Control → → → → More Control
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Licensing Franchising Corporate
Franchise Law
Potential franchisors need to know that franchising is a regulated industry. Most jurisdictions in Canada have franchise laws (some of which differ… a topic for another day). In Ontario, it is the Arthur Wishart Franchise Disclosure Act (the “Act”) and its regulations that govern. The Act requires franchisors to provide a disclosure document to prospective franchisees in Ontario (with some limited exceptions). The disclosure document must set forth a significant amount of information, with an aim to ensure the franchisee can make an informed investment decision. Some of the information is specifically referenced in the regulations (financial statements, etc.) while other information that is required is more general (all “material facts” which is a defined term in the Act). It takes significant time for a franchise lawyer to work with its franchisor client to prepare this document (and all other documents including the franchise agreement). Also, it is important to discuss the significant ramifications to the franchisor (and to its directors) for failure to provide the disclosure document including the “rescission remedy” that could be open for as long as two years after the franchise agreement is signed. The rescission remedy seeks to put the prospective franchisee back in the position it would have been in had it not made the investment in the franchise, and so damages for rescission can be significant and include personal liability for directors. Other high level considerations in the legislation include the duty of fair dealing and misrepresentation.
Changing Hats
Most business owners that discuss franchising their concept with us are running their own business at that time and in the “proving the model” stage. While some franchisors have successfully sold franchise units and continue to run their own units, it is our advice that wearing both hats (franchisor and manager/ operator of certain locations) can be difficult and our clients need to be prepared for this. In most cases a good franchisor is expected to provide excellent franchisee support, conduct quality assurance audits, manage an advertising fund, find new franchisees, assist in finding new locations, etc. In short, they commence wearing the time consuming “franchisor hat” very quickly, and as the system grows it can be overwhelming to wear both hats. This change can be difficult and we always walk our client through the transition as an important consideration before deciding to franchise their business.
Trademark Protection
Lastly, it is important to discuss trademark protection with prospective franchisors. In our practice, we require our franchisor clients have trademark protection in the jurisdiction they wish to franchise, to ensure that the brand is well protected.
Conclusion
Franchising can offer many benefits including rapid growth with a more limited capital investment but before deciding to franchise it is important to determine whether it is appropriate for the client. We have canvassed some important considerations in this post, but there are many more. If you are deciding whether to franchise your concept please don’t hesitate to reach out and give us a call.