The franchise model is a popular method of investment for individuals that are either looking to start a new business or expand their existing business. The model typically consists of two main parties: one, the owner (the Franchisor) of a system that sells and distributes products and/or services under a common name using specific marketing plan or scheme (the System); and two, the investor (the Franchisee) in the System who desires to individually own and operate a separate franchised location or locations using the System. The Franchisor and Franchisee work together under the terms of a Franchise Agreement which provides the Franchisee, among other things, with the legal rights to use the System in a particular territory in exchange for the payment of an upfront franchise fee as well as a continuing royalty payment (usually expressed as a percentage of gross sales) for the term of the Franchise Agreement. The Franchisee must adhere to numerous obligations and requirements under the Franchise Agreement, including strict adherence to the System, which helps ensure the integrity and consistency of the System as well as the overall success of the Franchisees. In a successful franchise, the Franchisor has created a "proven" System whereby the Franchisee essentially steps into a 'turn-key' business with an established track record for success, a 'road map' for the development of a franchised location, and a short time-frame for profitability. Use of the franchise model with these "proven" Systems is mutually beneficial in that it allows Franchisors to grow an existing successful business at a rapid pace, without necessitating a huge capital investment or considerable amount of risk over extended periods of time. Likewise, it benefits Franchisees in that it allows them to step into an existing successful business with a minimal amount of risk and a network of support from the Franchisor to ensure the Franchisees do not fail. This article will address the legal and practical concerns facing both Franchisors and Franchisees in using the franchise model as an investment vehicle or for business expansion.

To begin, Chapter 553 of the Wisconsin Statutes, the Wisconsin Franchise Investment Law, sets forth a number of rules and regulations for franchises in the State of Wisconsin. In addition, the Federal Trade Commission also regulates franchises on the Federal level under the FTC rule on Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures. All franchises in the State of Wisconsin are required to adhere to these state and Federal rules and regulations. Among them, before a franchise may be sold in the State of Wisconsin, the franchise must be registered in the state. Wisconsin is one of over a dozen states requiring a prior registration of a franchise, which is effectuated on a "notice" basis (in other states, such as Illinois, registration occurs on a "review" basis whereby state administrators essentially audit the franchise to ensure the accuracy of the franchise documentation). To register, the Franchisor is required to submit a franchise application and the appropriate registration fee to the Wisconsin Department of Financial Institutions, Division of Securities. In addition, all of the legal documents pertaining to the franchise must be submitted to the Division for review and approval.

One area of concern with respect to registration involves business relationships operating under licensing and dealership agreements, as well as various other forms of business relationships and joint ventures, which may include many elements of a franchise and could require registration. By definition, a "franchise" under the Wisconsin Franchise Investment Law must have three essential elements before a business relationship will be considered a "franchise." These elements include:

1. Being granted the right to sell or distribute goods or services under a marketing plan or scheme; and
2. The sale or distribution of the goods or services is substantially associated with a trademark, trade name, service mark, commercial symbol/logo or specific form of advertising; and
3. The payment of a direct or indirect, initial or continuing fee for the right to sell the goods or services.

Typically, under most licensing and dealership arrangements, the sale or distribution of goods or services is usually associated with a trademark, trade name, service mark, commercial symbol/logo or specific form of advertising and the licensor/dealer usually receives some direct or indirect payment for the right to sell the goods or services. Therefore, the second and third elements in the definition of a "franchise" are typically met. As a result, the issue usually becomes whether or not a specific marketing plan or scheme exists. Individuals entering into such licensing and dealership arrangements should be wary they are not inadvertently deemed to be "franchises", especially from the licensor's/dealer's standpoint, as registration of the "franchise" would be required. This is particularly concerning in light of the severe criminal and civil penalties under the Wisconsin Franchise Investment Law for violations of the statute.

Due to the extensive amount of state and Federal regulation of franchises, Franchisors and Franchisees must understand and address the various legal concerns facing them prior to entering into a franchise relationship.

Legal Concerns for the Franchisor. From a legal standpoint, prior to offering a franchise for sale, the Franchisor must draft and register all of the required franchise documents, which include the Uniform Franchise Offering Circular (UFOC) and the Franchise Agreement, among other documents. These documents must be filed with the Division of Securities prior to the sale of any franchise in the State of Wisconsin. The documents must adhere to the requirements set forth under Chapter 553 of Wisconsin Statutes and 16 CFR section 436.1 et seq.

One of the two main documents, the UFOC, is a standard 23 Item document, which requires all Franchisors to disclose a number of specific aspects of the franchise to potential Franchisees, including background information, litigation, estimated fees and total investment for the Franchisee, obligations of the Franchisor and Franchisee, the territory, all trademarks and other proprietary information included in the franchise, the ability to renew, terminate and transfer the franchise, earnings claims (if any), and a detailed list of all existing franchise locations, among various other required disclosures. This document is required to be written in "plain English" to allow all potential Franchisees to easily understand the particular aspects of the franchise (without belaboring the technical/legal mechanisms in the franchise).

