Franchising Your Business

A franchise involves an agreement by which one party (the franchisor) grants another (the franchisee), in exchange for money, the right to use its trademarks, trade names, certain systems and processes to produce and market a product or service according to certain specifications (the franchise).

The process of franchising a business and becoming a franchisor is entirely different from running the business. If your initial business is not successful and profitable, do not expect it to improve its fortunes by turning it into a franchise. On the contrary, the pressures of franchising will jeopardize not only the franchisees but also the business you started (you as the franchisor). A franchise attorney can assist you.

Five considerations that determine if you can franchise your business

You have to be convinced that the business you are interested in turning into a franchise is profitable and that your model can be successfully cloned – replicated in as many locations and scenarios as possible. This requires a superior product or service with sufficient demand to generate interest from those you intend to sell the concept to. In other words,  as a prospective  franchisor, your business must operate under a system that allows it to generate sales consistently and from these, a reasonable profit after covering expenses.

How do your sales compare to the competition?

I mean businesses that sell similar products or services.  If your franchise  prototype is not profitable in the long run, it is unreasonable to want to sell the idea to someone else and expect them to pay future royalties. Selling another unproven business or one that doesn’t make much money is asking for trouble in the courts. Anyone who buys a franchise expects the business to be “turnkey” – ready to operate with everything already thought out so that if the owner follows the processes, they will achieve a reasonable profit.

Unique Selling Proposition

For it to be profitable and generate enough demand, your business must have a superior product, different from the others. Your offer as a franchisor must propose something additional to what already exists in the market. I mean reasons for others to stop buying from the competition and buy a franchise from you.

Feasibility of additional units

How easy is it to recreate your prototype (where you plan to market the franchise)? Each franchise unit must be easy to recreate in terms of the cost of investment, the time to start the business, and providing the necessary training to operate it. If it works in some places and not in others, then the franchise model may not suit your needs.

A prudent step as a prospective franchisor is to open several locations before franchising the operation. If everything goes well, your financial position will improve; you will prove that the concept is replicable and increase your managerial competence with the complexity of managing multiple locations.

Change in perspective

As a franchisor, your role will change. Franchising will shift your focus from your own business to spending time selling, training, guiding, and supporting others in creating their own business. You will also mediate disputes with dissatisfied individuals who may not do as well as you or who insist on doing things their way. You will also no longer be able to act unilaterally or as quickly as before and will need to consider the other franchisees for future decisions.

Time and money

No matter the business you intend to turn into a franchise, you need capital and time to grow and expand; and I’m not referring to the current business – which you need to continue to run – but the franchise business. The operation that will sell franchises to others and subsequently support them. Some franchising areas that require time and money to move forward the franchising initiative include:

• Legal advice to protect copyrights, trademarks, logos, trade names of the franchise.
• Consulting to assist in the preparation of a proven and detailed operations manual that must be delivered to the franchisee. This manual is critical to maintaining franchising consistency in the brand, service, and product across different franchised operations. It will also need to be updated regularly as the franchise operation evolves.
• Legal advice for franchise contract preparation, processing the corresponding filings and permits, and assistance in preparing business and personal disclosures required by law to be given to prospects.
• Accounting and financial advice to help develop economic scenarios for setting fees and royalty percentages of the franchise. Assistance in preparing the company to submit audited annual financial reports and in managing the financial and tax matters of the franchisor operation. Remember that when talking about franchising, there are multiple parties involved. There is the main organization which is the franchisor and the owners of the individual franchises which are the franchisees.
• A strategic franchising plan that includes a marketing plan to develop your franchise operation. Many people are not attracted to the idea of investing time in developing an action plan. If you are not willing to create a plan with goals – at least 3 years, you are in the wrong business. Developing a business requires a serious and thoughtful plan; not those pro-forma plans that some banks are satisfied with for granting micro-loans.
• An essential component of this strategic franchising plan is the budget. In addition to additional payroll, other ongoing costs of the franchise operation need to be considered. Compliance with legal requirements should not be costly, but if you plan to expand to other jurisdictions, the legal bill could be in the tens of thousands. You will also need funds for marketing. This includes the preparation of printed materials for prospective franchisees (graphic artists, writers, brochures, literature, logos, designs, posters), strategic alliances with business brokers and franchises, marketing campaigns, websites, advertising campaigns, hiring of venues for presentations, etc.).
• Developing a franchise will take time away from your current business, which you need to continue to attend to because it is your calling card. This may involve hiring additional personnel, but there’s more. In addition to someone(s) to coordinate work with contractors (graphic artists, lawyers, architects, accountants, consultants, etc.), you will need someone – professional and trained – to assist you or take care of marketing and selling the franchises. The fact that the business is profitable does not mean that prospects will come running to buy a franchise. This work is essential for the success of the project. You will also need personnel to train each new franchise owner and provide ongoing support (and supervision). You can’t do it all.
• Real estate. If the franchise requires a physical location, you will need to hire the services of an architect to develop a prototype of the establishment and a real estate professional to help you identify the most promising commercial areas and approve them.

