Rush on Business : Iowa Corporate Lawyer & Attorney : Rush Nigut of Brick Gentry Law Firm : Serving Des Moines, Cedar Rapids, Davenport, & Sioux City

Joel Libava (a/k/a "The Franchise King") has a list of 20 Must-Do Things Before You Buy a Franchise. It's a great list so I thought I'd share the article with you.

The last item on his list is to "Lawyer Up". Joel explains that the franchisor has a lawyer so franchisees should too. He also says to find a franchise lawyer rather than just any business lawyer. Both are excellent pieces of advice.

My experience is that often prospective franchisees are reluctant to hire a lawyer because they don't believe the franchise agreement can be negotiated. This isn't always the case. I've worked with a number of franchisors who are willing to negotiate certain terms in their franchise agreements. Additionally, it's important to understand what certain provisions mean. For example, you may believe you have a "fully protected territory", yet the franchise agreement may have provisions that limit this territorial protection. If you are investing a substantial amount of your life savings, isn't it worth a legal review to understand exactly what it is you're buying?

But most of all I like how Joel has set out a step-by-step plan for someone to explore franchise ownership. It's not for everyone. Franchise operations fail at roughly the same rate as independent businesses. So it's critically important to look inside yourself, examine your finances carefully and choose a franchise that fits within your talents and financial means should you decide to pursue franchise ownership.

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I recommend prospective franchisees take a look at Empire Builders which is a series of videos highlighting successful multi-unit franchisees. 

Most of the prospective franchisees that come to see me are seeking to purchase a single franchise. Many of them dream of becoming a multi-unit owners but usually lack the capital (at least initially) to make that a reality. It's interesting to hear from multi-unit owners who have been able to harness the power of the franchising model and achieve great success. It is easier said than done.

There are some great videos in the series covering topics such as: 

• Challenges for franchisees;
• Advice to new franchisees;
• Choosing the right brands and many more.

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Potential franchisees should read this article from Robert Purvin on Franchising Myth One: Franchises are Safe Investments. In the article, Purvin discusses how franchises and independent businesses fail at roughly the same rate (something discussed at length in several of my blog posts).

It's critical that prospective franchisees understand that buying a franchise will not automatically increase your chances of success. I hear time and time again from people about how franchises have a "system" and "they will help me with marketing and getting customers". It's not always the case. 

Purvin gives some good advice to help avoid mistakes when deciding whether to buy a franchise operation:

When you and your franchise attorney are reviewing the Franchise Disclosure Document, don’t limit your investigation to the closure rates. Look at the profitability of each location, especially those that serve in markets similar to yours. Do your due diligence and speak with current and past franchisees. Ask them direct questions about their profitability. It is especially critical to talk to past franchise owners and to ask them why they left the franchise. If you get any sense that the franchisees had trouble making a profit, then think very carefully before moving ahead.

Most importantly, insist that your prospective franchisor provide you with sufficient data to evaluate the profitability of the business. Limit your search to franchisors that make financial performance representations (formerly called ‘earnings claims'). There are many franchise opportunities available that are able to authentically boast high rates of success and profitability. These tend to be the top tier franchisors that require the highest investments and strictly limit their franchisee pool. As you go down the rungs of the franchising ladder to less well-known brands, new franchisors, and those with very low rates of entry, the risks typically grow.

Understanding that buying a franchise, just like starting any business, carries significant risk is the first step. You could lose your money. I see it happen to franchisees frequently. Be sure to approach buying a franchise just like it was your very own. Because in the end it will be up to you, not the system, to make it successful.
 

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 I saw an interesting article on the LexBlog Network regarding how to deal with partner disputes. The post written by Texas restaurant lawyer, Matthew Sanderson, dealt specifically with restaurants, but the information contained in the post is applicable to any business. Sanderson recommends the following when a dispute occurs:

1. Avoid the conflict by identifying motivators and doing your homework;
2. Open the lines of communication;
3. Stand up for yourself and your rights (but don't lose your cool).

