FDD Fundamentals: Item 4

Item 4 is a fairly straight forward disclosure requiring the franchisor and any of its related parties (affiliates, parents, predecessors and certain individuals) to disclose a bankruptcy, or similar foreign proceeding, within the last ten years. And while the disclosure appears simple, there are some interesting nuances with respect to each party’s disclosure.

Franchisor

With respect to the franchisor, if it has declared bankruptcy it may indicate an increased potential for a future bankruptcy, and may further indicate that in the past, the franchisor has had problems preforming under its contracts. This is particularly important to a franchisee because the relationship between a franchisee and a franchisor is primarily governed by the franchise agreement.

Parent Company

In addition to the requirement for the franchisor entity, the franchisor’s parent company or companies are required to disclose any bankruptcy. This is because under those bankruptcy proceedings the parent may be required to sell its assets, which, depending on the relationship between the franchisor and the parent, may include the franchise system. Under this scenario, the franchisee will not have input over who purchases the franchise system, and the sale could be to a party inexperienced in franchising or possibly even to a competitor. Despite the fact that the franchisee may not like the new owner, she would likely be bound to work with the new owner under the terms of the original franchise agreement, because most franchise agreements contain assignment provisions that require the franchisee to be bound to the terms of that agreement even if the franchisor sells, transfers, or assigns the franchise system to another party.

Affiliates

The franchisor’s affiliates also need to disclose bankruptcies. One reason for this requirement is to alert franchisees to the possibility that the affiliate may choose to divert funds from the franchise system to cover costs etc. of the affiliate’s bankruptcy. While not a common scenario, this diversion of funds may reduce the franchisor’s ability to provided services to the franchisee. For this reason, the definition of “affiliate” for purposes of Item 4 is more broad than the definition under Item 3, i.e., it includes all affiliates not just those who have sold franchises under the franchisors principle trademark.

Predecessors

The franchisor’s predecessors also must disclose any bankruptcy proceedings under Item 4. The primary purpose for this is to prevent the franchisor from reincorporating or reorganizing under a different name in an attempt to avoid disclosing previous bankruptcies. 

Individuals.

Lastly, any individual person affiliated with the franchisor who has significant management responsibility over the franchise system is required to disclose their relevant bankruptcies as well. Relevant bankruptcies include any personal bankruptcy as well as the bankruptcy of any entity that occurred within one year of her serving as a principle officer or general partner.

For the franchisee, these disclosures have important implications when deciding whether to buy into a particular franchise system. A franchisee should be very attentive of the bankruptcy disclosure section and should keep in mind how each party’s bankruptcy could affect both the franchisee’s investment in the franchise and her relationship with the franchisor. Before declaring bankruptcy or selecting the franchise management team, franchisors should be aware of these disclosure requirements. Additionally, franchisors need to be aware of the various entities and individuals who are required to make Item 4 disclosures. Finally, one common mistake is to assume that the ten-year disclosure requirement automatically ends ten years after the person or entity filed for bankruptcy. However, under the FTC Rule this is not necessarily the case; it is ten years from the date of disposition. 

FDD Fundamentals: Item 3

Item 3 of the FDD requires disclosure of the franchisor’s material legal disputes. Legal disputes include formal lawsuits, arbitrations, and settlement agreements (including some confidential settlement agreements). For the purpose of litigation disclosures, “franchisor” means the franchisor company, any of the individuals with significant management responsibility, affiliates, parents, and predecessors. Similar to Item 2, the policy concerns that gave rise to the original version of Item 3 were concerns with deception, fraud, and unfair commercial practices used in the sale of franchises by franchisors. In drafting the revised franchise rule, the FTC expanded the disclosures to include suits initiated by the franchisor. The purpose for this expansion was to reveal the nature and amount of legal disputes within a franchise system, and to indicate the overall franchise system performance.

This blog post will address the following: (1) who needs to disclose, (2) what needs to be disclosed, and (3) the two types of disclosure.

Who Needs to Disclose

First, the franchisor, its affiliates, its predecessors, parents, or individuals working for the franchisor with significant management responsibility are the parties who need to disclose material legal actions. Parent companies need to disclose their litigation history only when they guarantee the franchisor’s performance or have post-sale obligations. Any affiliate that falls into one of the following three categories will need to make some litigation disclosures. Any affiliate who: (1) guarantees the franchisors performance; (2) offers franchises for sale under the franchisor’s principle trademark; or (3) under certain circumstances, affiliates who have sold franchises in any line of business within the last ten years. Importantly, these different subclasses of affiliates have slightly different disclosure requirements (discussed below).

