What is the Key to the Happy and Successful Franchisees?

What factors do you look at when recruiting franchises?  Do you look for the prospective franchisees with a college degree, prior business ownership experience, or industry experience?  Recruiting and identifying prospective franchises that will be successful and happy franchisee owners is a challenge facing every franchise.

[T]the motivation for an individual buying a franchise is much different for someone who has never owned business versus an individual who has previously owned a business.  In contrast, individuals who have been previously self-employed value the competitive advantages that franchises have over small independent businesses [Kaufmann & Stanworth, 1995].

A recent study entitled THE INFLUENCE OF HUMAN CAPITAL FACTORS ON FRANCHISING by Martin J. McDermott and Thomas C. Boyd from Purdue University Global which appeared in Small Business Institute ® Journal provides some interesting insight.  The study is based on 251 of 1,280 randomly selected home repair and improvement, maintenance, cleaning, and business service franchisees that responded to a 25 item self-administered mail survey.

While many studies have found a positive relationship between education and entrepreneurship, there were no significant differences found in satisfaction between franchisees that have a higher level of education versus franchisees with a lower level of education.

The study offers the following practical suggestions;

  • [F]franchisees who have never owned a business prior to buying a franchise most appreciate the ability to do things that don’t go against their own conscience.
  • [A]a market of aspiring entrepreneurs may be found in the Corporate America segment. A popular description of franchising suggests it is a way of being in business for yourself but not by yourself, which might appeal to the Corporate America sector.
  • [E]education and industry experience should not be core factors in deciding if a candidate is a strong fit for a franchise.
  • [I]individuals who have not owned a business prior to buying a franchise should be seen as an asset and not a liability to funding.
  • Because a system is in place, franchising allows an individual with no prior business ownership or experience the opportunity to be an entrepreneur because it can be taught and learned.

Caution in applying the study.
As stated the Study was limited to home repair and improvement, maintenance, cleaning, and business service franchisees.  For example, if you are a restaurant franchise model will the practice suggest hold?  The survey respondents were 41 percent business service franchisees, 32 percent maintenance and cleaning franchisee, and 26 percent home repair and improvement franchisees.
The survey respondents were overwhelming 40 years and older.  Eighty-five percent of respondents were over 40.  How about the newer generation of the franchisees?  Will the results be different? Furthermore, the study is largely based on men.  Of the 251 survey respondents, 204 or 81 percent were men.  Is the same true for women?
What is your experience?  What do you look for in franchisees?  Looking at your historical franchises, what are their educational backgrounds, work experience, and business ownership history?

How Long Must Franchisor Litigation be Disclosed?

In Item 3 of the franchise disclosure document [FDD], the franchisor must disclose if it, it’s affiliate who guarantees the franchisor’s performance; an affiliate who has offered or sold franchises in any line of business within the last 10 years, predecessors, parents, and any it’s management have any pending or past administrative, criminal, or material civil action alleging a violation of a franchise, antitrust, or securities law, or alleging fraud, unfair or deceptive practices, Federal, State, or Canadian franchise, securities, antitrust, trade regulation, or trade practice law, or which are material in the context of the number of franchisees and the size, nature, or financial condition of the franchise system or its business operations, or comparable allegations.
Convoluted?  Let’s look at the graphic below:

** last 10 years is calculated from the date a held liable or the date the orders became effective
* Affiliates includes affiliates that offered or sold franchises in any line of business within the last 10 years or affiliate who guarantees the franchisor’s performance

Abandoning Franchisee’s Claims Against Franchise Denied!

What is a franchisee to do when faced with a notice of default?  Abandon the franchise?  Should the franchise de-brand and begin operating as an independent business?  And, counter sue the franchisor for wrongful termination of the franchise?
That is what one BW-3 franchise in Akron Ohio did.  The case is Buffalo Wild Wings, Inc. [BWW] v. BW-3 of Akron, Inc.  Franchisor BWW sent the Akron franchisee a notice of the default for failure to update operating standards.  The Akron franchisee had 30 days to cure the default.  The Akron franchisee looked at the price tag to update and decided ‘naww not doing that.’  Instead the Akron Franchisee de-branded and began operating as an independent business using the name Gridiron Grill.
Franchisor sent the Akron Franchisee a Notice of Termination of Licensing Agreement but stated that it was holding termination in abeyance pending resolution by this case at hand.

Can the Akron franchise claim wrongful termination of the franchise?

