Recently I heard a conversation between attorneys regarding a business transaction they were in the middle of setting up for a client. The client wanted to do a series of LLCs or joint ventures with various partners. The client would contribute the business concept and name and the other “partners” would contribute money and time to operate the businesses. What these attorneys did not understand is that they were setting up a franchise system for their client.
Very often a business will be structured without realizing that the structure is a franchise. A franchise exists if the definition of a franchise is met, not if the franchisor knew they were selling a franchise. In this case, the client’s business transaction has all three definitional elements of a franchise: 1) Use of a trademark (the use of the client’s business name); 2) A marketing plan, substantial support, or community of interest between the franchisor and franchisee (the contribution of the business concept by the client); and 3) Payment of a fee (the financial contribution by the partners).
Because the client’s business transaction is a franchise, the client is required to comply with federal and state laws regarding the sale of a franchise, prior to entering into the business. This means that before entering into these partnerships, the client would be required to provide the financial “partner” with a disclosure document discussing information about the business and trademark, background information on the client and its business and affiliates, and other “partners” or franchisees of the client.
There are serious consequences for selling a franchise without complying with the franchise laws and regulations. These consequences include rescission of the business transaction, damages and attorney’s fees, plus the potential of fines or other penalties from state or federal agencies. In some cases, the transaction can be seen as criminal.
Next time you are setting up a business concept that has any of these elements (trademark, marketing plan, and/or fee), it is worth the time and cost to consult a franchise attorney to make sure that you are not an accidental franchisor.