A Deeper Look at Franchise Business

By KATHY WEBBER
and JEREMY GRABER | Attorney

The business of franchising in the United States has been around since the 1800s when a druggist named John S. Pemberton concocted a drink made of molasses, sugar, spices and cocaine (this ingredient is no longer used). Pemberton licensed select people to bottle and sell his drink that we know today as Coca-Cola.

FRANCHISING IS AN ARRANGEMENT where one party (the franchisor) gives another party (the franchisee) the right to use its trademark or brand name and provides a business model and expertise. The franchisee typically pays a one-time franchise fee plus a percentage of sales revenue as royalty.

Franchising should be a win-win for both parties. The franchisor grows rapidly for minimum or no capital outlay, and the franchise in return gains immediate name recognition, a successful business plan, and the ongoing support of the franchisor.

BECOMING A FRANCHISEE
Dobski & Associates
McDonald’s represents the epitome of franchising success. With 36,899 restaurants in 120 countries around the world, 31,230 of which are franchised, McDonald’s is the world’s second largest private employer with 1.5 million working for its franchises compared to Walmart’s 1.9 million employees.

Tom and Marilyn Dobski bought into the McDonald’s franchise nearly 36 years ago and own 14 restaurants located throughout Northeast Kansas. The Dobskis owned eight of the nine McDonald’s in Topeka until recently, when their middle son, Kevin, purchased one of the locations. Kevin Dobski plans to continue keeping the franchises in the family with his purchase of another location before the end of this year.

Being a McDonald’s franchisee truly is a family business for the Dobskis. Tom Dobski and his two brothers each owned a grocery store in the Chicago area called Edmunds Foods, but when the big grocery store chains moved into the area, the brothers sold their stores and each purchased a McDonald’s restaurant in a different state. Tom Dobski’s first McDonald’s was located in Leavenworth, Kansas, and he eventually purchased additional McDonald’s franchises in Lawrence and then Topeka.

The process to become a McDonald’s franchisee is highly regulated and can take several years. It took Kevin Dobski four and a half years to complete. As part of the process, McDonald’s corporation requires a candidate to be the General Manager of a McDonald’s for one year to prove they have sufficient business skills, and all applicants must attend Hamburger University located in McDonald’s Corporation headquarters in Oak Brook, Illinois.

“It is a real thing,” Kevin Dobski said. “People think it is just McDonald’s terminology, but we actually have a fully functioning accredited University called Hamburger University where you get your degree in Hamburgerology.”

Once qualified, owners are expected to sign a 20-year lease, pay monthly fees and undergo inspections every 18 months.

mcdKevin Dobski said the McDonald’s corporation also expects its franchise owners to invest in their restaurants and keep up with current trends and designs.

“They want more successful, profitable operators that can afford the reinvestments that are expected,” Kevin Dobski said. “When you have been in business for as long as McDonald’s has, they only want the best of the best. I can understand that. It hurts us as a brand if we aren’t invested like they expect us to be.”

Kevin Dobski said his dad always wanted his sons to be in the McDonald’s business and was pleased when he decided to begin the process to be a franchisee.

“My dad did not necessarily want to be the most successful; he wanted to be the most well respected. He has set the expectations for us high, so just trying to meet or exceed those has always been a little challenging,” Kevin Dobski said.


MULTIPLE FRANCHISE LOCATIONS

Congratulations, you are expanding into new markets. In addition to having a larger footprint, you are also presumably obtaining various efficiencies and economies of scale based on your growth. Hopefully, it also means more revenue. Before moving into new locales, you should keep in mind the following:

  1. Are there any new permits, fees, license or related authorizations that you need to obtain? These permits, etc. can vary by city, even within the same county. Is there proper zoning in place for where you want to locate?

  2. Crossing state lines raises a whole host of additional issues. Will you be creating a new entity? Or will the existing entity be used? If the existing entity, it likely needs to be registered as a foreign entity with that state’s secretary of state (or equivalent) to do business there. If creating a new entity, follow that state’s laws (and annual filing requirements). Some states impose franchise taxes that will be triggered by either registering an existing entity or creating a new one.
  3. Be sure you are handling sales and income taxes correctly. Each city, county, and special taxing districts charge varying levels of sales tax. It is typically your obligation (as the selling merchant) to collect and remit those properly. In addition, some municipalities charge an earnings tax (like Kansas City, MO). Is this new location subject to any of these sorts of special taxes?
  4. Expansion likely means more employees. Does this growth cause you to be subject to additional employment laws that you were not previously subject to? For example, do you now have to offer health insurance because of the Affordable Care Act? You also may be subject to FMLA and WARN if you have grown to more than 50 employees.
  5. Do you have any license agreements for software (e.g., point-of-sale software and equipment) that has limits on the number of users or various size restrictions? Will your growth cause possible violations of the current agreements? If so, they should be restructured or new agreements entered into.

  6. Lastly, any political issues with opening in the new location? Understand local politics for your franchise before signing a lease or expending significant resources if the politics simply will not allow you to operate business there.

In short, hire an expert (or experts) in tax, business, and employment matters before expanding to new markets.

Provided by:
Jeremy L. Graber, Attorney
Foulston Siefkin LLP


BECOMING A FRANCHISOR
GreatLIFE
Rick Farrant owner of GreatLIFE started his business with three separate golf country clubs in Topeka and the surrounding area: Berkshire Country Club, Lake Perry Country Club and Prairie View. In 2006 Farrant made the decision to change the three properties he owned to be branded under one name, GreatLIFE. GreatLIFE added the fitness side of the business in 2006 and grew to include eight golf and fitness facilities.

greatlife 1

It wasn’t until around 2009 that Farrant determined he needed to look at other options to grow his company and began to look into the concept of franchising. He credits the economy crash during that time period for helping facilitate that business decision. Because of economic conditions, Farrant said, it was extremely difficult for anybody to obtain a business loan for a golf course, so he needed to be a little creative.

