What is Franchising?
Fast Food Restaurants, Hotels and Motels, Carpet Cleaning Services, Muffler and Brake Shops...
These are just a few examples of businesses that are often associated with a nationally-recognized chain. Individuals can become affiliated with the product or service of such a nationally-known chain through a business plan called a "franchise." Many people are attracted by the opportunity a franchise often provides to "be your own boss" and become a "business success."
What is a franchise?
A franchise is a business arrangement in which a person purchases the right to engage in marketing a particular product or service according to a specified or suggested plan.
For example, a hotel chain may want to open new hotels in a particular region. One of the ways it can accomplish this is to enter into agreements with persons in that region, granting each the right to operate a hotel under the name of the chain and according to a business plan established by the chain.
Under such an arrangement, both the business itself and the right to engage in the business are often referred to as a "franchise." The person or business entity that sells to others the right to engage in the business is the "franchisor." The buyer of that right is the "franchisee."
In Wisconsin, offers of franchises are regulated by the Division of Securities in the Department of Financial Institutions, under the Wisconsin Franchise Investment Law, Chapter 553 of the Wisconsin Statutes. This law defines a franchise as an agreement between a franchisor and a franchisee which includes three specific elements:
- A Marketing Plan
- A Trademark Association
- A Franchise Fee
A Marketing Plan is designed by the franchisor to guide the operation of the business by the franchisee. The plan typically includes a list of products and services to be sold to the public, along with required or suggested procedures for product preparation and marketing, advertising, and recordkeeping.
A Trademark Association is the use of an identifying mark, such as a trade name or logo, which associates the franchisee with the franchisor and its products and methods of doing business.
A Franchise Fee consists of any direct or indirect payment made by the franchisee for the right to enter into the business under a franchise agreement. The fee may consist of a one-time payment or continuing payments. It may include or consist entirely of payments to the franchisor of royalties - a percentage of sales receipts. The fee also may consist of price mark-ups on products in excess of bona fide wholesale prices.
Franchises and Business Opportunities
"Business opportunity" is an informal term used to describe a variety of ways of starting a business. A franchise is one type of business opportunity. In Wisconsin, all three elements - a marketing plan, a trademark association, and a franchise fee - must be present if the business opportunity is to be classified as a franchise. If any one of the three elements is not present in a business arrangement, it is NOT subject to the provisions of the Wisconsin Franchise Investment Law.
An example of a business opportunity which is not generally considered a franchise is a distributorship. This type of business opportunity involves the sale of goods at a bona fide wholesale price by a supplier to a distributor for resale under the trademark of the supplier. It is not normally a franchise under Wisconsin law because usually no franchise fee is paid by the distributor to the supplier.
Many business opportunities in Wisconsin, including all franchises, are subject to the Wisconsin Fair Dealership Law, Chapter 135 of the Wisconsin Statutes. This law provides for certain renewal rights. It also provides protection from unfair or unreasonable termination of a business relationship.
The Franchise Relationship
The relationship between franchisor and franchisee is typically defined by a "Franchise Agreement" signed by both parties. It is very important for a potential franchisee to recognize and to understand the legal rights and obligations of both parties before entering into a franchise agreement. The potential franchisee should contact tax and/or legal advisors.
Often, the franchisor retains strict control over such things as the quality of the franchisee's performance, uniformity among franchisees, and standardization of the marketing plan. In such cases, the franchisee is bound by the franchise agreement to abide by the prescribed marketing plan, to make all required payments to the franchisor in a timely manner, and to conduct the franchised business in a way that will protect the franchisor's reputation. In addition, the franchisor may impose sales quotas or inventory purchase requirements which may increase over time.
In return, under the agreement the franchisee may obtain from the franchisor: an opening inventory, promotional materials and advertising assistance, the franchisor's assistance in selection of a business location, and training to run the business.
The Wisconsin Franchise Investment Law and the Division of Securities
The Division of Securities administers the Wisconsin Franchise Investment Law for the benefit and protection of potential franchisees. That law requires a franchise to be registered prior to its being sold in Wisconsin, unless the sale qualifies for a specific exemption from the registration requirement.