The Court said ‘No.’  The franchise was not terminated.  The Akron franchisee abandoned the franchise by ceasing to the operate the business under the BW-3 name.  The Akron franchisee’s counterclaim for wrongful termination of the franchise agreement was dismissed.
The Court further sided with franchisor BWW maintaining that the Akron franchisee’s failure to the update the franchise per brand standards could, in fact, be a violation of franchisor’s trademark rights and could possibly lead to customer confusion.

When Can the Franchisor Withhold Approval?

Franchisee enters into a Purchase Agreement for the sale of 5 franchises.  Under the Purchase Agreement, the Purchase Price is $880,000.00 for each franchise or a total Purchase Price of $4,400,000.
The franchisor refuses approval for the sale of the franchises.  A over 4 million dollar sale on the line and the franchisor refuses to give approval for the transfer. Franchisor says it would only approve the sales transaction if the purchase price is reduced to $550,000, the estimated the value of the equipment of the five franchises.  How do you reconcile this?  The Franchisor will consent to the sale if the Purchase Price is reduced to 1/5 of what the franchisee seller and buyer agreed upon in the Purchase Agreement.
Can the franchisor do that?  Franchisee asserts not. The franchisor did not even evaluate the potential buyer to see if the buyer qualifies.  A look at the Purchase Price, approve withheld.  Franchisee files a complaint for more than a half dozen claims.  The case is Picktown Foods, LLC, et al. v. Tim Hortons USA, Inc.  In a claim by claim analysis, the Court dismissed claims in turn for lack of pleading or factual deficiencies.  But the Court upholds franchisee’s claim for Tortious Interference with Contract.

The franchisor is artificially freezing the Franchise Purchase Prices to ensure any new franchisee will have more resources to invest in the brand, building, and real estate owned by franchisor.

The premise of the franchisee claim is that the franchisor failed to act upon an obligation to proceed in good faith.  The franchisee alleges the franchisor is artificially freezing the Franchise Purchase Prices to ensure any new franchisee will have more resources to invest in the brand, building, and real estate owned by franchisor.

The Court rules there is sufficient evidence for the franchisee’s claims to be heard in court.

The Court rules there is sufficient evidence for the franchisee’s claims to be heard in court.  The conditions for franchisor approval of transfer as stated in the franchisee agreement did not state that the Purchase Price had to be equal to the franchise equipment value.  Item 17 of the franchise disclosure document did not state the Purchase Price must be equal to the franchise equipment value.  The franchisor did not evaluate the buyer qualifications.
Was the franchisor’s denial of the transfer in bad faith?  Was it Tortious Interference with Contract?  The case proceeds to trial for  determination.

What Financials are Required for Startup Franchisors?

The Federal Trade Commission Franchise Disclosure Laws [FTC Franchise Disclosure Rule] requires disclosures in item 21 of the Franchise Disclosure Document [FDD] of the franchisor’s financials.  Typically, the financials of the franchisor must be audited by an accountant.  This can be costly and timely.
The FTC Franchise Disclosure Rule cuts new franchisors a little slack.  It allows startup financials for new franchisors.  In the first year of franchising, the franchisor financials do not need to be audited.  The franchisor simply needs to include an opening balance.


What is Required

Year 1 Unaudited opening balance sheet
Year 2 Audited balance sheet opinion
Year 3 All required financial statements for the previous fiscal year, plus any previously disclosed audited statements.

For year two, franchisors are going to need to contact an accountant.  But, a full-blown audit is not required. For year two franchisors will need an audited balance sheet opinion.
Year 3 the franchisor is like established zors.  A standard audit is required.
This is the federal law.  Most states accept the federal law startup financials for the franchisors.  But caution, there are a few states that do not accept startup franchisor financials including Minnesota, New York, and Rhode Island, Illinois, and Virginia.

When is Franchise Transferee Bond?