What Must Be Disclosed

Second, the Franchisor et al. must disclose three types of legal action and some regulatory actions.

       a)  Pending legal actions, these parties must disclose pending criminal, regulatory, or civil actions involving illegal or deceptive conduct or unfair trade practices.

           b) They must disclose any past convictions, no contest, or guilty pleas within the last ten years resulting from criminal, regulatory, or civil actions alleging illegal, deceptive, or unfair actions or practices.

        c) They must disclose material civil actions involving any franchise relationship. Additionally, they must disclose currently effective injunctive or restrictive orders brought by a public agency that involve violations of securities, franchise, or trade practices.

However, as mentioned above, the third class of affiliate, those who have offered or sold a franchise in any line of business, are required to disclose any injunction or restrictive order brought by a public agency. Conversely, franchisors et al., do not need to disclose suits not directly related to the operation of the franchise business. For example, suits only involving suppliers, other third parties, or suits for tort indemnification do not need to be disclosed. These types of lawsuits do not need to be disclosed because, according to the FTC, they are not indicative of the franchise system’s overall performance.

Additionally, under the amended Franchise rule of 2007, franchisors must disclose confidential settlement agreements. However, there are exceptions to this disclosure requirement. First, the franchisor need not disclose any settlement that has a neutral or favorable outcome for the franchisor. These types of disclosures are not required because they would not be deemed “material” under the FTC’s interpretation of Item 3. Second, the Franchisor need not disclose any settlements entered into before it started selling franchises. One reason for this exclusion is that these parties would not have considered franchising during these negotiations, and consequently, it would be unfair to make the party disclose those settlements for franchise disclosure purposes. Finally, any franchisor who operated under the franchise rule – Not the UFOC – need not disclose any settlements it entered into before the new franchise rule became effective on July 1, 2007. One reason for this exclusion is that disclosure of these types of settlements was not previously required.

Two Types of Disclosure

It is important to note that Item 3 permits two classes of disclosure. The first requires quarterly disclosures. Legal actions are material civil actions involving the franchise relationship. Specifically, they typically involve the contractual obligations between franchisee and franchisor that relate to the operations of the franchise business. The second type of Item-3 disclosure requires only annual updates, e.g., franchisor initiated suits. However, a franchisor initiated suit can be moved into the quarterly disclosure group if a franchisee asserts a counterclaim related to the contractual obligations of the franchisor to help operate the franchise business.

Item 3 of the FDD is meant to help the franchisee understand how the franchise system is performing and how often lawsuits occur within the franchise system. However, as the franchisee, it is important to keep in mind the exceptions to the disclosure rule. As with all large investments, it may be important for the franchisee to preform additional research if there has been a recent change to the franchisor’s principle trademark, or if the franchisor has been selling franchises for some time. One way to obtain additional information is to contact former and current franchisees and ask for information regarding the franchise system’s performance and culture.

From the franchisor’s perspective, there are a few important things to remember. First, be sure to disclose all required information involving lawsuits and settlements. Second, understand your business organization, specifically which entities have been involved in settlements or lawsuits that need to be disclosed and whether those entities or individuals fall into a class that needs to disclose. Third, moving forward, you should attempt to prevent problems before they arise. Attempt to avoid situations where a lawsuit or unfavorable settlement is likely to occur. For example, be engaged in your franchisee’s success. Keep in touch with them, and do your best to help them be successful. Successful franchisees are less likely to sue their franchisors. However, if a problem does arise, before immediately initiating a lawsuit, attempt a resolution outside of the courts, and utilize competent legal counsel. 

FDD Fundamentals: Item 2

To begin it is valuable to review some of Item 2’s relevant background; the original rule making commission found that some individuals offering franchises were misleading consumers regarding important facts about the franchise business. For example, how long the business had been operating and the experience of the parties managing the franchise. The FTC concluded that these types of misrepresentations could mislead reasonable consumers, causing them to believe that the franchise offering was a more secure investment than it actually was. Accordingly, they added a rule requiring franchisors to disclose information about their business including names and addresses for the franchise business, any parent companies, and any sellers. Additionally, they had to provide background information for any sellers, officers, and directors.

