Franchising is one of the best ways for entrepreneurs to jump into the business world. From restaurants to gyms to retail stores, becoming a franchisee allows you to work with an established brand, take advantage of a proven business model and receive ongoing training and support.
But what exactly does franchising mean? And what are some of the legal ramifications you should be aware of?
At its core, franchising is a legal agreement between a franchisor and a franchisee — and it comes with a set of governing regulations. These regulations, which protect both the franchisor and franchisee, are referred to as franchise laws.
Here’s an overview of what you should know about franchise law before becoming a franchisee.
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What are franchise laws?
Franchise laws are a combination of federal and state laws that regulate the registration, offer and sale of franchises, as well as the legal relationship between franchisors and franchisees.
The intention is to protect and create safeguards for franchisees from franchisors and to ensure transparency in the franchising process. Similar to other laws that have federal and state input, franchise laws are governed by a common federal element: compliance with the Federal Trade Commission’s Franchise Rule. States may have added laws and protections, but that varies from state to state.
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What is the Franchise Rule?
The Franchise Rule is enforced by the Federal Trade Commission (FTC), an independent United States government agency.
Think of the Franchise Rule as an overarching federal law that governs all franchise transactions in the United States. The Franchise Rule falls under the FTC’s jurisdiction because the FTC works to prevent fraudulent, deceptive and unfair business practices.
The crux of the Franchise Rule and the FTC’s enforcement of it lies within the requirement for a franchisor to provide a franchise disclosure document before the offer or sale of any franchise.
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What is the franchise disclosure document?
The franchise disclosure document (FDD) is a comprehensive agreement that includes detailed information about the franchisor and the overall franchise opportunity.
The FDD is required to include information about the franchisor’s history, how the franchise system operates, the required initial investment, ongoing royalties and other fees, territory restrictions and other important details related to the franchise.
The FDD is provided to potential franchisees before the franchisor and franchisee enter into a legal franchise agreement.
That said, the goal of the FDD is to help franchisees make an informed decision about the franchise as a whole — and whether or not to invest in it.
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Time to review the FDD
The Franchise Rule dictates that the franchisor must provide the FDD to potential franchisees no less than 14 calendar days before franchisees sign any agreement or pay any money to the franchisor.
Within those two weeks, franchisees are encouraged to review the FDD with their franchise lawyers and financial advisors before making a decision.
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Investigating violations of the Franchise Rule
It’s the FTC’s right to enforce the Franchise Rule by investigating franchisors that fail to provide the required disclosure documents, provide incomplete disclosure documents, misrepresent information in the disclosure documents or engage in other deceptive or unfair practices, whether purposefully or accidentally.
After an investigation, the FTC can take legal action against franchisors that violate the Franchise Rule. Consequences of such violations include fines from the FTC, but they can also lead to private lawsuits from the franchisee.
What to know about franchise laws
In addition to the Franchise Rule, each state has its own set of franchise laws that must be followed. Differing by state, state franchise laws could require additional disclosures and documentation or provide further protections for franchisees.
Franchisors must comply with both federal and state franchise laws to legally offer franchises in the United States.
Protecting franchisors and franchisees
Franchise laws are an integral part of the franchising industry, providing protections for both franchisors and franchisees. The Federal Trade Commission enforces the Franchise Rule, so it’s essential for all franchisors and franchisees to comply with the rule.
Keep in mind that there may be other laws and regulations franchisors and franchisees must comply with, so the best practice is to check with a local legal professional.
Related: Considering franchise ownership? Get started now and take this quiz to find your personalized list of franchises that match your lifestyle, interests and budget.