One of the inalienable rights to owning your own business is the ability to transfer and sell your business. The sale and transfer of a business can be tenuous with many moving parts.  In the franchise world, this already tenuous transaction is further complicated.  Once a franchise seller and prospective franchisee buyer come to deal, the franchisor must approve the sale.
When approving the prospective franchise buyer, the franchisor will review the sales agreement, vet the prospective franchisee buyer, and set stipulations to the sale.  Common stipulations, among other things, includes payment of a transfer fee and payment any outstanding debt.
In some extenuating situations, there may be an urgency to the transaction because of health or family issue, finances of the franchisee, and other general life issues.  The formalities and the work-through of the sales process can be arduous.  However, the push to forgo the formalities and work-throughs should be thwarted.  Failure to do so may yield an inability to protect the franchise business and the franchise brand.
Hence the case of Rocky Mountain Chocolate Factory v. Timothy Arellano et al.  Franchisee and a buyer, defendant Arellano entered into protracted sales negotiations.  A sale agreement was sent to the franchisor, Rocky Mountain Chocolate Factory [RMCF].  Franchisor RMCF approved the franchise transfer pursuant prerequisite conditions, including among other things, the payment of delinquent amounts owed totaling $25,000.  The prospective franchisee buyer took over the operation of the franchise prior to the sale of the franchise being perfected or franchisor giving approval. Franchisor RMCF accepted and filled orders for inventory from the prospective franchisee buyer, Arellano, that had taken over the store.
The sale negotiations broke down.  No one wanted to pay the delinquent $25,000 owed to the franchisor.  Franchisor terminated the franchise agreement for failure to pay the $25,000.  But, by this time the prospective buyer and defendant Arellano has taken over the franchise business.  Despite the termination, Arellano refused to cease business operations or de-brand the business.  Franchisor sued Arellano in the franchisor’s home state of Colorado.  It was a dead stop, brick wall.  Franchisor does not have personal jurisdiction over Arellano because Arellano never signed the franchise agreement or anything else.
Hoping nothing goes wrong and bending does not always work out for the best.  When working through a transfer process, it is important to follow procedures carefully.  There are lots that can go wrong and remember until the buyer signs on the dotted line; there is not much that can be enforced.

When Can You Recognize Initial Franchise Fees?

As part of franchise disclosures, franchisors are required to disclosure financials.  The financials included in the franchise disclosure document [FDD] must be prepared in accordance with U.S. GAAP standards, which are set by the Financial Accounting Standards Board [FASB].
GAAP Standards were recently updated by the FASB.  One of the changes called into question how franchisors recognized initial franchise fees in their financials.  Instead of being able to include and recognize the entire initial franchise fee as revenue, franchisors would have to amortize the initial franchise fee over the life of the franchise agreement.
Per an article in Franchise Times:

There were a lot of changes (which you can read about here) but one of the trickiest was how initial franchise fee revenue was to be recognized……So instead of being able to take those funds into income in year one, to be spent on site selection help, training, equipment or anything else, it looked as if most of the fee revenue would have been recognized over time, which wouldn’t have been consistent with how franchisors work in practice. http://www.franchisetimes.com/news/December-2017/FASB-Clarifies-Confusing-Revenue-Recognition-Language/

This would hit hard against the franchisor’s financials in year one.  Franchisor revenues would be lower at a time when the cost to franchisors for startup cost for such things as training, site selection, and prospect franchisee vet are highest.  As a result, there would a lower bottom line for franchisors on paper and higher hard cost.
The FASB is giving a little relief.  A quote of staff issued FASB highlighted in the Franchise Times states:

One of the most prevalent questions from the franchising industry involves determining whether or not pre-opening activities constitute a distinct performance obligation. Under current GAAP, franchisors generally recognize the initial fee when the location opens and recognize the subsequent royalty stream over time. Because industry-specific GAAP exists, franchisors historically have not had to assess whether the pre-opening services are a separate deliverable. In making this determination under the new standard, the first step for the franchisor is to determine if the pre-opening activities contain any distinct services. If none of the pre-opening services are distinct, then the initial fee would be part of the transaction price for the combined performance obligation of the license and services and, thus, recognized over the entire license period.  http://www.franchisetimes.com/news/December-2017/FASB-Clarifies-Confusing-Revenue-Recognition-Language/

For a link to the full link to the FASB handout.  Visit the link above.
Franchisor financials are big deal.  Franchisor financials matter when prospective franchises consider the brand.  And, it is used by state examiners to determine if initial fees must be deferred or escrowed or alternatively a surety bond is required.

When does a Franchise Claim Becomes Stale?

