using capital obtained from the franchisee to fund expansion. (The cynics among us have an acronym for this. It’s called OPM and it stands for Other People’s Money.) The franchisor’s business is being expanded not only through the franchisee’s efforts but also due to direct and indirect contributions of money by the franchisee. It has been said that companies that do not need to franchise (because they have the capital necessary to finance expansion), don’t. (Starbucks is an example of one of the companies that don’t need to franchise.)
For a hundred different reasons, franchising works well. But it doesn’t always work, and it’s important for all prospective franchisees to realize that.
2. Is a License Agreement the Same as a Franchise Agreement?
Sometimes franchisors will deliberately call their contracts “license agreements” instead of franchise agreements. This is largely done for marketing reasons. Franchising is often perceived as the home of fast food and french fries. Calling the contract a “license agreement” may give the agreement and, I suppose, the franchise system an air of panache and sophistication that a franchise might lack in the eyes of mortals. Nevertheless, you should be aware that all franchises are essentially “licenses.” A license is the right to use the property of another; it does not convey ownership. Accordingly, if there is a fee such as an initial license fee and/or an ongoing royalty fee, and there is the licensed use of the licensor’s trade-mark, and the licensee has been granted the right to engage in the business of offering, selling, or distributing goods or services under a marketing plan or system substantially prescribed by the licensor, then it is a franchise, whatever the licensor calls it.
Ontario, Prince Edward Island, and Alberta have specific legislation governing franchising, which provides definitions of what a “franchise” is, regardless of what the “licensor” has called its business model.
3. A Brief History of Franchising
Back in the mists of ancient time (when a Quarter Pounder with Cheese® meant nothing and Colonel Sander’s parents were still in diapers), it’s said that franchising was born. Although some have suggested it started in England with the Crown granting exclusive territories to tax collectors for the collection of the 13th century equivalent of GST, for us in the modern world, common wisdom seems to agree that it started with the Singer Sewing Corporation (sewing machines) in the United States. Singer licensed retail stores to sell their sewing machines and sewing supplies in the 19th century. This evolved over the 20th century, and other businesses adopted the model; chief among them being soft drink bottling companies and gas stations.
For those of you who might recall the 1960s and 1970s as being the salad days of rock and roll, free love, and funny cigarettes, it was also the heyday of franchising. The United States became the grand central station of franchising activity; so much so that franchising became the subject of government legislation and regulation. (Around this time, the Alberta government also got involved with franchising legislation and regulation.)
The government did not get involved in the regulation of franchises because it needed the money, or because it wanted to take over the McDonald’s corporation and run it like the US defense department. Although McDonald’s and some other well-known brands were working rather nicely, thank you very much, the state legislators got involved because many other concepts were not running as well. Some consumers (in this case, those voters who were acquiring the franchises) lost their shirts (and their houses) as a result of getting into franchises in which the franchisor wasn’t capitalized enough, or misrepresentations were made by franchisors or their salespeople to get the consumers into the deal. Complaints were made to politicians and the government reacted.
Laws were enacted that treated the sale of a franchise like a “securities” offering, which required franchisors to make disclosure of material facts to franchisees and to give them some time (i.e., 14 days) to do their due diligence and think about the deal before they signed on. In short, the politicians got involved because a few bad operators caused them to get involved. (Government doesn’t tend to get involved unless events force it to or people are pressuring it to.)
4. US Disclosure Agreements and Regulations
Since the 1970s, US-based franchisors have been subject to a witches’ brew of state and federal laws governing the sale and operation of franchises to franchisees. Currently, US-based franchisors are subject to either the Federal Trade Commission Rule on franchising or a regulatory review in select states. The Federal Trade Commission Rule on franchising requires disclosure of all material facts to prospective franchisees through the use of a disclosure document (sometimes referred to as a Uniform Franchise Offering Circular [UFOC]). This is now called a Franchise Disclosure Document (FDD) in the United States. Franchisors can also be subject to regulatory review in approximately 15 US states that currently have legislation specifically regulating franchisors. As of the date of writing, those states are California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Oregon, Rhode Island, South Dakota, Virginia, Washington, and Wisconsin (although some registration requirements differ markedly in these states).
In these registration states, unless the franchisor obtains or otherwise qualifies for an exemption from the authorities, a document similar to a securities prospectus must be prepared by the franchisor’s lawyers, and must usually be filed with and approved by the state regulatory authority together with the franchisor’s franchise agreement, sublease, trade-mark license agreement, general security agreement, and other agreements that normally comprise the package to be signed by the franchisee.
In most cases, the franchisor’s audited or reviewed financial statements must also form part of the disclosure package, which is in and of itself an expensive undertaking. But the state authorities don’t just “rubber stamp” a franchisor just because the franchisor has submitted the documentation to the regulators. The state regulatory authorities read and review the material and may reject the franchisor altogether, or impose conditions on the franchisor’s ability to trade in franchises in that state. This could mean that the franchisor is required to hold a portion of collected initial franchise fees in escrow for a period of time or it may mean capitalization requirements and other conditions.
As you might appreciate, the preparation of these documents by hordes of well-paid attorneys, the vetting process with state regulatory agencies, and the tangled web of rules under which franchisors are required to lawfully “sell” their franchises is extremely complicated, very specialized, and lawyer intensive. It costs a lot of money to start a franchise in the US. Franchising south of the border is not for the faint of heart or those who live in abject fear of large legal bills.
5. Are US-based franchisors required to give Canadian franchisees disclosure documents?
US-based franchisors do not always give and are not always required to give disclosure documents to prospective Canadian franchisees. As a prospective Canadian franchisee, you might not be provided with this information even if you ask for it.
It’s possible this material could be on the public record and a great deal of information can be learned about a US-based franchisor from its FDD. Accordingly, if you have been approached by a US-based franchisor, but have not been provided with a copy of its FDD, you should ask for it. If the US franchisor refuses to give you a copy of its FDD (your heightened sense of suspicion having now been justifiably aroused), you might well wonder why, given that it is normally a publicly obtainable document and you can probably get a copy of it from the private company FRANdata (www.frandata.com) or from FranchiseHelp (www.franchisehelp.com).
The following list outlines the types of “material facts” that would be useful for you to know in advance of making your decision