As the FTC enforced the franchise regulations, it became apparent that franchisors were still misleading consumers by misrepresenting relevant information about the business. Specifically, the franchisors would leave out information about their predecessors (entities or individuals who had previously owned or operated the franchise). Alternatively, franchisors would give the people managing the sales or services titles other than officer or director to avoid disclosing their unappealing backgrounds in the FDD. Consequently, the FTC amended the rule to require franchisors to disclose information about its predecessors and about any party with significant management responsibilities.

It is important to understand that Item 2 contains only work experience for the prior five years. Franchisors are not allowed to place information inside of Item 2 that is considered extraneous or unrelated.

            The Franchisee’s Perspective for Item 2:

There are a few red flags to look for in Item 2 of the FDD. First, if there are predecessors then the franchisee will want to research what happened to them. Did they go bankrupt, suffer significant legal problems, or did they sell the system to investors? If the conditions of the sale were concerning, and if the management is the same then you may want to reconsider franchising with that particular franchisor. Second, you will want to research the individuals who are managing the system. If they lack experience or they have a history of business mismanagement or failure you may want to reconsider franchising with them, because those traits are likely to permeate the entire franchise system. Finally, these red flags can be mitigated or exacerbated depending on the level of franchisor involvement. If the system is complicated, or you are unfamiliar with the underlying business, then these red flags are even more important. If you are inexperienced you will likely need significant help, at least at first, from the individuals managing the franchise.

            The Franchisor’s Perspective:

There are a few concerns that a franchisor should keep in mind when drafting Item 2. First, the FDD is not supposed to contain extraneous information. While you may want to include information about awards or accolades your management staff has received or a particularly impressive work position from more than five years ago, don’t. Registration states may require you to delete this information before they will accept it, and you can share this information with your perspective franchisees in other ways. Second, the exact definition of “management responsibility” is not explicitly defined in the Franchise rule leaving franchisors often to question whether an individual has management responsibility. However, some additional insight can be gained from an examination of the original rule (UFOC), and the commentary preceding the amendment to the franchise rule.

The old rule generally provided that an officer was an individual who had significant management responsibilities for marketing or servicing franchises. The old rule was amended because franchisors were giving these responsibilities to individuals who were not given the title or name of officer or director. To combat this naming problem, the FTC amended the rule to include any individual with significant management responsibilities. The amended rule was not changed to cover additional or different activities, but to cover individuals acting like officers (managing services or sales to franchisees). Ultimately, the rule of thumb for a franchisor is that any individual who actively controls the marketing or servicing of franchisees should be included in Item 2.

Finally, it is important to remember not to include individuals in Item 2 who do not have significant management responsibility. In other words, it may be misleading to include a notable individual who might attract franchisees, but who does not actually participate in the management of the franchise. For example, if Warren Buffet had a small interest in the franchisor, but exercised no control over the franchisors marketing or services it would likely be misleading to include his name in Item 2, and could result in a lawsuit.

Item 2 is an important part of the FDD, and while it may seem strait forward at first blush, there are important nuances that both franchisors and franchisees should both be aware of.  

FDD Fundamentals: Item 1

Generally, Item 1 is all about the franchisor. The information includes all of the franchisor’s affiliates and related companies, e.g., companies that own it, companies it owns, companies owned by the principles of the franchisor, and companies that are partially owned by a principle of the franchisor that provide goods or services to franchisees.

The Franchisee’s Perspective:

Item 1 performs two functions: first, it requires the franchisor to disclose true information about itself and the second follows from that if the information is misleading, then the franchisee could sue for damages or recession of the franchise agreement. Item 1 requires that the franchisor disclose information in three general categories. First, it must disclose information about itself. This includes the franchisor’s name, business address, and its business experience. It is important to note that “franchisor” here includes any predecessor (person who previously owned the franchise and sold it to the current franchisor) or affiliate (an associated business entity controlled by, controlling, or in common control with the franchisor) of the franchisor. Second, it must provide the name and address of its non-affiliate parent entities (for example a holding or shell company) and its agent for service of process. Third, it must describe the business opportunity it offers. This description includes a general description of the market and competition for the products or services offered and any laws or regulations that are specific to the franchise business industry.