As the old adage goes nothing lasts forever.  Under the Federal Trade Commission [FTC] Franchise Disclosure Rule, Franchisors are required to provide prospective franchisees with accurate and complete disclosures.  Failure to provide complete and accurate franchise disclosures can provide fertile ground for franchisee claims of unfair or deceptive trade practices.  But, a claim of a franchise disclosure violation should not be left to age and ferment on the counter like a loaf of bread. It will become stale.
The case is Haigh et al. v. Superior Insurance Management Group, Inc. out of the North Carolina.  Five franchisees sued their franchisor, Superior Insurance Management Group [Superior Insurance] for unfair or deceptive trade practices, breach of contract, breach of the covenant of good faith and fair dealing, breach of fiduciary duty, and declaratory judgment.  Superior Insurance moved to the dismiss claims of-of unfair or deceptive trade practices claiming the statute of limitation had run.

When the period of time specified in a statute of limitations passes, a claim might no longer be filed, or, if filed, may be liable to be struck out if the defense against that claim is, or includes, that the claim is time-barred as having been filed after the statutory limitations period. 

In North Carolina, a claim of unfair or deceptive trade practices must be brought in 4 years or the claim is time-barred.  The franchisee plaintiff signed their franchise agreements at issue between 2009 and 2011, clearly beyond the 4-year statute of limitations.  The court held that

‘Superior Insurance’s failure to provide the disclosure and the resulting Franchise Rule violation were necessarily apparent to the plaintiffs before they signed their franchise agreements[i].

Franchisee waited too long to bring franchise disclosure disclaims.  If the franchisees were harmed by inaccurate or incomplete disclosures in the franchise disclosure [FTC], they would have brought the claims earlier.
Each state has their own statutes of limitation for unfair or deceptive trade practices.  And, that the statutes of limitations for unfair or deceptive trade practices, do not apply to breach of contract, breach of the covenant of good faith and fair dealing, and breach of fiduciary duty.  These claims have their own statute of limitations.  It is well serving if a claim arises, to raise it.  And inverse if a claim is raised, look at the date when the events occurred.
If the statute of limitations has expired or passed, it is as if the wrongdoing [if any] did not occur.  There will be no recovery, no money damages awarded.
[i] No. 17 CVS 2582 Business Franchise Guide – Explanations, Laws, cases, rulings, new developments ¶16,072

What is Unlawful About Franchise Designated Supplier?

Years after the franchise agreement was signed franchisor designated and began to require franchisees to purchase windows from a designated supplier.  The designed window supplier charged franchisee higher window prices than other window buyers.  Franchisee discovered that franchisor derived a large part of the revenues from designated suppliers including the designated window supplier.
Franchisee filed a complaint in court against the franchisor and the designated window supplier alleging a violation of the Robinson-Patman Act; violations of the Sherman Antitrust Act; and violations of the Racketeer Influenced and Corrupt Organization Act [RICO].  The case is Bendfeldt v. Window World, Inc.

The Robinson-Patman Act provides in pertinent part:
It shall be unlawful for any person engaged in commerce…to discriminate between different purchasers of commodities of like grade and quality…where the effect of such discrimination may be substantially to lessen competition or tend to create monopoly in any line of commerce or to injure, destroy, or prevent discrimination with any person who either grants or knowingly receives the benefit of such discrimination or with customers of each of them…

The franchisee could prove that it was paying high prices than other window buyers in the Midwest and Nationally.  But, the franchisee did not produce evidence showing that franchisee lost sales to any local competitor which purchased the windows at lower prices.

A Sherman Act prohibits A tying arrangement that
is ‘defined as an agreement by a party to sell one product but only on the condition that the buyer also purchases a different (or tied) product.’ Tying suppresses competition in two ways: ‘First, the buyer is prevented from seeking alternative sources of supply for the tied product; second, competing suppliers of the tied product are foreclosed from that part of the market which is subject to the tying arrangement.’” It's My Party, Inc. v. Live Nation, Inc., 811 F.3d 676, 684 (4th Cir. 2016) (internal citations omitted). The Amended Complaint alleges that WW's “‘license’ for use of its trademarks, trade dress and business methods was the ‘tying’ product and that [AMI's] windows and associated materials served as the ‘tied’ product.” (Am. Compl. ¶119.) No. 5:17CV39-GCM Business Franchise Guide - Explanations, Laws, cases, rulings, new developments ¶16,048 http://www.wkcheetah.com/#/read/2f4740607cda1000940090b11c18cbab01a!csh-da-filter!WKUS-TAL-DOCS-PHC-%7B4A1F7BEF-FFD4-4348-9D22-81311C5BA95F%7D--WKUS_TAL_11587%23wkusd11363f92971876f09323a8ab40c1a1f?searchItemId=&da=WKUS_TAL_11587

The franchisee could not show that the franchisor and the designated supplier had market control [dominance] .

