Structuring the Franchise Relationship

• Author: Dennis E. Wieczorek and Max J. Schott II
• Pages: 59-90

59

Structuring the Franchise Relationship

CHAPTER 2

Dennis E. Wieczorek and Max J. Schott II

Contents

This chapter outlines issues that should be considered in developing and struc-

turing typical business format franchise systems. Given that the success of a

franchisor and its franchisees is uniquely intertwined, the design and legal and

contractual aspects of the parties’ relationship is of critical importance.

The first part of the chapter analyzes the advantages and disadvantages

of franchising as a growth vehicle and how it compares with other methods of

business expansion. This analysis is followed by a discussion of single-unit fran-

chises, the three most common forms of multi-unit franchises, and general tips

for drafting franchise agreements.

I. Why Franchise? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

A. Advantages of Franchising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

B. Disadvantages of Franchising . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

II. Other Methods of Business Expansion . . . . . . . . . . . . . . . . . . . . . . . . 64

A. Vertical Integration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64

B. Joint Venture/Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 5

C. Licensing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

D. Dealerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

E. Sales Representatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 7

F. Exemption-Based Franchising . . . . . . . . . . . . . . . . . . . . . . . . . . . 67

III. Single-Unit Franchise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

IV. Multi-Unit Franchises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70

A. Area Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71

1. General Description . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71

2. Advantages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73

3. Challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74

4. Key Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 4

60 Fundamentals of Franchising

B. Subfranchise Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

1. General Description . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

2. Advantages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

3. Challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78

4. Key Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 0

C. Area Representation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

1. General Description . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

2. Advantages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

3. Challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

4. Key Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 5

D. Drafting Tips . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 6

E. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 0

Chapter 2 Structuring the Franchise Relationship 61

I. Why Franchise?1

The owner of a trademark or service mark can extend the reach of its brand in

several ways. It can do so itself or it can have third parties take on the task. A

third party may establish a relationship with the brand owner by buying a prod-

uct containing the brand or by setting up an outlet identified by the brand. If the

brand owner has created a model for operating a business under the brand and

that model can be replicated and taught to others, then franchising is a popular

structure for expanding the brand owner’s business. A franchise is typically

defined as a license to use a trademark and method of doing business in ex-

change for a fee. While modern business format franchising had its genesis in

the 1950s, franchising in various forms had been around for many decades

before that, albeit focused on product distribution schemes (described in more

detail below).

A. Advantages of Franchising

A brand owner arguably takes a leap of faith when it entrusts its brand equity to

a barely known third party. But it does so knowing that franchising offers a

range of advantages in terms of expansion of its business.2

First, franchising is a vehicle for accelerated growth. An entity that does

not have the capital to expand to new geographic markets may cede those mar-

kets to a competitor if it does not move quickly. By deploying franchisees in

multiple markets simultaneously, a franchisor can grow the brand at a more

rapid pace. Even if it prefers vertically integrated expansion, unless it has exten-

sive labor and capital resources, a brand owner cannot expand on the same

scale absent a franchising program.

Similarly, the engine of growth through franchising is fueled by capital

supplied by franchisees (to acquire real estate, purchase operating assets, estab-

lish a workforce, etc.). At least at the outset, a franchise program requires much

less capital than an expansion initiative funded by the brand owner. In addition,

capital may be more available to local owners and at more favorable rates.

1. This chapter does not address the issue of whether a particular concept is ripe for

franchising or “franchiseable.” For a discussion of this issue, see Kenneth F. Darrow, Mark

Siebert, & Phyllis Alden Truby, The Structural Elements of a Franchise System and Their

Economic and Legal Implication for Start-up and Existing Systems, in ABA 30th ANNUAL

FORUM ON FRANCHISING, W2, 1 (2007); Jim Meaney & Max Schott II, Starting a Franchise

System: Practical Considerations, Planning and Development, in ABA 33rd ANNUAL FORUM

ON FRANCHISING, W24, 5 (2010).

2. For additional discussion of the advantages and disadvantages of franchising, see

Darrow, Siebert, & Truby, supra note 1, at 12.