Starting a business as part of a franchise is a complicated process with its own set of legal considerations. These include understanding both the potential benefits, and -- more importantly -- the likely costs of a franchise relationship.
According to the Federal Trade Commission (FTC), which has the authority to regulate franchises, there are two types of business arrangements that may constitute a franchise:
Under the FTC’s definition, generally a franchise exists if:
In practice, the last of these conditions, the $500 minimum fee, is a non-issue, as it usually costs far more money to buy into a franchise.
As franchisors will often be quick to tell you, operating a business as a franchisee does provide certain potential benefits. These include being given a preexisting business plan, getting certain help as needed when running your business, and benefiting from group marketing.
In exchange for the benefits of being part of a franchise, there are significant costs. Generally speaking, you will have to operate under far more restrictions than if you opened your own independent business. More specifically, you will be subject to a franchise contract which will favor the franchisor, and which likely will give the franchisor rights to:
Along with the restrictions contained in the franchise contract, you should keep in mind the financial costs of a franchise. Apart from a large initial franchise fee, expect to be required to pay the franchisor:
Elsewhere on this website you can find a detailed list of reasons why the costs of buying a franchise, both financial and legal, may well outweigh the possible benefits; see Nolo's article, Want to Buy a Franchise? Ten Reasons Not to Do It.
The FTC requires franchise sellers to make a Franchise Disclosure Document available to prospective franchisees. By law, this document should have sections covering roughly two dozen critical issues, such as:
The franchisor is required to make the Franchise Disclosure Document available to you at least 14 days before you sign any franchise contract, or at your first face-to-face meeting with the franchisor.
You should read through the entire document and be aggressive about asking questions. Keep in mind that if something in the document appears too good to be true, it probably is.
If you decide to buy a franchise, you will need to sign off on a lengthy franchise agreement. You should carefully read the entire agreement. Among key areas of potential concern are:
In light of the risks and costs involved, you should seriously consider having a lawyer assist you in this reviewing this contract.
A detailed overview of franchises is contained in Legal Guide for Starting & Running a Small Business, by Fred Steingold (Nolo). There is also excellent, detailed information on franchising on various webpages within the FTC website.