Do you know the legal definition of a franchise? Everyone knows a franchise when they see it, visit it, eat in it, stay in it, or exercise in it. The legal definition of a franchise, however, is probably broader than you think. And that’s why we’re here—to make things easier on aspiring franchisors by providing legal counsel and the essential information you need to know before you dive into the process of franchising your business.
We often hear from people who were told they could avoid the regulations of franchising if they simply granted a “license” or entered into a “consulting agreement” with a person who approached them about opening a similar business. You should always be wary of such advice that sounds too good to be true. In most cases, these suspicious arrangements are unregistered franchises that can expose you to significant liability. As they say, “if it quacks like a duck…” well, you know the rest. Let’s talk about what it really means to franchise your business.
As the franchisor, you will essentially sell the rights to own and operate franchised locations of your business to individuals who want to take advantage of your brand name. Licensing is a key part of the Franchise Agreement: while you retain ownership of your brand and have the ultimate say in how each franchised location is run, you grant the franchisee use of your intellectual property. So, what exactly makes a franchise a franchise (and therefore subject to state and federal franchise laws), and not just a license arrangement?
There are 3 basic elements to a franchise. If a business relationship has all 3 elements, it doesn’t matter what you or anyone else calls it—it’s a franchise, and it’s subject to all the laws and regulations of franchising. If anyone approaches you about opening a similar business, be sure to examine the parameters of that agreement for the following components.
Right to Use a Name or Logo
If you enter into an agreement that allows somebody to use your name or logo in the operation of a business or to sell goods that bear your trademark, you have met one element of a franchise. This is true even if use of the name is optional!
Payment of a Fee
If you charge someone a franchise fee as part of a business relationship, you have met the second element of a franchise. You might call it a license fee, a territory fee, a consulting fee, or even a training fee, but if you charge a fee, you’ve just checked that second box. The only exception to note here is for the purchase price of goods for resale. Even then, this is only an exception if the price is a bona fide wholesale price and the quantity purchased is the amount a reasonable business person would purchase for initial inventory. However, if other fees are charged, then the second element of a franchise will have been met.
Significant Assistance or Supervision
If you provide training in the operation of the business, you’ve met the third and final element of a franchise. Providing operating standards or supervising the other person’s activities counts here, as well. Minnesota and Wisconsin have a “community of interest test” instead of the significant assistance or supervision test, but at the end of the day, most licensing arrangements that meet the significant assistance test and fulfill the first two requirements will also meet the community of interest test.
While licensing is a part of the franchise process, it can certainly also stand on its own. Take the Minnesota Vikings, for example. When the Vikings license their name to someone to make and sell clothing, that is a true license arrangement. The Vikings don’t train or assist that person in selling the clothing, and they also don’t establish standards for the operation of their business. The 3 elements of a franchise are not met here, so this agreement is simply a license arrangement.
However, most people that talk to us about licensing arrangements have something very different in mind. The important thing to remember is if you let someone use your name, you charge them a fee, and you provide them training and assistance, you have likely sold them a franchise. If you do that, but fail to comply with state and federal franchise disclosure laws, you open yourself to significant civil and criminal liability. This is a mistake that will stick with you—if you later seek to become a franchisor, you will have to disclose these relationships to state regulatory authorities, which will open you to all the risks of having sold an unregistered franchise.
Set Up a Franchise System That Works
The bottom line is that if it quacks like a duck, flies like a duck, and swims like a duck, it is a duck, regardless of what you call it. The same is true for a franchise, and the ramifications of trying to call such a system anything else can be significant.
At Larkin Hoffman, we make it our business to guide you through the ins and outs of franchise law, helping you expand your brand and navigate the complex process of setting up a franchise system. We’re excited to explore the possibilities of franchising your business with you—reach out today to schedule a complimentary initial franchise consultation, or take our Fit to Franchise evaluation to get a better idea of whether or not your company can be franchised.