Under the registration requirement, a franchisor is required to file with the Division a copy of the disclosure document the franchisor will use in Wisconsin. It must provide written disclosure of all relevant information concerning the franchisor and its business. Under the Wisconsin Franchise Law, advertising can be used and offers made prior to any filing with the Division. Furthermore, an application for registration becomes effective upon filing; no review as to the adequacy of the disclosure is made by the Division.
The Division does have the authority to require that initial fees payable by franchisees be withheld from the franchisor, and instead be held by a third party (such as a bank) in an escrow account until no later than the time of opening the franchise business, if there is concern about the franchisor's ability to fulfill its obligations to franchisees. However, the Division can exercise this authority only if so requested by the franchisee and the Division finds that the franchisor has not demonstrated the financial ability to fulfill its obligations to the franchisor.
Some things to watch for
- Franchising is often promoted as an opportunity to participate in an established business arrangement. However, the purchaser of a franchise can expect to make substantial commitments of money and time. Because the franchisee may be dependent upon the business experience, expertise, integrity, and financial stability of the franchisor, it is important that the potential franchisee investigate and obtain as much information as possible before entering into a franchise agreement.
- Is the franchise registered for sale in Wisconsin, or does it qualify for a registration exemption? You can check by calling the Division of Securities.
- What does the franchise disclosure document disclose about the financial condition of the franchisor? Is that financial condition likely to have an adverse effect upon the franchisor's ability to fulfill its obligations to franchisees? If so, you can request that the Division require that your initial fees be escrowed until the opening of the franchise business under the escrow procedure described above. If you are not familiar with business financial statements, you should seek the advice of an accountant or other financial professional.
- Does a parent company or affiliate of the franchisor guarantee the franchisor's fulfillment of its obligations? If so, what is the financial condition of that parent or affiliate?
- What does the franchise disclosure document disclose about the franchisor's "track record"? What does it tell you about franchise locations which have had to close, as well as about those that have been opened? Have lawsuits been filed against the franchisor by franchisees and others? If so, what has been alleged and what have been the results of those lawsuits?
- Does the franchise disclosure document fully disclose the total cost you will have to pay? Will you need to borrow money to set up the franchise business? If so, how much will the interest on the debt add to the operating costs of the franchise?
- If the disclosure document includes revenue projections, what are they based upon? Are they based upon franchisee-owned locations, or are they based upon locations owned and operated by the franchisor? Beware of projections or earnings claims given to you that are not disclosed or are different from those disclosed in the offering circular. Material differences between projections and earnings claims in the offering circular and those given to you in some other manner may make the sale to you illegal.
- If and when you want to leave the franchise business, what are the restrictions on the sale of your franchise?
- What grounds might the franchisor have for terminating your franchise agreement? For example, are there mandatory sales levels and ever-increasing sales quotas? What protections will you have in the franchise agreement concerning termination of your franchise by the franchisor, or a refusal by the franchisor to renew the franchise agreement when it expires?
- Does the franchise agreement restrict your ability to operate a similar business after you leave the franchise?
Avoiding Franchise Investment Fraud in Wisconsin
Investigating and obtaining detailed information before purchasing a franchise can prevent unpleasant surprises after the franchise relationship begins.
All franchise filings made with the Division are public records. Thus, a prospective franchisee has an opportunity to compare a variety of franchise disclosure documents before making an investment decision. If you are interested in reviewing any of the filings, or if you have questions regarding the operation of the Wisconsin Franchise Investment Law or whether a franchise is properly registered or exempted in Wisconsin, contact the Division at:
Department of Financial Institutions
Division of Securities
PO Box 1768
Madison, WI 53701-1768
(608) 264-7979 (fax)
The Division of Securities is located at 4822 Madison Yards Way, North Tower in Madison.
NOTE: Users of this Brochure should remember that the laws and rules discussed here are subject to revision and the information provided in this Brochure is summarized from those laws and rules.