So again, this is Patrick Findaro, co-founder at Vetted Biz and Visa Franchise, very excited to bring on Courtney Hutchinson, again, a franchise attorney based in Naples, Florida, who represents clients throughout the United States on all types of franchise legal matters. I’m about to bring on Courtney Hutchinson. Hey, Courtney.
Courtney: Hello. Hi, Patrick, thanks for having me.
Patrick: How’s it going?
Courtney: It’s going great.
Why she became a Franchise Lawyer
Courtney: I know it’s probably not the most common kind of law to go into, but essentially, like you said, I grew up in the franchise business and worked behind the counters of all of my parents’ stores, and not only just behind the counters but help them manage their multi-unit franchise businesses and all the things related to that. And so when I went to college, I was still working and involved in all of those aspects of their business.
And then when I got into law school, I was still employed doing the same things for those businesses and figured, “Hey, what a great way to take my first-hand knowledge and all of this stuff that I’ve learned over the years and help other people with it, especially since, you know, the franchisee-franchisor relationship is largely one-sided and leaves franchisees with little recourse.” You know, knowing those ins and outs of how to deal with franchisors and what to expect has really been invaluable to my clients. So that’s kind of how I got interested in franchising and franchise law and I still enjoy it to this day.
Steps to Evaluate a Franchise For Sale
Patrick: That’s great. And, you know, tell me, someone that’s looking to buy a franchise and maybe they’re in the initial stages, but they wanna own…they wanna basically sign a franchise agreement and open up a franchise in the next year, whether they’re working with Visa Franchise or on their own, what should they do from a legal process in the beginning so they don’t stall their plans of opening up a franchise?
Courtney: That’s a good question. Good question. So the number one thing that I tell my clients is you need to establish a business entity, which will be the executing party of the franchise agreement, meaning that you should establish an LLC or a corporation that is going to act as the party to the franchise agreements. So if you’re opening a franchise in the state of Florida or you’re investing in a franchise in the state of Florida, you need to get an attorney or to file your articles of organization for an LLC, or articles of incorporation for a corporation, and get that process started as soon as possible.
And then another crucial aspect of this is getting your Employer Identification Number from the IRS. Due to COVID, there are a lot of delays currently in processing and issuing EIN numbers, especially for foreign nationals. What used to take 4 days for the IRS to do is now taking 7 to 10 weeks and beyond. So getting your LLC forms, getting your EIN, your EIN is important because you cannot open a business bank account without it, do those things before you invest in your franchise, before you sign that franchise agreement. And you really want all those franchise fees to go ahead and be funneled through that, LLC, if at all possible.
So those are some of the main things that I say, you know, that’s what you need to do from a setting up perspective, from a legal perspective. And then, of course, you know, have a franchise attorney review your franchise documents. You don’t wanna go into these franchise relationships blind, it could have some material repercussions
Patrick: Well said. And I imagine a lot of people are thinking, you know, I can just go online and open up a business and, you know, what, maybe 70% like they do it, but if there’s a dispute or if they did something wrong, then it can really cost them a lot of money later on.
Courtney: Exactly, exactly. Especially like here in the state of Florida and like in most other states. You have to have certain documentation. You have to have certain things that are in place before you can even file these documents with the government. Also you have to have someone within the state, that’s going to be there to receive all your legal notices. So you have to establish that relationship. And oftentimes attorneys will act in that capacity on your behalf. So it’s always good to reach out to an attorney to facilitate that process for you.
Patrick: That makes sense. And especially in this world where people are working remote, traveling, you know, they’re not maybe at the same place and they’re working remote, it’s good to have an attorney and receive that information. So God forbid there is a legal situation notice, they can act fast.
