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The Ultimate How-To Guide on Franchising Your Business

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The Definition of a Franchise and How Franchising Works

What is a Franchise?

So let’s talk a little bit about what exactly is franchising, let’s start with that as a starting point. Franchising is a legally defined term. Franchising is three things according to the federal government; it is the use of common name or trademark, the provision of significant operating assistance to a franchisee or exercise to the significant operating control and the payment of a fee. If you have those three things, you’re a franchise, it doesn’t matter what you call it, you can call it a license or business opportunity, it’s a franchise. So it’s important to understand our definition of a franchise is based on the federal definition of a franchise.

Now there’s some state definitions too, some different states will have some regulations relative to what they call a franchise but there all really similar in terms of what the definitions are. So bottom line is if it has these elements it’s a franchise.

You may be wondering: What is a franchise? To answer, one must look closely at the definition of a franchise.

The definition of franchising helps businesses determine if they are qualified to operate as a franchise. In the U.S., the Federal Trade Commission and state regulatory agencies have developed a formal set of disclosure requirements and franchise-specific prohibitions that franchisors must follow in their relationships with their franchisees. To determine whether or not a business meets the definition of a franchise, under the Franchise Rule, the Federal Trade Commission applies three definitive criteria that are summarized below:

Trademark

According to FTC Rule 436, “This element will be satisfied only when the franchisee is given the right to distribute goods and services which bear the franchisor’s trademark, service mark, trade name, advertising, or other commercial symbol.” Note that it is the right, not the obligation, which triggers the first element of the franchise definition.

Use of “significant control or assistance”

FTC Rule 436 lists 18 specific criteria in the area of significant control or assistance, any one of which may trigger the second element of the definition. Some of these elements include site approval, site design or appearance requirements, specified hours of operation, accounting practices, personnel policies, required promotional campaigns, training programs, and the provision of a detailed franchise operations manual.

Required payment

According to Rule 436, “The franchisee must be required to pay the franchisor (or an affiliate of the franchisor), as a condition of obtaining or commencing the franchise operation, a sum of at least $500 . . . within six months. . .” Required payments include franchise fees, royalties, or even from training fees, bookkeeping charges, payments for services, rent, or even from product sales (if they are sold above a bona fide wholesale price).

If you are contemplating a business relationship which involves all three of these criteria, you are contemplating a franchise – regardless of the label you choose to use for your business relationship.

As a franchise, you are required to provide prescribed disclosure documentation to prospective franchisees at the first face-to-face meeting during which the sale of a franchise is discussed. Failure to provide this documentation may result in fines of up to $10,000 per violation at the federal level. Moreover, in some states, the violation of franchise laws is actually a felony.

WARNING: Some companies are franchising and don’t even know it! And there are significant penalties for violators.

To learn more about the legal requirements of franchising, request our free video.

If you would like to get a PDF version of FTC Rule 436, along with some additional information about franchise legal requirements and franchising in general, please email us at [email protected] and provide us with your contact information.

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