March 6, 2014

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Crossing the Line

Reviewing Franchising and Business Opportunity Fundamentals

By Lee Wright

March 6, 2014

After creating a successful business model, expansion becomes the next natural step. But such growth usually requires the involvement of third parties, especially if resources are limited. There are several ways to expand your business including franchising, licensing, business opportunities, joint ventures and independent distribution. Each has its pros and cons as well as levels of complexity.

As franchising often seems like an overly involved approach, many business owners choose what they perceive to be an easier business model to begin expanding. While licensing or distributor arrangements may seem less involved, simply declaring that you operate under one of these alternative models does not necessarily make it so. What determines whether a business is a franchise or business opportunity requiring certain legal disclosures depends on the nature of the relationship, not what the owner calls it.

Over the years, we have helped clients untangle business relationships that, although called something else, included elements of a franchise or a business opportunity. Whether a company is non-compliant with federal and state laws or regulations from the beginning or inadvertently crosses the line into franchising or business opportunities later on, the consequences can be substantial.

Federal law requires franchisors to provide disclosures to potential franchisees that include 23 specific items. On the national level, franchising is regulated by the Federal Trade Commission (FTC). Additionally, there are formal franchisor registration requirements in 14 states. While Utah does not have state-specific franchise regulations, the states in which you hope to expand may be regulated at the state level. If a franchise location is in a registration state, you must follow both the FTC disclosure requirements as well as the state’s registration and regulations.

What is a Franchise?

There is no universal definition of a franchise between federal and state law, which makes it even more confusing to determine whether or not you are a franchise in various states. But generally, the definitions have three elements in common. If you currently operate a multi-location business and these elements apply, then you are likely operating a franchise subject to regulation:

1)Seller provides a trademark or other commercial symbol.

2)Seller exercises significant control or provides significant
assistance in areas such as business operations, management, training and/or marketing.

3)Seller requires a payment of $500 or more during the first six
months of operation.

What is a Business Opportunity?

The sale of a business opportunity is governed by federal disclosure laws as well, with additional requirements in 26 states, requiring registration in some states including Utah (Utah Code Ann. § 13-15 and Utah Admin. Code R152-15). While each state defines a business opportunity differently, the FTC defines a business opportunity as an agreement between two independent parties under which the:

1)Seller enters into a new business with an independent party.

2)Seller requires a payment (no dollar limit under FTC rule).

3)Seller makes representations to provide business locations, lead generation, training or other customer-finding activities and/or provides a buy-back of products or services.

Review Your Agreements

The key elements for both franchising and business opportunities are very similar, particularly regarding operational or marketing assistance, making it difficult to distinguish between these two business models. Allowing a buyer to use a trade or service mark is generally the unique feature of a franchise.

The more a buyer relies on the seller’s control or assistance, the more likely the need for compliance with franchising or business opportunity regulations—and in a dispute about the nature of a relationship, seller control or assistance is not difficult to find.

As a business relationship evolves, owners may feel compelled to help struggling licensees or distributors succeed. It is at this juncture where the line into franchising is often crossed. Even a trademark license under which the licensee pays more than $500 in the first six months of the agreement may actually be a franchise if the seller offers significant assistance marketing the product. An independent distributor may actually be a franchisee if the seller provides training, marketing and/or site-selection services.

If you have agreements with third parties involving the sales of your products or services, the following steps may help ensure you have not accidentally sold a franchise or business opportunity:

  1. Pay attention to the nature of all agreements you have already
    made or make in the future involving distribution of company products or services.
  2. Review the terms of any agreements you have to see whether any of the three elements of a franchise or business opportunity apply.
  3. If you have any doubts about whether you are or should be operating as a franchise or business opportunity, seek legal assistance. Although penalties and fines may apply for non-compliance, it is often less costly to proactively contact the FTC and state regulators to explain your situation.

Ideally, understand and determine the best structure for your business concept before you launch your expansion or write your growth plan. If you even think you may need to exert control over how your products or services are sold, you should seek qualified legal advice to make sure you are set up for a long and compliant future.

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