Courtney: Yes. Well, an FDD under federal law is the franchisor is required to provide a prospective franchisee with what is a franchise disclosure document, FDD. And the purpose of this essentially is to protect the interests of the prospective franchisee. The FDD contains about 23 informational disclosure items, and these items are designed to educate a prospective franchisee on the franchisor, their system of operation, and whether the program agreement offered is well-established and generally profitable, or at times, you find that it’s unproven and risky.
So it’s really, really important to review this FDD, any FDD from a franchisor. You need to know their business experience. You need to know if they’re in any kind of litigation. Whether it’s initiated by franchisees or the government. That’s good information that you need to take into consideration before you invest. Some other things that are really important when considering if you’re going to enter into a franchise relationship is to look at the territory, and all of this as outlined in the FDD, your dispute resolution provisions. Also, most importantly, this is what I always say, the financials of the franchisor. You wanna look to see if the franchisor is liquid enough, is profitable enough to provide you competent support throughout the franchise relationship.
And you need to assess whether the profitability of the current franchisees within the system warrants an investment in that particular program. So, you know, a thorough review of an FDD is a must-do before you enter into a franchise relationship.
Patrick: Yeah, and you’d be surprised…I mean, we look initially, and from more of like a non-legal perspective at these franchisors’ P&Ls and balance sheets, and there’s been some like franchise fraud where the franchisor had like their Porsche Cayenne on the balance sheet and looking at franchise fees collected of 15 million, but only 100K of royalties or nothing in royalties. So we’ll look at some of these things from like an economic perspective and business case perspective, and then, obviously, Courtney is complementing that with, like, what does the territory mean and what more from a legal basis, which is not our forte. We’re not attorneys, so
Courtney: Very well said. Yes, that is very true. I also have seen some shady things happening in these franchise disclosure document. So it’s essential to look it over.
Patrick: You know, we have a data mine now, I think 5,000 plus franchise disclosure documents representing like 1,800 brands. And that’s on our site Vetted Viz and we take a lot of the key metrics out. But yeah, it’s a good 200 to 500-page document where we’re taking out the data points. But there’s also all this legal language that I don’t fully understand, and you gotta complement it from….you gotta complement the data with the legal expertise of Courtney and other franchise attorneys.
Courtney: Yeah, exactly. And not only just the legal aspect of it but being that I have been involved in the franchise business for so many years. I see the practical application of what these agreement terms actually mean in day-to-day operations. So you might look at a section and go. “Oh, okay. The franchisor, they’re gonna require me to only use approved vendors, right? Okay, no big deal.” However, you know, there could arise major issues. And what if there’s a shortage in the supply of that vendor? Well, you know, then your store suffers and, you know…
Patrick: And I have seen some franchisors have a crazy vendor vetting fee, thousands of dollars, anytime you bring them a vendor or another franchisee brings them a vendor. And it’s just like another fee that you gotta pay.
Courtney: Yeah. And those are things that you wanna take a look at. You might wanna consider adding as a negotiation point in the future.
Patrick: Beyond the royalties of the franchisor, we really wanna make it very clean for our clients to understand, like, how the franchisor is making money and ideally it’s much more royalties and then the franchise fee just to cover some expenses. But are they legally liable to disclose how they’re making money in the franchisor-franchisee relationship?
Courtney: Yes. Yes. All fees. In the FDD, all fees are outlined. So your initial franchise fee is outlined. That is the fee that you’re going to pay upfront at the time of the execution of your franchise agreement. But not only that. The FDD also discusses the ongoing fees, so royalty fees, marketing fees, licensing fees. Any other fee that, as a matter of an ongoing concern, you are going to be responsible for paying. Most of the royalty fees are going to be based on a percentage of your gross sales. However, there are some franchisors that require a set royalty fee. So that means…
Patrick: Or a minimum royalty fee.
Courtney: Or a minimum royalty fee. So regardless of if you’re making money, you’re still paying, you know, that set minimum royalty fee. And also, you know, you wanna take into consideration any fees that the…or no fees, but income that the franchisor will realize as a result of the relationship with the vendors. So…