Thus, as the franchisee, this item is very important. You can be reasonably confident in this information because there are potentially significant repercussions for the franchisor if it is misleading. However, it is important to remember that the FDD should not be your only source of information about the franchisor. You should use the FDD as a starting point for additional research. Additionally, there are several red flags to watch for in Item 1. First, if the information regarding the franchisor’s business is very vague or overly general as this could indicate that the franchisor lacks a real understanding of what it is offering, or that the franchisor believes the franchise would not be appealing if the details were fully spelled out and disclosed. Second, you will want to look at the predecessors, parents, affiliates and business experience of the franchisor. You will want to investigate the circumstances surrounding any potential transfer of the franchise business and you will want to look into management of the franchise to see their business histories. If the franchisor has a checkered business past, you may want to reconsider purchasing a franchise from them. It is important to remember that while you are legally considered an independent business owner, the franchisor will exercise significant control over your business and you will want to be sure that you trust them, and can work well with them.

Third, if you decide to consider purchasing a franchise you should compare the information in the FDD with the other information the franchisor gives you. If there appears to be conflicts between the information in the FDD with what the franchisor is telling you, this is a red flag. Finally, if franchise business is subject to significant governmental regulation, you will want to be aware how this may increase the cost to operate the franchise business and increase the potential liability for the franchise business. For example, some franchises offering business opportunities in the health care industry are subject to significant regulations including regulations on storing and sharing patient information, doctor self-referral laws, licensing requirements, employment requirements, and fee sharing.

The Franchisor’s Perspective:

            For franchisors, it is important to remember that the FDD can serve two important functions. It protects the franchisor from liability should a franchisee try to sue the franchisor and it also conveys information about your franchise business. If you comply with the regulations and make appropriate disclosures then it can protect the franchisor from future liability, but if your disclosures are not sufficient or you do not comply with state and federal regulations then it can result in significant liability down the road.

The franchisor needs to balance two interests: the need to provide sufficient, accurate information such that a franchisee cannot claim he was materially misled, and the interest to present an attractive franchise offering. However, it is important to remember that although the FDD does convey information about your franchise to prospective franchisees, its primary purpose is not advertisement but disclosure. Individuals who are looking at your FDD are already interested in your business concept, and (despite what was recommended above) the fact of the matter is that most franchisees who receive your FDD will not read the entire thing, and even if they do, it is unlikely to change their mind. Accordingly, the most important thing is to make sure the information in the FDD is correct and that no information required by federal or state law is omitted.

            Therefore, comparing the franchisor and franchisee perspective of Item 1 gives additional insight into how each party can use Item 1. On the one hand, the franchisee can see that while the information is likely correct, it may not be very detailed and the franchisee should use the information in Item 1 as jumping off point for additional research. On the other hand, the franchisor should keep in mind that although the FDD conveys information about your business to prospective franchisees, its primary function is disclosure. It is important to be careful to include only true information and not leave out any required information. 

Fundamentals of the Franchise Disclosure Document

At the start of every franchise relationship, the prospective franchisee is given the Franchise Disclosure Document ("FDD") which discloses all the requirements in the pending franchise relationship. Often this document is difficult to navigate for both the franchisor and the franchisee. Over the course of the next several weeks, we will break down each item in the FDD and give a summary of what can be expected and what is required within the FDD.

The FDD came about due to the federal government's concern about fraud and corruption in the franchise industry. Accordingly, since 1979, the Federal Trade Commission requires all franchisors to provide a disclosure document to all prospective franchisees. In July 2007, the FTC updated their requirements and renamed the requirements as the FDD. The general purpose of the FDD is to require franchisors to disclose information the federal government believes will reduce fraud and assist franchisees’ in making informed decisions about whether to invest in a particular franchise. The FDD is broken down into 23 Items. Each item addresses a specific topic. With respect to each topic, there are two important perspectives to consider: first is the franchisee’s perspective and second the franchisor’s perspective. Each upcoming post on the FDD will take a brief look at each of the 23 Items from each of these perspectives.

We look forward to sharing our understanding and perspective on the FDD. 

Effective Communication with Franchisees

Creating effective communication strategies with franchisees is a vital part of franchise systems of all sizes. Today there are more communication tools than ever before and many are literally in sitting your back pocket, your purse or wherever you keep your smart phone. It is important to remember that when a franchisee succeeds, the franchise brand and system succeeds, and communication is a tool to that success.

A franchise relationship is like any long-term relationship. In order to succeed, both sides need to be willing to listen and to work together. Effective communication builds support and buy-in of new ideas and concepts. It also gives the franchisee a reason to share their ideas and thoughts. Remember, some of the most successful concepts, advertisements and services have originated from a franchisee. As a franchisor, you don’t want to lose out on taking the next big thing system-wide simply because you did not have an effective communication system in place.

