Franchise Law
Business 101
Business 101 involves issues of concern when starting any business – whether
a franchise or not.
1. Entity
A number of different types of entities are available to you as a business
person. A sole proprietorship is basically no entity at all. We do not recommend
it because there is no protection from personal liability. The same is true for
general
partnerships; partners are personally liable for partnership debts. There are
certain legal entities that limit your liability as an investor or shareholder. These are corporations,
limited liability corporations and limited liability partnerships. The major benefit
of these entities is that, properly
structured, you may avoid personal liability for debts. Certain tax benefits may
also flow from having an entity. You will need to retain a CPA to inform you what
the best entity from a tax perspective is.
2. Personal Guarantees
Major vendors, lenders, and franchisors usually ask for this. Try to get out of
it if you can. A personal guarantee means that you are securing the obligation with your own personal
assets; your house, money, and personal property. We typically recommend that
you form an entity
anyway because you will have other creditors. When forming a corporation,
you will likely need a lawyer to help.
3. Licenses and Insurance
Certain businesses require local, county or state licenses. Food preparation,
construction, real estate, barbershops come to mind. These may or may not be
disclosed on the franchise offering – so you need to do your own due diligence.
You should ensure you have appropriate insurance coverage for liability
and in case of fire or other property damage. Also consider the need for
disability insurance in case you are injured and cannot work. Business
interruption insurance can protect your income in the event your location is
damaged by some unforeseen event.
4. Capitalization / Pro forma Profit and Loss Statements
You need to evaluate the franchise as a business unless it is merely a hobby for
you. If you
want to make money, you should analyze your potential by way of a pro forma. Detail
your expected income and expenses. The difference is your profit. What are your
major expenses in running a business? Rent, cost of goods, salaries, and build-out
if you have a physical location. These happen in every almost every business. In a
franchise, you tack on royalties, ad fees, initial franchise fees and other
fees. Do not forget to figure an appropriate salary to pay yourself. This is going to be your source of income. And
if you are borrowing money your will need figure in the loan payments as an expense.
5. Employees
If hiring employees you will have to pay them the minimum wage, proper overtime
wages, make withholdings, provide workers comp insurance, and comply with
employment laws. You must provide them with meal breaks and rest breaks. We
recommend that you consult a lawyer. The State of
California also has websites that can help you.
If you give employees paid vacation, you cannot have a use it lose it policy but you
can have a policy where no additional vacation accrues until the employee uses
up all his vacation. When you fire someone, you have to pay them immediately all
amounts owed. When they quit, you have pay them within 72 hours.
If you don’t follow these rules, awful things can happen. You can subject to
what are called waiting time penalties for up to 30 days wages and you can be
subject to the employee’s attorney’s fees and other penalties. Don’t fall into
the trap of thinking you can hire an “independent contractors” to work for you.
If you control what they do and how they do it, they are employee’s not
independent contractors no matter what your agreement states. Moreover, you can
be personally liable for unpaid minimum and overtime wages under Federal law.
6. Leases
This is a complex commercial obligation for which you should seek legal counsel. A lawyer can help you negotiate beneficial provisions.
Commercial leases are much
different than residential leases. If you break a commercial lease the landlord
can sue you for the balance of the term and in many cases does not have to even
try to re-rent the premises. Sometimes you can get a provision that if the
franchise is terminated you can get out of the lease – try to get this.
Our law firm also helps franchisees review leases and negotiate terms.
7. Marketing / Publicity / Competition
Another important consideration is how you will market your goods and service.
When you have a franchise, the franchisor may take care of some of this
marketing, but not
all of it. But they will exercise controls over how you can market and the content of
the advertisements. Depending on the franchise, there may be national network television
ads – something a small business likely could not do. But if it’s a new
franchise there likely will not be a national ad program. In addition it's important to analyze the
competition in your market, where they are located and aspects of their business
including pricing.
8. Exit Strategy
Various circumstances may arise where you or your heirs might need to get out of the business. For
example, you might get sick or disabled; or die. With your own business you have
maximum flexibility. But with a franchise there is a contract that will cover what
you can and cannot do. If you decide you want to sell the business, you may be
limited in the terms, who you can sell to and the price you can receive. In your
own business, this would not be the case.
9. Buy-Sell Agreements
There are usually multiple franchise agreement terms and rules that will
apply to the transfer of your business or if you buy an existing franchise. One
issue to be aware about when buying a business with equipment is that here may
be liens on the equipment. You do not want to be in position of paying for
equipment and finding out somebody else has a superior interest. Therefore, you
should conduct a UCC search with the state. There are a myriad of other
issues involved for which you should seek competent legal counsel.