The Franchise Agreement is the other main franchise document, and it entails the legal contract between the Franchisor and Franchisee for the franchise. This document effectuates many of the items set forth in the UFOC by providing a contractual basis for the relationship between the Franchisor and Franchisee and by establishing rules which all Franchisees will operate under. In addition, the Franchise Agreement should provide adequate controls of the franchise for the Franchisor to ensure the integrity and consistency of the System amongst its Franchisees. Such controls include the requirement to purchase all or a substantial portion of its goods or services from designated or approved suppliers, the requirement to follow specific marketing and operating plans and procedures as described by operations manuals or in training sessions, the establishment of reporting requirements for gross sales and net profits with adequate controls thereto, and the right to terminate, repurchase and refuse to renew the franchise under certain circumstances.

The Franchisor may also have a variety of other legal concerns including the establishment of an operating entity to promote and sell the franchises, the securing of all of its legal rights incident to the franchise (trademarks and other proprietary rights), the creation of various other documents incident to the System which may have some legal effect (operations manuals, marketing materials, pamphlets, warranties/disclaimers, etc.), and the ongoing legal issues involved in securing and maintaining Franchisees under the Franchise Agreement (addendums, amendments, default/breach, etc.).

Legal Concerns for the Franchisee. From a legal standpoint, prior to entering into a Franchise Agreement, the Franchisee should perform a due diligence review of the franchise model to ensure that the System is in fact "proven" and that the Franchisee has a low risk for failure with the model. The due diligence includes: reviewing the UFOC and other documents setting forth the System; contacting the Franchisor and existing Franchisees to find out candidly about the franchise; performing independent research on the franchise; determining the costs for establishing the specific franchised location; creating a business plan; securing adequate financing to cover necessary costs and expenses until the franchise creates 'cash flow'; performing a legal review of the UFOC, Franchise Agreement and other documents required under the franchise (such as area development agreements, guarantees, licenses, non-competition agreements, rights of first refusal, etc.); ensuring the Franchisor has addressed all necessary requirements to legally sell the franchise; and, creating a legal entity for the operation of the franchise.

The Franchisee may also have a variety of other legal concerns including the establishment of appropriate investment arrangements for the franchise where multiple investors are involved (operating agreements, shareholder agreements, etc.), addressing the legal issues in purchasing or leasing commercial real estate and/or equipment for the operation of the franchise, creating and registering necessary franchise documents if the Franchisee is a "Master" Franchisee, and handling various ongoing legal concerns in the Franchisee's relationship with customers, employees and the Franchisor (employment issues and agreements, purchase contracts, vendor contracts, default/breach, etc.).

In addition to the legal concerns facing Franchisors and Franchisees, there are a number of business and practical concerns with respect to franchising. From a practical standpoint, the Franchisor must determine if in fact its business is ready for franchising. Has the business model been tested over time? Is there a proven track record for success? Is the imposition of a royalty on potential investors (Franchisees) justified, and if so how much? Has a trademark or commercial logo been established and/or secured? Are there appropriate procedures set forth through training sessions and operations manuals to adequately train and guide Franchisees in the business? Have marketing materials been created to aid Franchisees in the promotion and sale of the goods and services? Is the Franchisor committed to investing considerable amounts of time and money to appropriately develop the System and aid in the establishment of the System with Franchisees? Has the Franchisor created strategic relationships with franchise broker agencies to aid it in the sales and promotion of the franchise?

From a practical standpoint, the Franchisee must also determine if franchising is appropriate for him or her, and if so, which franchise model would best suit the Franchisees' strengths, ambitions and desires. With the numerous amount of available options for franchising, potential Franchisees should also consider working with a franchise broker to aid in their selection of a particular franchise. The franchise broker would work with the potential Franchisee to determine the appropriate model or models for review, by taking into consideration a person's particular characteristics, preferences and goals, and then matching them up with the corresponding franchise models. Franchise brokers typically work with dozens and dozens of franchise models to ensure an adequate selection of franchises to cover the entire spectrum of potential Franchisees. Most franchise brokers charge a minimal or no fee for this service, and are only paid upon the placement of a Franchisee with a franchise (and in this instance the broker is paid a portion of the initial franchise fee already due to the Franchisor).

If done correctly, franchising allows individuals to be in business for themselves but not by themselves, in an interdependent win-win relationship with mutual benefits for growth. So, whether you are considering investing in a business or expanding your existing business operation, consider the franchise model as a means to that end and retain the assistance of an attorney experienced in franchise law to assist in the legal and business concerns that must be addressed to ensure the greatest chance for success in franchising.

chad.richter@wilaw.com