Anyone who’s ever visited a McDonald’s, Pizza Hut, or Sheetz is familiar with franchises, on a surface level. In the United States, it’s all but impossible to visit a town and not find at least one example of a popular franchise. After all, franchises are very much a part of American history. While it can be a great way for entrepreneurial-minded individuals to work together and grow a business, it can also get quite complicated for those who don’t understand the nature of the relationship upfront and even worse for those that end up in an “inadvertent franchise”.
The idea of the franchise actually dates back to medieval times, where the original concept of lending and borrowing to create a mutually beneficial relationship originated. Officially, the definition of a franchise is “[t]he right or license granted to an individual or group to market a company’s goods or services in a particular territory; also a business granted such a right or license.” In a feudal society, the rights were granted by the European governments to high-ranking church officials and/or nobility who would conduct business and collect taxes on behalf of the court. These ambassadors would then pay royalties back to the crown, while keeping a share of the profits for themselves. Sound familiar? Fast forward several centuries to the American Industrial Revolution, and that’s where franchising as we understand it today truly began.
Isaac Singer, of the Singer sewing machine fame, pioneered the arrangement so popular today. Not only was he the first to create a practical sewing machine, along with the payment plan that would allow most households to afford it, but he also found a way to get word of his invention out to more people. By seeking out individuals who wanted to sell his revolutionary machine and charging them a licensing fee for a share of the profits, he got more funding for the manufacturing while they got their own business out of the deal. Shortly thereafter, the advent of the automobile occurred and a new form of franchising, known as the dealership, was born. Thus, ensuring the rise of this business model in America. To learn more about the history, check out this great article: http://articles.bplans.com/the-history-of-franchising-as-we-know-it/. The legal history of franchises, while not nearly as long, is vastly more complicated.
Even though other terms may be used, such as licensing, dealership, or even consulting, if the agreement has the three key elements of a franchise, it’s legally a franchise. The first piece is shared association with a trademark. Usually, this takes the form of licensing the trademark and utilizing it for promotion, but courts have found that this can exist even if the trademark is never displayed as long as “substantial association” still exists. The next element requires some sort of payment exchange between the two parties. This can be in the form of an upfront licensing fee, or less obvious transactions, including “[o]ngoing royalty payments or payments characterized otherwise, such as consulting fees, training fees, or site assistance fees, [which] are sufficient, as long as they are for the right to operate the business.” Most states have a minimum requirement to meet this standard—such as $500 or less within the first 6 months—but if the relationship continues for years, and the exchanges continue to add up, you may find yourself in what’s known as an “accidental franchise.” Lastly, there must be some sort of shared marketing plan in place, whether it’s through promotional materials or simply training documents and/or operations manuals. When Singer developed his business plan, he offered training to new vendors so they’d know more about his sewing machine, and thus be able to better sell them. Additionally, this model is further cemented by the interdependence the two entities have. If the primary company can place limitations upon the franchisee, or the day-to-day operations, more likely than not, it’s a franchise. For the full details regarding this complicated form of contracting, visit the American Bar Association’s site: http://apps.americanbar.org/buslaw/blt/2010-03-04/grueneberg-solish.shtml.
When the relationship is unclear from the start, legal battles ensue, including those that gave us many of the rules and regulations we have today. Prior to California’s adoptions of franchise regulations in 1970, many business were operating blindly. By understanding your rights and responsibilities as a franchisor or franchisee, you limit your liability in the future. If you enter the status of an “inadvertent franchise,” both sides have the ability to go back and claim legal compensation against the other party. In an effort to limit that, it’s always recommended that you seek legal counsel, such as that available from The Law Offices of Kirk Halpin & Associates, before entering into a business arrangement – whether a formal franchise, marketing or license agreement or something much less formal such as a short letter agreement.