Franchising Your Business: The FTC Rule, Disclosure, Registration, and Other Considerations

Now that tax season is behind us and you have a fresh perspective on your company’s financial health, you may be looking to capitalize on your business’ success with a view toward expansion. Many small businesses turn to franchising as a means to expand on an already successful business model with a strong brand presence. Before taking the leap into franchising, it is important to be mindful of the practical and legal hurdles you will encounter along the way.

The FTC Rule: The Disclosure and Registration Umbrella

The offer and sale of franchises are regulated under both state and federal law, so a business owner must be mindful of all regulations that may apply to his new venture. The Federal Trade Commission (FTC) is the main governing body that will oversee your attempts to sell franchises of your current business. The FTC and its state counterparts will require you to comply with federal and state regulations of the sale of franchises including, primarily, registration and disclosure requirements prior to selling a franchise.

Disclosure: Protecting Both Parties

The disclosure requirements are set out primarily by the FTC Rule, which has been in effect since 1979. Under the FTC Rule, a franchisor must disclose to a prospective franchisee, within set timing requirements, detailed information regarding the franchise including audited financials, projected costs, projected earnings, trademark information, and more. The FTC Rule is designed to protect both the franchisor and the franchisee. By giving the franchisee all of this information prior to the purchase of a franchise, the franchisee knows exactly what it should take to make the franchise a success. From the franchisor’s perspective, disclosing this information to the franchisee provides a level of protection in that the franchisee will find it difficult to blame the brand should the franchisee struggle to succeed.

State by State Regulations

In addition to the disclosure requirements under the FTC Rule, many states have their own regulations regarding the sale of franchises. Currently 15 states have franchise regulations that require pre-sale disclosures similar to the FTC rule described above. Of those 15, 13 have regulations in place prohibiting the sale of franchises unless the franchisor has registered with the state and provided the state with certain documentation. These registration requirements range from a simple letter informing the state of the intent to sell franchises within its borders to a full-fledged analysis of the financial health of the franchisor. In some instances, states may require the franchisor to establish an escrow account in the state where all franchise fees must be impounded between the time of the closing of the sale and the time the franchisee opens its doors for business. In addition to disclosure and registration requirements, 26 states have business opportunity laws. While the disclosure requirements under these business opportunity laws are often less burdensome than in registration states, the penalties for failing to comply with a state’s business opportunity laws are often severe and can result in punitive damages and awards of attorney’s fees.

With this in mind, the key question you must ask yourself when considering the expansion of your business to multiple locations operated by different entities is whether that business qualifies as a franchise. According to the FTC a franchise is defined as follows:

A continuing commercial relationship wherein a franchisor represents:

(1) that the franchisee can operate a business or sell goods associated with franchisor’s trademark;

(2) the franchisor has some level of control over the franchisee’s business; and

(3) franchisee pays franchisor in connection with this business.

Does your business fall within this definition? Even if you don’t think that it does, could you make an argument as to why it may fall within this definition? If so, you must consider the potential federal and state regulations that may apply to your proposed expansion.

Applying the FTC Rule to Louisiana Businesses

While Louisiana is not a state that requires registration in order to sell a franchise, it still falls within the purview of the FTC. This means that even though a business does not have to file anything with the Louisiana Secretary of State in order to sell a franchise, it still has to comply with the FTC Rule and various disclosure requirements.

In addition, the registration statutes focus on the location of the franchise unit, not on the location of the franchisor or franchisee. This means that Louisiana companies doing business outside of Louisiana should familiarize themselves with the registration requirements of those states.

Selling franchises of your business can be an excellent way to expand your company while retaining control over the brand. It is vital, however, to be familiar with the FTC Rule and its implications, and to keep in mind how your success may broaden your exposure to franchise regulations. Franchise law can be complicated, but it is designed to protect everyone involved, including the franchisor, so make sure your plans for expansion comply with these regulations.

If you are considering expanding your business through franchising and would like more information about franchise law, you can contact author Chris Hatcher at Blue Williams, L.L.P.