If you are a franchisor, ask yourself these five questions to find out if your communication needs some reworking:

1. How often do you communicate with your franchisees? Once a week? Every month? Only at the annual conference? The more often you communicate, the more your franchisees will see and come to believe that you are truly invested in their success. The franchisee has invested their own money and time and they want to know that the franchisor is as invested as they are.

2. Is your communication in the same format each time? Are you a one-trick-pony communicator? If so, switch it up. There are a multitude of technologies available to you from webinars to surveys to conference calls. Don’t just send out emails. Invite groups of franchisees to participate in a web conference;

3. When was the last time you sat face to face with a group of franchisees and just listened to what they had to say? Often, as a franchise system grows, those at the top stop spending time with their franchisees and stop hearing what they have to say. Just because the system is expanding it does not mean that everything is going well and that franchisees are happy. And even if they are happy, it is still a good idea to sit down every once in a while.

4. Are your franchisees able to openly communicate with one another? You should encourage your franchisees to share their success stories and best practices with one another.

5. Do you know if your franchisees understand the mission and vision of the company? If the last time you shared your vision of the company with franchisees was at initial training, it might be time to get your franchisees excited again. Help your franchisee to become your cheerleaders. They are out there every day and working with the public. If they know the mission and vision and are excited about it, the public will be able to feel it.

Taking a page out of the Dunkin’ Brands CEO’s playbook, franchisors need to remember that franchisees are their customers. Just as good customer service is vital for the success of a franchisee’s business, good customer service from the franchisor helps the franchisor’s business thrive.

Reader Topics

Dear Reader,

First we would like to thank you for reading our blog and supporting The Franchise Business Law Group. 

Second, in an effort to make sure that our blog addresses not only the most current topics in franchise and business law, but to make sure we are addressing those topics and subjects relevant to our readers, we are asking for your help. What would you like to read? Is there a topic that you would like us to address or to provide more information on? Simply comment to this post or send an email to either kmartin@toolaw.com or christiant@toolaw.com. We will select a few topics and make them the subject of upcoming blog posts.

Again, thank you for reading and we hope you come back often to find information on franchise and business law. 

New gTLD's and the Trademark Clearinghouse

In 2012, ICANN (Internet Corporation for Assigned Names and Numbers) announced that companies and individuals would be able to customize their top-level domain or “gTLD” (the part coming after the ‘dot’ in a domain name). This customization costs $185,000 per domain. In order to protect federal trademark owners from infringement, cybersquatting and other illegal acts by those seeking to obtain a customized gTLD, ICANN created the Trademark Clearinghouse (the “TMCH”).

Starting on March 26, 2013, federal trademark holders are able to register their trademarks with the TMCH. This registration will give the trademark owner protection from another user obtaining a customized top-level domain using their trademark (i.e. instead of just the .com, .net etc., the gTLD can be customized, such as .cocacola, .pepsi …).

The TMCH is limited trademarks that fall into one of three categories: 1) to those with federal trademark registration here in the United States, or the equivalent in another jurisdiction; 2) those who have had the mark validated by a court proceeding at the national level; or 3) those protected by statute or treaty. Both trademark owners and valid trademark licensees have the right to place a trademark on the TMCH.

However, as with anything, there are exceptions to the above rule, and the registration does not come without a price.

First the exceptions. Several trademarks, even though they meet one of the three above criteria, will not be eligible for registration with the TMCH. The main reasons creating ineligibility are: 1) the trademark contains a design element where the words are not the predominant part of the mark and where the words are not easily separable from the design; 2) the trademark contains a '.'  (dot); or 3) the trademark contains an unusable character in the name, such as & or other symbol. If any of the above apply to your mark, you will need to re-apply for federal trademark registration in the modified form.

The price tag is also a hurdle to overcome. For a one year registration, a trademark owner or licensee with an eligible trademark can file with the TMCH for $150. The three-year fee is $435 and the five-year fee is $725. This fee is per mark that is registered. If you file for what turns out to be an ineligible trademark, at this time the fee is not refunded. There are discounts offered for registrations done through Trademark Agents, but you will have to pay a fee to that agent.

If you are interested in registering, or learning more about customizable gTDL’s, you can visit the Trademark Clearinghouse website at: http://trademark-clearinghouse.com/, or the ICANN website at: http://newgtlds.icann.org/en/.

