In its simplest form, “Franchising” is the license of the franchisor’s business or operating system and its trademark to a franchisee for some period of time, in exchange for a fee. The fee usually takes two forms: an initial franchise fee paid up front and an ongoing monthly royalties paid during the life of the franchise.

A common mistake of businesses wishing to expand in the U.S. is their attempts to avoid U.S. state and federal franchise laws that may apply.  In other words, these would-be franchisors attempt to avoid the disclosure requirements applicable to all franchisors in order to save on legal fees in the short-term.  However, this mindset may lead to substantial problems down the road.  These businesses oftentimes try to hold themselves out as “licensors” instead, and in doing so fail to provide to their “licensees” the franchise disclosure document (“FDD”) required of franchisors.

Although the preparation and annual maintenance of an FDD may not be cheap, the short-term legal costs are money well spent compared to the financial and other costs associated with lawsuits from disgruntled licensees, or even worse, investigations by state franchise administrators.

For example, a company’s failure to abide by state and federal franchise laws that require franchisors to disclose to the prospect in an FDD all material facts relating to the franchise system to prospective franchisees, and to register that FDD in certain states, can be catastrophic.  In addition to potentially giving a licensee/franchisee the right to rescind its agreement, other penalties include repaying back to the licensee/franchisee of all amounts paid to the company.  In addition, fines and/or penalties payable to the state may also be required.  Not to mention the legal fees that accrue with dealing with all of these potential issues.

The message is simple – don’t trade long-term security for short-term savings.  Have an experienced franchise lawyer advise you on the requirements of franchising at the outset.