I often compare partnerships to a marriage. In any marriage good communication is essential to maintaining a happy household. Where I've seen partnership disputes fester and cause problems is when the partners fail to communicate with one another. So I think Sanderson's bullet points are right on target.

Further, a helpful piece of advice for avoiding partnership disputes is to set clear expectations of what each partner is bringing to the table. Even though it isn't a part of your typical operating or shareholder agreement, you may what a letter of understanding defining the roles of each partner. Partnerships work best when the partners have complementary strengths. For example, a strong sales person combined with strong operations or details person may have a strong partnership together where two partners with the same skill set lack the balance needed to run the overall business.

Partnerships are not easy. Be sure to have a partnership agreement in place that details what happens if a dispute occurs or the partnership ends due to death, disability or other reasons. Sanderson's last point on not losing your cool is especially important. Make sure you think things through before you react and hopefully you'll be able to avoid costly mistakes if a partnership dispute occurs.

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The Des Moines Register reported that investor group Plains Angels has invested $750,000 over the last eight months. This is great news for Iowa startup companies. Venture capital in Iowa has lagged and groups like Plains Angels are definitely trying to change that.

There is a $300 application fee to present before the Plains Angels' group. In some blog posts and other social media outlets, I've seen the fee criticized by some who expressed concern that it was just a fee collection group. I considered that assertion somewhat naive on the part of some seeking funding, but the recent news should alleviate some initial fears that the group is actually making investments in companies rather than just collecting fees. The significant investment made over the last eight months in three Iowa companies is very promising for the Iowa startup scene.

If you're interested in learning more about the process for Plains Angels or becoming an investor, be sure to visit the Plains Angels Website.

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In January  I wrote about the new Iowa Business Specialty Court Pilot Project.  This week the Iowa Supreme Court announced that three judges have been selected to hear cases for the business court. The judges include:

• Judge Michael Huppert of the 5th Judicial District, which includes Dallas, Polk and Warren counties;
• Judge Annette Scieszinski of the 8th Judicial District;
• Judge John Telleen of the 7th Judicial District.

I have had the opportunity to appear before or work with all three of these judges. It's an excellent list of judges to get this pilot project off the ground.  Again, I'd like to see the threshold amount come down from $200,000 so that more business cases can be involved but it will be interesting to see how the new business court is received by lawyers and the public. Eligible cases can begin to be transferred May 1, 2013.

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With the recent passage of a new state law in Ohio and a new bill offering greater protection for franchisees in California, it will be interesting to see whether this growing trend of more pro-franchisee laws continues.

Interestingly enough it is Iowa that is often cited as a pro-franchisee state because of its franchise act. However, the growing economic market in Des Moines and throughout Iowa has not kept franchisors from establishing businesses in the state over the recent years. In my view, the opportunities for growth in Iowa far outweigh any negativity franchisors may have toward the Iowa franchise act.

But added protections for franchisees isn't necessarily a bad thing. Most franchise agreements are very one-sided in their terms and often have significant legal protections for the franchisors. You generally have a sophisticated business entity on one side (the franchisors) and less sophisticated people (the franchisees) on the other side. Most franchisees are small business people just looking to make a good living and may be investing their life savings into a franchise. Offering greater protections to franchisees should not hurt good franchise operators that deal fairly with franchisees. It will set them apart in the long run. Moreover, franchisees may feel more comfortable to go into franchise businesses.

So it will be interesting to see if the trend continues toward tougher franchise laws and the impact these laws will have on the industry.

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 There are 5 people every entrepreneur should meet when starting a business:

• Lawyer;
• Accountant;
• Banker;
• Insurance Agent; and
• Marketing professional.

How do hire a lawyer that's right for you? See my article on my new site, Iowa Business Law Services.

As we are now in the heart of tax season, many business owners are looking for an accountant to complete their taxes. That's the wrong time to do it. Business owners need to establish a relationship with an accountant from the very beginning. It's important to receive tax advice on which business entity is right for your tax situation. Hiring a good accountant for your business is absolutely essential. A terrific accounting blog is the Tax Update Blog.