Franchise Programs for Veterans

As franchisors look to recruit new franchisees, one viable segment of the population is veterans transitioning out of active duty. The International Franchise Association (“IFA”) has established the VetFran program that links veterans with franchisors willing to offer discounts and incentives to veteran franchisees.

If you, as a franchisor, are interested in participating in the IFA’s VetFran program, you must be a member of IFA. All members of IFA are eligible to participate and there is no fee to be listed as part of the VetFran program. If you are already a member of IFA, you can sign up for the VetFran program by going to: http://dev.vetfran.com/franchisors/signup/.

While there are no fees directly associated with joining the VetFran program, there are requirements that a franchisor discount fees. Each franchisor must offer an incentive to veterans of no less than a 10% reduction on the initial franchise fee. Beyond that, there is no restriction as to what types of discounts and/or benefits are offered to incentivize veterans. Several franchisors eliminate the franchise fee entirely or offer a lowered royalty rate.

Once the franchisor is part of the program, the franchise system is listed in a directory of franchise opportunities. If you desire to have a more prominent listing, for an additional fee, a franchisor can have their franchise system featured prominently in the directory and in certain advertising. It should be noted that the VetFran website receives over 40,000 hits per year and the IFA is constantly working to establish relationship with national veterans programs and groups to bring this program to their attention.

The advantages to joining VetFran are several. The franchisor is able to use the VetFran logo on all promotional material and can use it on their letterhead and website which can be a helpful marketing tool to let the public understand the franchise system supports veterans. It is a minimal investment (through membership in IFA) to have access to a group of prospective franchisees that may otherwise not be as accessible. In addition, the franchisor can create a “calibration” assessment to help the VetFran program locate ideal franchisees. The assessment helps match a prospective franchisee’s skills and experience with a particular franchise opportunity. Lastly, VetFran is part of the Veteran Job Bank that allows veterans to search for veteran-friendly job opportunities upon transitioning out of service.

Once a part of VetFran, there is no prohibition against the franchisor making direct contact with veterans programs to promote the franchisor’s discount and veteran-specific offering. A franchisor is not restricted to using only the advertising made available through the VetFran program.

Should you desire more information about the VetFran program, you can find information on their website at: www.vetfran.com.

(This blog post is provided for informational purposes only and is not legal advice or an endorsement of any product, service, group, organization or program.)

Business and Franchise Tips

Over the past month, our office has gathered some basic information that relates to businesses and franchising, and more specifically to franchises in the restaurant industry. The basic information below is meant to help franchisors plan for the year and future growth and expenses. While some of the information has been taken from various publications and resources, some of the information is our opinion. The below is not legal advice or our promotion of any products or services and should not be construed as such.

1.    Bernstein Research in New York expects a 4% growth in restaurant sales in 2013—assuming the economy remains about where it is now.

   2.  OBAMACARE –the below are some statistics that are meant to help you understand the possible impact of the health care mandate.

a.    The Hudson Institute (for IFA) estimates the health care mandate will cost the franchise industry $6.4 billion dollars.

b.    McDonald’s estimates that it will cost $10,000 to $30,000 per store.

c.    Jack in the Box estimates the cost to be $10,000 per employee, but that the cost can be covered by a 1% increase in menu prices.

d.    Most sources and experts are recommending a price increase over cutting working hours, but that is in flux. Each franchise system needs to balance the fear of backlash relating to cutting working hours versus the fear of backlash relating to increased menu prices and/or loss of menu items.

e.    GE Capital believes the restaurant sector will ultimately weather this and will be able to cover the increase in costs through price increases alone. However, the amount of price increases and the public perception of an increase as the economy remains slow was not specifically addressed.

3  3.  CONSCIOUS CAPITALISM BY JOHN MACKEY

This book may be a helpful read to franchisors and business owners in all sectors. We have not read the book but several articles have referenced both John Mackey and his book in recent publications. John Mackey is the founder of Whole Foods. His basic theory is that the owners of a corporation should view the business as an opportunity to create value for the owners, employees and the communities where they do business. Value is defined in many different ways. In the long run a company that creates value will do far better because doing so changes the way the managers and other employees view what they are doing. However, it is important that the value created needs to become a central part of the corporate culture if this Whole Foods model is to succeed.  The book questions the traditional “profits and all costs” model as being often counterproductive and one that can readily create enemies.