GreatLIFE acquired its first franchisee in 2011 in Lebanon, Missouri, but after Farrant’s attorney became terminally ill, the franchise business model stalled for a few years. However, Farrant did not let this setback stall his company’s growth. GreatLIFE now has 60 golf and fitness clubs, four of which are franchisees.

Farrant said GreatLIFE will continue to focus on the franchise model going forward because it is a much easier way to grow the business.

“When we buy a location, we put our heart and soul into it. You grow at a lot slower pace if you are buying and growing them internally than you do if you franchise,” Farrant said.

While franchising has helped his own company grow, Farrant said it also gives franchisees a stronger foundation on which to grow their own businesses.

“We can go to a business and say, “Here are 20 or 30 mistakes we made, and you don’t have to make those now,”” Farrant said. “We can also use our buying power to pass our discounts on to the franchisee, and almost always, the net benefit of that pays for the franchise fees. We believe that we can help a lot of golf courses that are financially struggling.”


OFFERING FRANCHISE OPPORTUNITIES

You must be doing something well because other people want to expand on your ideas. This allows you to grow, without taking all of the financial risk. It also permits your brand to gain access to untapped markets that you are not familiar with or could not navigate on your own. Although franchising can be complicated, there are two key documents/requirements to keep in mind: (1) the franchise agreement between the franchisor and franchisee, and (2) complying with state and federal franchise laws.

THE AGREEMENT
The franchise agreement is the contract you have with your franchisees that outlines the control you retain versus the autonomy the franchisee has and the sharing of revenues, expenses, advertising costs, etc. As a new franchisor, you may be more willing to be flexible with a franchisee that shows significant potential. As you grow, most, if not all, of your franchise agreements will be identical. Individualized franchise agreements are too unwieldy for the Subways and McDonald’s of the world. This may not be true for a newer franchise.

FRANCHISE OFFERING
If you are offering a franchise, you must comply with federal law, particularly the disclosure requirements of the Federal Trade Commission’s Franchise Rule. This applies regardless of the state you will be offering the franchise in. Secondly, certain states have additional requirements. For some states, this is filing a simple form, and for other states the process is more complicated. Individualized filing requirements should be understood before considering new markets.

FRANCHISE VS. SECURITY
Lastly, be certain that you are offering a franchise and not a security. A franchise is a contractual agreement between franchisee and franchisor where both parties have some degree of control over, and involvement in, the underlying business. A security is an investment and is subject to state and federal securities law requirements, such as registration and anti-fraud rules. The line can be gray, and you should obtain the advice of counsel before offering any franchising arrangement.

Provided by:
Jeremy L. Graber, Attorney
Foulston Siefkin LLP


CHOOSING A DIFFERENT PATH
CryoX
When Heather Keener and Eric Buckman, co-owners of CryoX, opened in Topeka in October of 2016, they had the opportunity to buy into an existing franchise to start the business. While it might have made the initial setup and marketing easier, Keener said they chose to start the company from scratch and haven’t regretted that decision.

cryoxCryoX provides cryotherapy, a treatment that uses freezing temperatures to relieve chronic pain and inflammation, as well as other medical benefits. Cryotherapy, which has been used medically for many years in other countries, is relatively new to the United States, so a limited number of franchise choices were available for purchase. Keener said she didn’t see any franchises that looked like a viable option.

“I had an idea already in my head of what I wanted the business to be and how I thought it should look,” Keener said. “I wanted to go more toward the relaxing spa feeling rather than the sporty gym doctor’s office feeling, which is what most of them were geared toward.”

While Keener admits purchasing a company with an established business plan might have been easier at times, she stands firm on their decision to create their own business model.

“Looking back now, I am glad we did it. I felt we could create everything we were going to get out of a franchise without having to pay franchise fees, and not have to stick to certain standards and restrictions,” Keener said.

Now that CryoX has established a successful business model, Keener said they are researching ways to grow their business—even possibly offering a franchise opportunity to others.

“We designed and built this to be a cookie cutter for additional locations, whether it be opening other locations with investors or franchising this business format,” Keener said.

MAKING THE FRANCHISING DECISION
Regardless of whether a business chooses to purchase an existing franchise, expand its own footprint by selling franchises to others, or forge its own path, the guidance of a legal expert is always a good decision.


CHARTING YOUR OWN COURSE

Paving your own trail comes with increased risk, but also increased reward. You have total control over your business and its operations, and therefore, you control all of the upside benefits. You are also not subject to any limitations of a franchise agreement or particular standards or requirements of a franchisor.

The downside flows from the upside. You do not have the same brand recognition as a franchise. Financing may be more difficult and other support that may accompany an existing and established franchise (e.g., relationships with vendors and associated discounts) will not be there. Be careful not to infringe on any intellectual property of a similar business.

This may include trade dress (the general appearance) and any patented or trademarked processes, symbols, etc. An over-the-top example of what not to do is the fast food restaurant “McDowell’s” mimicking McDonald’s in the classic 80’s movie, “Coming to America.” Don’t be Mr. McDowell.
Heather Keener, co-owner of CryoX, stands firm that creating their own business model was the right decision to provide what they envisioned.

Provided by:
Jeremy L. Graber, Attorney
Foulston Siefkin LLP