Lots of business owners also wait to establish a relationship with a banker until they need a loan. Again, that's the wrong time to start. Instead of opening an account at any old bank, get some recommendations and talk with business bankers before opening an account. Tell the business banker about your business and your plans. Try to stay in contact with the banker periodically if just to remind them you are still there. You never know when you might need a line of credit or loan. Establishing a relationship with a banker in the beginning can pay big dividends.

Find an insurance agent that specializes in insuring businesses. There may be hidden land mines out there that you can insure. I recently communicated with a business insurance agent regarding a contract matter for a client. The business insurance agent had important input that will protect my client moving forward. I seriously doubt an insurance agent dealing primarily with car and home loans would have known about the specific issues we were dealing with.

And if no one knows about you it will be tough to succeed! Consult with a marketing professional that is knowledgeable in your industry.  A tremendous blog on marketing is Drew's Marketing Minute.

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 I am very happy to announce my new companion Web site to go along with this blog at www.iowabusinesslawservices.com. The site will feature information on my legal practice areas, a simple way to submit information for formation of a new corporation or LLC and also a video resources section with tips on business and franchise law. We'll also feature many other business and franchise law resources as we develop out the site.

A new offering with the new site rollout is that I am immediately implementing a Subscription Services Plan to make legal services more affordable for the new or early stage company. Check it out for details.

I also set up a new Facebook page for the blog be sure to 'Like' the page for easy access to updates on business and franchise law.

Thanks so much for following Rush on Business. And look for some other exciting offerings from me very soon relating to franchise law.

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 The Classic Battle

A group of franchisees file a lawsuit contending the franchisor forces them to buy products and/or services at inflated prices while setting retail prices so low the franchisees cannot profit. The lawsuit also alleges that the franchisor omits or misrepresents key facts about its business operations when selling the franchise.

The franchisor, of course, denies the allegations and intends to vigorously defend the lawsuit.

The Issue

Many franchise agreements contain restrictions on the products and suppliers the franchisee may use. While this may seem reasonable in the beginning, (after all, you're buying a proven system, right?) many franchisees discover later they can get cheaper products and find better suppliers than they can using the franchisor's system.  The franchisees begin to question why they are paying for higher priced products along with paying royalties which eat into profits even more. When this happens franchisees tend to get upset and file lawsuits like the one described above.

If the franchisee agreement you are considering contains restrictions on products and suppliers be sure to consider those provisions very carefully. Be prepared to ask the tough questions of the franchisor when it comes to products and suppliers. Also, don't take for granted just because you are going with a franchise that you are getting the benefit of the franchisor's "bargaining power."

Above all, make sure to talk with as many current franchisees as possible regarding the products and services of the franchise and conduct your due diligence.

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I've seen it many times. A certain market or industry becomes "hot" and all the sudden franchises start popping up all over the place. For example, a few years ago the 24/7 fitness market took off. In the Des Moines, Iowa area there were all kinds of fitness franchises that entered the 24/7 fitness market. Unfortunately many of them went out of business and only a few major players remain.

This happens in other industries. Right now the self-serve premium yogurt market seems to be really taking off. You add the toppings yourself and then weigh the cup just prior to paying. Looks to be a "hot" concept. But in the end how many of these franchises will be around in 10 years? Don't know but it's safe to say there will probably be some winners and losers in that market. 

It's not a surprise that a significant percentage of franchises will fail. After all, the majority of businesses fail within the first 5 years. With the typical franchise agreement lasting 10 years, it's important to choose a concept that will have staying power rather than just the latest "hot" concept.

Buying a franchise is a major investment. Success is not guaranteed. Choose wisely.

For interesting reading take a look at this article on the Top Franchise Trends for 2013.

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This is Lesson #3 in a five-part series on the top reasons I've seen franchisees fail. 