4  4.  RULE OF THUMB FOR EQUITY CAPITAL –For Investors in a restaurant system

As a typical rule of thumb for restaurant acquisitions, the equity capital investor is looking for:

a.         $750 per square foot in sales;

b.         $300 per foot cost to build;

c.         18-20 percent unit level cash flow;

d.         Cash-on-cash return on investment of at least 40%

The above points and tips hopefully will help you in your business whether it is in creating growth, in creating a new corporate culture or in preparing your business for acquisition by another individual, company or investment firm. 

Preparing Your Business Tax Filings

We are well into tax filing season and small business owners have the added pressure of filing not just personal taxes, but business taxes as well. While we are not tax attorneys or tax specialists, we have gathered some useful tips over the years to help our small business clients better prepare for tax season and to help them with accurate filings.

1. Keep on top of important filing deadlines. Most of us know the looming April 15 “Tax Day” deadline for personal tax filings. However, you need to be aware that some business taxes and returns must be filed as early as mid-March. Talk to your accountant or tax specialist for more information on deadlines in your state and for your business.

2. Review your financial reports. Prior to submitting the information to your accountant or tax specialist, you will want to take a close look at your profit and loss statements and financial reports. Specifically, you want to review those areas of gross income that may trigger different taxes. Additionally, review your payroll taxes and make sure you or your payroll company are taking all the appropriate deductions.

3. Review your business receipts. Tracking receipts and keeping a filing system up to date is often difficult, but this is an area ripe for an audit. Look over your receipts and make sure they are properly noted to document the business expense, who you were with and what it was for, and scan the documents. A paperless receipt filing system is easier to retain and store than a file folder with hundreds of loose receipts.

4. Review elections and deductions with your accountant or tax specialist. Make sure you are properly itemizing your capital expenditures. Knowing the difference between what does and what does not qualify as a capital expense. Also, don’t forget to track all your available reimbursable expenses and to ensure that you are taking your available deductions, such as automobile deductions.

5. Give yourself plenty of time. If you have not already started preparing your business tax filings, do not put it off another day. There is a lot of work and preparation that goes into your business filings and you do not want to be left spending all day and night in the days before the filing deadline. Additionally, some tax professionals will charge a premium to prepare your business taxes in the days leading up to the filing deadlines. Preparing in advance can save you both in time and money.

6. Post-filing review. While it is nice to breathe that sigh of relief once the filings have been sent in, take some time to review what worked and what did not work in your tax preparation. Use the time to set up better filing and retention practices, to review whether your gross income is coming from the sources you thought it was (or should) be coming from. And take time to make sure that in the future, your tax preparation can be as seamless as possible.

Any U.S. federal tax advice contained in this communication (including any attachments or links) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

Some helpful articles:

http://www.startupnation.com/business-articles/1169/1/AT_Tax-And-Bookkeeping-Mistakes.asp

http://www.nolo.com/legal-encyclopedia/top-tax-deductions-small-business-30176.html

http://www.squidoo.com/top-5-tax-tips-business-taxes-2013

Managing the Seasonal Franchise

Both service and product related franchise systems and small businesses often have to navigate the seasonality of their business. As an owner of a seasonal business you are likely constantly facing the off-season revenue cliff and trying to figure out ways to keep the business stable during the off-season.

This post offers a few tips on helping you overcome the off-season revenue cliff that can help sustain your business year-round.

1.    Modify your labor costs to reflect the applicable revenue season.

As a rule of thumb, your labor costs should not exceed 20% - 30% of your revenue at any given time. As a seasonal business your labor costs need to adjust up and down depending on whether you are in the high or low season of your business. This means having fewer employees when you are bringing in less money. Decide which employees are necessary for operations and stick with that smaller scaled-down staff during the low season. 

1.    Try and modify your lease agreements.

Many landlords are willing to work with the seasonal business to allow for higher rents in the high season and lower rents in the low season. The landlord that understands the nature of your business and the flow of revenue during different times of the year is often more likely to work out a solution that will benefit both you and the landlord.

The same could be said of vehicle leases. If your seasonal business is reliant on company vehicles, work with your lender to come up with a viable solution to accommodate the flux in your revenue stream.

2.    Adjust inventory levels.

This seems common sense, but many seasonal businesses forget to adjust their inventory down during the low season. If you operate a year-round business that has a high and a low season, you will need to adjust what inventory and even what offerings are available during the low versus the high season. Take time during the low season to create different purchasing matrices that can be used during the different revenue seasons.