Legal aspects

Regulation of Franchises in Puerto Rico

Despite the fact that many states have had franchise laws for years, Puerto Rico – a jurisdiction so heavily regulated – oddly does not have  franchising regulations. There is Law 75 that regulates distribution contracts, but not much else. The Federal Trade Commission or FTC has promulgated a regulation called the FTC Franchise Rule, which requires the disclosure of certain information about the franchisor and the franchise. This disclosure is known as the Franchise Disclosure Document or FDD. It requires the franchisor to disclose specific and detailed information on 23 topics related to issues such as the identity and financial status of the franchisor (including financial statements) and parent and affiliate entities, predecessors, and affiliates; the experience of the officers running the franchise; pending litigation; bankruptcies; initial fees to be paid, royalties, and other recurring payments; the estimated total investment to be made by the franchisee; the franchisor’s obligations regarding assistance and information on advertising, training, computer systems, the franchisee’s rights to the territory; duties and obligations regarding factory brands, copyrights, and patents related to the franchise, renewal information, etc.

Legal structure of the franchise

From a legal perspective, franchise contracts “are characterized by granting independent entrepreneurs the privilege of distributing products of certain brands or providing names. When we refer to the franchise contract, we are not referring to a single document. Typically, other interrelated contracts are included in the ‘package’ that focus on different aspects of the franchisor-franchisee contractual relationship, including documentation regarding any financing provided.  Apart from Law 75 that regulates distribution contracts and Law 22 that regulates sales representative contracts, there is no specific law in Puerto Rico to address the relationship between the franchisor and the franchisee as in many US states.  However general contract law under the Civil Code of Puerto Rico fully applies.  Thus, franchising a business in Puerto Rico is valid as long as it is governed by the will of the contracting parties, provided it is not contrary to laws, morals, or public order, and is based on the good faith relations of both parties.

Master Licensee

As an end note, it’s important to mention that franchisors frequently do not directly engage with individual franchisees. Instead, they often enter into contracts with a sub-franchisor, who operates or grants individual franchises within a designated territory. In the United States, this sub-franchisor is typically referred to as a Master Licensee. In such instances, the contractual relationship between the franchisor and the master licensee differs from the typical franchise agreement.

The role of the master licensee goes beyond that of a typical franchisee. For all practical and legal purposes, within the assigned territory, the master licensee assumes the role of the franchisor. They are responsible for managing and overseeing the franchised operations, supporting individual franchisees, and ensuring the brand’s consistency and compliance with the franchisor’s standards. This arrangement allows for the expansion of the franchise concept into new markets and territories, often on a larger scale, while maintaining the franchisor’s control and quality standards.

In summary, the use of master licensees is a strategic approach employed by franchisors to facilitate expansion and efficiently manage franchise operations in specific regions, with the master licensee acting as the franchisor’s representative within that territory.