Tucked away in nearly every franchise agreement is a provision that very few franchisees consider when they are purchasing a franchise business. The provision I am referencing gives a franchisor the right to sell or transfer its business to another person or entity. Now I am not saying that a franchisor shouldn't have that right. Of course a franchisor would like to reserve the right to sell its business as a succession plan or outright sale for profit. But unfortunately I've seen many franchise relationships change dramatically after the sale.

On many occasions I've found that the new franchise owners lack the spirit and care for the franchisee that the original owners may have possessed. The new franchise owners may not have the same goals or aspirations as the original owners. They may even change business models, pricing or marketing which could have a significant impact on your business. As a result, many franchise operations fail after the franchise has been sold.

If you are going into franchising, have careful and detailed talks with the franchisor about their goals. Find out if the franchisor is in talks with anyone to sell the franchise business or whether that is an ultimate goal of the franchisor. The franchisor may not always be candid with you but perhaps they will be and you will have gained valuable information in the process. If sale talks are imminent, you may be better off waiting to see what the new owner has in store for the franchise business. But no matter what be aware that the franchise business could be sold and consider carefully whether you are buying a "system" or whether you are getting caught up in the persona of the franchise owner. Because if you are buying the owner rather than the system, you may be in for a rude awakening if the franchise business is sold.

In the end, you are not likely to eliminate the risk that the franchisor could sell. An astute franchisor would not negotiate that provision away in a franchisor agreement. But consider that possibility from the start and whether the franchising "system" is right for you.  

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The franchising model is available in almost every industry. (Even law firms apparently). Reports have indicated there's nearly 1 million established franchised businesses in the U.S. Among those franchises are many unknown (or relatively unknown) franchises. In my opinion it is critical to buy franchises with brand recognition.

Does that take out many new franchises from consideration? Perhaps even the future Subway or McDonald's? Why yes, it does. Let someone else be the guinea pig. (This shouldn't be too hard in Iowa because most franchises become popular somewhere else before coming here). My rule of thumb - ask 10 of your friends if they have heard of your franchise opportunity. If they haven't, perhaps you should reconsider the opportunity. The upfront costs of franchising are often considerable higher than starting your own business. If the brand isn't recognizable, can you really justify the higher costs associated with buying a franchise or perhaps you are better off starting your own independent business?

I've seen several franchisees buy unknown franchises. In many instances it hasn't worked out. They spent a lot of money but really didn't get much in return. Part of the appeal of franchising is to license someone else's trademark. An easily identifiable trademark gives a franchisee a potential leg up. It doesn't guarantee success, but all things being equal, look to franchises with brand recognition. Sinking money into an unknown franchise is generally a poor investment in my experience.

For a good discussion on the pros and cons of buying well-known franchises read Does Buying a Big-Name Franchise Ensure Success?

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This is first a series of five blog posts on the top reasons I've seen franchisees fail.  

There's no substitute for hard work - Thomas Edison.

I often hear from franchisees that one of the main reasons they have decided to purchase a franchise business is "all the support I am going to receive from the franchisor." The franchisor has the system, the brand, the marketing plan and the experience, right?

I am here to tell you that these beliefs are often not the truth. Many franchisees I've represented have been sorely disappointed about the lack of support and assistance they have received from a franchisor. Often though it's not the franchisor's fault. After all, many franchisors never really promise support or assistance in their franchise disclosure documents and franchise agreements. So how in the world do franchisees get the impression that they'll have a leg up on starting their business?

Well, the franchise industry has done a terrific job of marketing itself. There are many success stories in franchising and it truly is a wonderful business model for franchise owners if executed correctly. Consider this quote from Wikipedia on franchising with a little emphasis from me:

Franchising is the practice of using another firm's successful business model.

The issue is that all franchisors are not created equal. There's no guarantee that the franchisor has developed a successful business model. In fact, many franchise business models are not successful at all. The truth is many franchises out on the market may have no real system, no brand recognition, no marketing plan or perhaps even little to no business experience with the franchise owners.

