Franchise Law Q&A with Harold Kestenbaum – Gordon & Rees LLP

How do you assess whether a business has franchise potential?
 
There are many factors that we asses to determine franchiseability.  The first is whether the business is a viable one.  A business that loses money or that cannot make a profit is not going to be a model that anyone would be interested in owning; we look at whether the business can be taught to others in a basic manner.  An inability to do this will make the concept undesirable for franchising.  We look at the concept itself, is it something that is different or unique, or is just another knock off of an existing franchise concept.  The self-serve yoghurt business is a perfect example.  This has become a hugely crowded category and many are going out of business.
 
How can you effectively calculate the initial fee for setting-up each franchisee in business?
 
It is important to understand that at the inception of the franchise program, the initial fee is not going to be a profit centre.  In fact, the new franchisor may lose money on the first few sales.  One measure of calculating this fee is to look at what the competition is charging.  As a new franchisor, you do not want to charge more than an established competitor.  If you are the first, then choosing a fee that is reasonable and that can be justified as a fee that will at least allow you to recoup some of your sales expenses and salaries of your training staff.
 
Can you outline the step-by-step process for developing a franchise program properly?
 
First, have a meeting with the prospective franchisor, either in person or virtually, this will allow you to discuss the various business and legal aspects associated with franchising a business.  Once you have done that, the potential franchisor should be provided with a detailed questionnaire that outlines the contents of the disclosure document that needs to be prepared.  Once that is completed, you need to review it with the client to determine whether the responses are adequate and detailed enough.  At that point, the drafting of the disclosure document can commence.  It is important to emphasise to the client the importance of developing the appropriate training program, operations manual and marketing materials for the program.  Those items should be completed with the help of a qualified franchise consultant.
 
What should be included in a well-drafted franchise agreement?
 
There are a substantial number of key provisions in the franchise agreement, way too numerous to spell out here.  Suffice it to say that an experienced franchise attorney will draft this agreement appropriately.
 
Can you assess the potential difficulties a franchise poses to the reputation of the brand and outline how can the company image be safeguarded?
 
Franchisors must always maintain a certain quality control over their franchisees.  They need to monitor their system frequently in order to make sure that the reputation is never in jeopardy.  This is generally accomplished by frequent field visits, conference calls and using the Mystery Shopper as method for maintaining the quality of the brand.
 
What must a franchisor consider when deciding whether to provide regionalised franchisee support or alternatively attempt to support all franchisees directly from the corporate office?
 
This will be a function of the number of franchisees and where they are dispersed geographically.  If they are clustered in one geographic area, then it may not be necessary to have area or regional directors who visit the locations and this can be done directly from corporate.  However, as the system grows beyond the driving distance from the home office, the franchisor will need to implement a regional program
 
How important is it to develop a financial model?
 
As I mentioned above, if your pilot operation or operations are not profitable, then trying to role out a franchise program is basically an effort in futility.  If you cannot make money, how do you expect your franchisees to?  Not likely to happen.  Therefore it is imperative that you have a financial model that works and that allows franchisees to make money and an eventual return on their investment.  While you should be sharing this model with franchise prospects, you as the franchisor should develop your own pro forma and profit and loss statement for a single unit.
 
How can you break down its analysis of franchisee performance and what are the methods for identifying the warning signs?
 
The key here is monitoring your franchisees and their operations.  This means employing the use of Mystery Shoppers who go in and look at the operation under cover, so to speak, and see how the franchisee is operating the unit.  Analysing the weekly sales figures from each franchisee is a very important indicator of how they are doing and whether they are going to survive.  This means that as a franchisor, you must require your franchisees to provide this financial reporting on a weekly basis.  This is essential and cannot be overlooked.  You will know soon enough if the franchisee is making money or losing their shirts.
 
What are the advantages and disadvantages of a Work Out?
 
Many franchisors would prefer working out a deal with a struggling franchisee rather than have them close.  Unless they are great operators and are failing for reasons other than a poorly run operation, I am not sure you want to work out a deal with a failing franchisee.  It may be more prudent to have that franchisee sell their unit and leave the system that way, as opposed to an outright termination.  Other franchisees will be watching how this is handled, so you need to make sure you make the correct choice.
 
Can you outline the main legal issues facing franchise owners?
 
There are many issues facing franchisees today.  Not the least of which is Obama care and how that will impact their bottom line and their ability to keep good employees.  In the fast food industry, there is a revolution brewing regarding minimum wages and unionisation, this will have a significant impact on the franchisee’s bottom line.  In the food industry, there have been numerous lawsuits dealing with overtime pay and the failure to treat employees as employees and not as independent contractors.  This is a major tax issue for franchisees.  Finding and keeping competent staff is an issue that continues to plague many franchise owners and one that will not go away.
 
Due to financial difficulties, many franchisors are looking to emerging markets.  What barriers to success does Franchise Law impose on potential franchisees when entering these new markets?
 
It is no secret that many US franchisors are turning to foreign market s to sell their franchises.  They face much less legal governmental compliance issues than they do here in the US.  Although there are 22 countries with some type of franchise law, only a handful have pre-sale registration or disclosure laws like we have here in the US.  This provides US franchisors with easy entry into these markets with little if any legal resistance.  Take the Middle East for example, there are no franchise laws over there and any US franchisor, whether successful here in the US or not, can sell their franchises over there without any governmental interference or resistance.  This makes it very enticing for US franchisors to sell deals over there just to capture some large cash payments.
 
How can an organisation overcome financing difficulties?
 
Franchisors facing financial issues can look to the private equity marketplace for funding, as there is a great deal of cash available, but that presupposes that the franchisor is successful and has a growing system.  Struggling franchisors will continue to have financial issues if their systems are not successful.
 
What industry in particular has been affected by the financial lapse?
 
Mostly the food industry, where obtaining franchisee financing remains an issue and tight credit continues to persist.
 
In an ideal world what would you like to see implemented or changed?
 
I would like to see less US regulation on a state-wide basis.  I believe that many state examiners are impeding the economic growth of their respective states in the name of trying to protect franchisees.  This is a fallacy and the state regulations do not afford franchisees any greater protection than what the Federal government has given through the FTC Rule.  Self-policing of the industry does a much better job than government intervention.  The states that regulate franchising are harming and stunting the growth of their state economies, and they don’t even realise it.  I would do away with the review process, and just have companies file their disclosure document in the state and not have the lengthy and ridiculous review process.  It is basically useless.  I would also like to see the credit markets open up even more than they have in the last two years.  Recovery from the recession has not been easy and the continued tightness in the credit markets has only hurt expansion.