(helpful article by the National Food Service Management Institute) 

3.    Find new revenue streams.

This is not as easy as it sounds, but it is a worthwhile practice. As a seasonal business, you do have an advantage in being able to take time to evaluate your business and to streamline the offerings and decide if adjustments in low season offerings can and/or need to be made. Use this time to plan ahead for how to attract new business and customers during the peak season and how to maximize your profits once the high season hits.

This can also mean trying to diversify what you offer your customers. Examine your business and decide if your offering easily crosses into an off-season offering. This is often easier for certain industries. For example, it is more logical for a landscaping business to cross into the snow removal business than for an ice cream establishment to cross into another industry. Be creative. There may be something your business can succeed at with little cost or effort during the low season to help sustain the business and keep the revenue flow moving in a positive direction.

There are several other helpful articles available to the small business owner. Speak to others in the industry and take time to analyze your business. You may be able to save on costs or create new revenue streams in ways you had not previously thought possible.

  

Annual Franchise Renewals

If you are a franchisor, you are (or need to be) aware that it is, for most franchise systems, franchise renewal season. It is that time of the year when you are required to update your FDD with any material changes and to include a new audit for 2012. It is important to note that for most franchise systems, if you do not update your FDD you will be unable to offer or sell franchises after April 30, 2013, and as early as March 31, 2013 in some registration states.

This post is meant to give some helpful tips on preparing for this hectic time of the year.

·         Order your audit early –as in today. In reality, we recommend that your audit be ordered no later than January 31, 2013. This is because audits can take time and you will not have a completely updated FDD without an audit.

·         Between now and early February, sit down with your sales team and/or those overseeing the franchise system to discuss what material changes you would like or need to make to the FDD and franchise agreement. This can be anything from a change in royalties to how training is conducted. If you have found that you are continuously waiving a “requirement” with each new franchisee, you will want to talk to your franchise attorney about whether or not that should be a material change. A good place to start is with your Items 5, 6 and 7 and make sure that all the amounts stated are still true and accurate.

·         Take time to accurately fill out Item 20. This is often left to the last minute, but the 5 required tables are important and should accurately reflect the status of the franchise system.

·         Review any ancillary agreements you require your franchisees to sign. According to the FTC Amended Rule, “franchisors are required to attach a copy of all proposed agreements relating to the franchise offering that the franchisor provides or for which the franchisor makes arrangements.” This can include a required lease agreement form, ADA Certification, Personal Guarantees, Confidentiality Agreements, ACH Agreements, and many others. You will want to discuss with your franchise attorney all the agreements you require or provide for your franchisees to determine if they are required to be included in the FDD.

The renewal process can be long and arduous. But if you follow the above tips and take the time early on, the process can be smoother and you will be able to offer and sell without any delay.

Several registration states offer guides and tips in helping you through the annual renewal process.

The California Department of Corporations 
The State of Indiana
The State of Virginia (franchise forms)

New Year Checklist for Your Business

Setting resolutions and goals are a big part of each new year. While this is a common practice among individuals, it is often overlooked when it comes to businesses and assessing what needs to be done in the coming year for your business’ overall health. Below is a short checklist for the small business and the franchisor business that can help you make sure that your business is adequately set up for 2013.

·         Do you have a Buy-Sell Agreement in place among your partners? If not, this should be a priority.

·         Update and review your Employment Agreement(s).

·         Update (if necessary) your Bylaws or Operating Agreement to reflect any changes from 2012 and make the appropriate changes with the government agency regulating entities.

·         Make sure your trademark filings are up-to-date and appropriate renewals have been filed.

·         Double check on your UCC-1 filings either you have filed against someone or that someone has filed against you. For your filings you want to make sure you have not let them lapse or expire.

·         Update or create your will or other estate plan.

If you are a franchisor, you want to be especially careful that over the next couple of months you are making sure that you follow a schedule to ensure timely registration and renewal of your franchise.

·         Order your audit. In our experience this is the most common hold-up in the renewal and registration process each year. Ordering your audit early can help ensure that you can have timely renewals and registrations.

·         Sit down and review your system. Have you made any material changes or do you want to make any material changes to your system?

·         Set up a time to meet with your attorney to go over material changes in your system.

·         Have everything prepared and reviewed by March 20 so that you can submit your registrations and renewal filings on time. 

·         Make sure that you have all the documents from new franchisee purchases in 2012 (i.e. signed franchise agreement, certificates of insurance, dba filings, entity filings, etc.).

·         Set up a time to review sales restrictions and requirements with your franchise sales force.