 “When pled as RICO predicate acts, mail and wire fraud require a showing of: (1) a plan or scheme to defraud, (2) intent to defraud, (3) reasonable foreseeability that the mail or wires will be used, and (4) actual use of the mail or wires to further the scheme.” Wisdom v. First Midwest Bank, of Poplar Bluff, 167 F.3d 402, 406 (8th Cir. 1999). “[T]he term ‘scheme to defraud’ connotes some degree of planning by the perpetrator, [and] it is essential that the evidence show the defendant entertained an intent to defraud.” Atlas Pile Driving Co. v. DiCon Fin. Co., 886 F.2d 986, 991 (8th Cir.1989) (alterations in original) (quoting United States v. McNeive, 536 F.2d 1245, 1247 (8th Cir.1976)). No. 5:17CV39-GCM Business Franchise Guide - Explanations, Laws, cases, rulings, new developments ¶16,048 http://www.wkcheetah.com/#/read/2f4740607cda1000940090b11c18cbab01a!csh-da-filter!WKUS-TAL-DOCS-PHC-%7B4A1F7BEF-FFD4-4348-9D22-81311C5BA95F%7D--WKUS_TAL_11587%23wkusd11363f92971876f09323a8ab40c1a1f?searchItemId=&da=WKUS_TAL_11587

There was no fraud.  The franchisor did not deceive the franchisee.  The franchisee knew that the franchisor could designate suppliers.  And, the franchisee know it would have to buy from the suppliers that franchisor designated.

The Bendfeldts [Franchisee] knew from the moment they signed their agreements that WW [Franchisor] could change the number and identity of approved window suppliers. They admit that they agreed to buy windows only from WW-approved suppliers: In other words, Plaintiffs [Franchisee] were on notice that WW [Franchisor] could designate one approved window supplier if it wished to do so. No. 5:17CV39-GCM  Business Franchise Guide – Explanations, Laws, cases, rulings, new developments ¶16,048 http://www.wkcheetah.com/#/read/2f4740607cda1000940090b11c18cbab01a!csh-da-filter!WKUS-TAL-DOCS-PHC-%7B4A1F7BEF-FFD4-4348-9D22-81311C5BA95F%7D–WKUS_TAL_11587%23wkusd11363f92971876f09323a8ab40c1a1f?searchItemId=&da=WKUS_TAL_11587

In short, all of the franchisee’s claims regarding designated suppliers failed.  It is not unlawful for franchisors to designate new or different supplier after signing the franchise agreement.  And, it is, not unlawful for the franchisor to derive revenues from designator supplier sales to franchisees.
It may make a franchisee or all franchisee mad.  It may increase franchisees’ operating cost.  But, these things alone are not sufficient to be unlawful.  More is required to show required for wrongdoing.

How Your Trademark May Limit Expansion

To gain trademark rights all you have to do is begin using the trademark.  From the day that you begin using a trademark, you garner trademark rights without doing any more than using the trademark.  This is referred to common law trademarks rights.
Common law trademark rights give your superior exclusive rights to the trademark name, above all others henceforth in the area that you are doing business.  However, common law trademarks rights are limited to the area in which you do business.

 Common law trademarks rights are limited to the area in which you do business.

To get trademark rights beyond the area in which you do business, you must register the trademark with the USPTO [United States Patent and Trademark Office].  A USPTO trademark registration precludes anyone from using your trademark nationally post the registration even if you are not doing business nationally.  In addition, upon a USPTO registration, an infringer of your mark will be liable for greater damages including attorney fees.

  A USPTO trademark registration precludes anyone from using your trademark nationally post the registration.

The limits of common law trademark rights are being tested in a recent case reported to the Credit Union Times.  The Red River Bank has filed a trademark infringement complaint against Red River Federal Credit Union [FCU].  For years Red River Bank established 1999 in Louisiana and Red River FCU established 2008 in Texas coexisted without complaint.  Then Red River FCU acquired branches in Louisiana and Mississippi.  This was too close for comfort.  As reported in the Credit Union Times Red River Bank’s complaints states:

“RRB [Red River Bank] has received numerous inquiries from members of Shreveport Federal Credit Union and the community at large regarding their belief that RRB [Red River Bank] has taken over Shreveport Federal Credit Union.”


If you have an expansion plan or if you want to protect your name beyond the common law, a federal trademark is a must.