Franchising vs. Business Opportunity Expansion Options
By: By Kevin B. Murphy, B.S., M.B.A., J.D. on Sep 14, 2012 03:04:58 PM

Franchising vs. Business Opportunity Expansion Options

Contents

The starting point in the analysis is to consider the legal aspects, then the business aspects. In considering the legal aspects, we begin with the following observation that applies to both options. If you put someone into business (or allow them to use your business name/mark) this transaction will normally be a regulated activity, subject to substantial penalties for noncompliance.

Background Of Franchise & Business Opportunity Laws

Why does regulation exist? The government, due to documented past abuses where tens of thousands of individuals lost all of their net worth by investing in nonexistent or worthless business endeavors, has devised two principal consumer protection mechanisms:

(1) franchise disclosure-registration laws; and

(2) business opportunity laws.

It doesn't matter what terms are used by the parties in contracts or other documents to describe their relationship. For example, the contract may call the relationship a license, a distributorship, a joint venture, etc., or the parties may form a limited partnership or a corporation. This is entirely irrelevant in the eyes of governmental regulators, in particular the Enforcement Division of Federal Trade Commission (FTC). Their focus is not on semantics, but on whether certain elements are present. The list of required elements is quite short, and although certain exemptions and exclusions are available, the statutory framework was designed to pigeonhole "putting someone in business" relationships into either a franchise or business opportunity box. In fact, the title of the FTC Rule says it all: "Disclosure Requirements & Prohibitions Concerning Franchising and Business Opportunity Ventures." So, the focus must be on which box is better to use, not on how to avoid using either box.

The Franchise Box - Regulation By The Feds

Let's consider the franchise box. Under FTC regulations a thick document (called a Basic Disclosure Document) must be prepared and given to prospective buyers for a minimum of 10 business days before any money is paid or contracts are signed. This document contains 20 categories or chapters of information, as well as current, audited financial statements and a copy of the actual contract(s) to be signed. It is designed to give prospective buyers enough pre-sale information about the company, its financial condition, the proposed contract, investment requirements, trademark rights, etc., so informed decisions can be made before long-term contracts are signed. For companies that attempt to disregard federal law, the FTC Act authorizes the Commission to recover civil penalties of up to $10,000 per day for each violation of its Rule, plus injunctive relief, consumer redress (obtaining complete refunds, canceling contracts), etc.

State Regulation Of Franchising

Because regulation of franchising is at the federal and state level, the effect of state regulation must also be considered. The FTC Rule sets minimum standards and applies in all states, unless a particular state sets higher standards, and then that state's law applies. There are approximately 16 states where a registration process or some type of filing must happen before franchises can be offered (i.e. advertised) or sold. None of these states accept the FTC's Basic Disclosure Document. Instead, these registration states require a format known as the Uniform Franchise Offering Circular (UFOC), a thicker, document containing 23 categories or chapters of information. To ease the obvious predicament created by UFOC vs. FTC format, the FTC allows companies to use the Uniform Franchise Offering Circular format as an alternate to its Basic Disclosure Document.

Franchise Box Summary

Bottom line on the franchise box: By preparing a single disclosure document, and using the Uniform Franchise Offering Circular format, a company satisfies the federal requirement and is positioned to offer and sell franchises throughout the United States. Although certain state-specific information and disclosures may be required in the minority of states having a franchise registration process, this can normally be accomplished in a couple of extra hours per state.

The Business Opportunity Box

Now, let's consider the business opportunity box. At the federal level, the same, thick Basic Disclosure Document containing those 20 categories of information must be prepared and given to the buyer at least 10 business days prior to the sale of the business opportunity. At the state level, the picture worsens. There are approximately 24 states that regulate and register business opportunities. Unlike the franchise registration states, there is no such thing as a uniform business opportunity disclosure format. Business opportunity rules and registration requirements differ in each business opportunity state. Many of these states also have a "cooling off" period, usually a couple days after the sale where the buyer can change their mind for any reason and receive a full refund. For a company that's going the business opportunity route two different documents must be prepared and provided: the FTC's Basic Disclosure Document and a state's more abbreviated business opportunity disclosure document. Also, different timelines must be observed: the FTC's 10 days before, and a business opportunity state's cooling off period after. Bottom line on the business opportunity box - if you're an attorney with a business opportunity client, get ready for hundreds of billable hours, you've just landed a big one. But, if you're the business paying the legal bills, it's going to be a lot less money to go the franchise route. Prepare a single, UFOC format franchise disclosure document, register in a state or two as expansion efforts begin, and you're essentially done.

There are also other factors to consider in the franchise vs. business opportunity legal analysis, including liability issues (definitely a greater risk in the franchise arena) but these are beyond the scope of this article, which is not intended to offer legal advice. Companies should consult with competent, informed legal counsel about the specifics of their particular situation before making any decision.

Business Aspects

The business aspects of the franchise vs. business opportunity option are relatively straightforward. It all boils down to image from a marketing standpoint. Does your company want to stand toe to toe with the likes of McDonalds, Radio Shack, H & R Block and other franchised household names? These are the mental images formed in the mind when an average consumer hears the word franchise, along with familiar, highly advertised slogans like "being in business for yourself, but not by yourself," "complete training," "support where and when you need it," etc. This, coupled with the complete package of training, start up and ongoing support services offered by franchise companies, makes a franchise a more attractive commodity in the eyes of the prospective buyer and an easier sale.

Business opportunity, on the other hand, suffers from definite image problems that translate into difficult marketing issues. If you ever need proof of this, just attend any business opportunity show. You'll see a host of fly-by-night opportunities such as worm breeding in backyards, exotic plants raised in glass bowls, condom vending machines (not a bad idea these days) and the like all promoted by fast-talking, high pressure salespersons. Does your company really want to be associated with these companies and the reputation they project? Poor image, coupled with the fact that business opportunity ventures typically provide little training and no ongoing support, make them a much more difficult sale to prospective buyers. In a business opportunity, the buyer is just thrown a ball, and it's entirely up to them how to run with it.

About the Author: Kevin B. Murphy, known in the industry as "Mr. Franchise", is a San Francisco Bay Area attorney, author, instuctor and expert.

 

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