So that makes the initial decision on which franchise to choose so critical. Don't get sucked in by hype. At the end of the day, regardless of the franchise, it is so important to remember:

IF IT IS TO BE, IT'S UP TO ME. 

Don't get into the mindset that you'll receive a turnkey operation that will run itself. You will need to work your tail off to make your franchise operations work. If you don't, you are almost sure to fail. Unfortunately, I've seen way too many people who didn't understand this before they buy a franchise. Franchising does not guarantee success. Studies have shown that franchises fail at about the same rate as independent businesses. Don't automatically assume that just because a business has franchised that it is successful, or that the franchise can create success for you. Because at the end of the day your success will most assuredly rest upon your shoulders.

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The Iowa Supreme Court has announced that it is beginning a three-year project for an Iowa Business Specialty Court for complex cases with $200,000 or more in dispute. To begin the project, three Iowa judges will be hired for the court based upon their educational background, judicial and trial experience with complex commercial cases and personal interest.

Participation in the pilot project will be voluntarily and all parties to the dispute must agree to opt into the business court pilot program. It is anticipated the court will begin accepting cases no later than May 1, 2013. The Court covers the following:

Only cases in which compensatory damages totaling $200,000 or more are alleged, or claims seeking primarily injunctive or declaratory relief, will be eligible for assignment to the business court docket. In addition, to be eligible a case must satisfy one or more of the following criteria:

      I.        Arise from technology licensing agreements, including software and biotechnology licensing agreements, or any agreement involving the licensing of any intellectual property right, including patent rights.

   II.        Relate to the internal affairs of businesses (i.e., corporations, limited liability companies, general partnerships, limited liability partnerships, sole proprietorships, professional associations, real estate investment trusts, and joint ventures), including the rights or obligations between or among business participants, or the liability or indemnity of business participants, officers, directors, managers, trustees, or partners, among themselves or to the business.

   III.        Involve claims of breach of contract, fraud, misrepresentation, or statutory violations between businesses arising out of business transactions or relationships.

 IV.        Be a shareholder derivative or commercial class action.

  V.        Arise from commercial bank transactions.

 VI.        Relate to trade secrets, non-compete, non-solicitation, or confidentiality agreements.

 VII.        Involve commercial real property disputes other than residential landlord-tenant disputes and foreclosures.

VIII.        Be a trade secrets, antitrust, or securities-related action.

  IX.        Involve business tort claims between or among two or more business entities or individuals as to their business or investment activities relating to contracts, transactions, or relationships between or among them.

This is a step in the right direction in my opinion. I first starting writing about business courts here in Iowa in 2008. At that time, I asked whether Iowa needed a business court to compete. While I think it's a great step in the right direction, I'd like to see the threshold amount come down. Many small business owners express frustration because the costs of litigation are so high. Perhaps we can have a modified "business small claims" that would include cases in a minimum amount of $25,000 or so. That's real money for a lot of small businesses. But I am excited to see how the pilot program works and commend the Iowa Supreme Court for taking this initiative.

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In meeting after meeting with prospective franchisees I am asked what I would look for in a franchise opportunity. It's not an easy question. But trust me when I say that all franchise opportunities are NOT created the same.

What separates the good franchising opportunities from the bad franchising opportunities in my experience? Here are my top four reasons:

1. The Brand Must be Recognizable. Talk to 10 of your friends. If they've never heard of the franchise you may want to reconsider the opportunity. The upfront costs of franchising are often greater than starting your own business because of the associated franchise and other upfront fees. If the brand isn't recognizable, can you really justify paying the franchise fees or are you better off starting your own independent business?
2. The Franchise Has a Fantastic System. Are the operational processes the franchisor has in place so special that you couldn't duplicate it yourself or perhaps it would take you years to develop?  I say a franchise better have those fantastic operational processes in place or it probably isn't worth buying.
3. Unique Concept or Product. Does the franchisor have an unique concept or product that you are unable to duplicate yourself or perhaps it would be to expensive to develop on your own? 
4. Protected Intellectual Property. Does the franchisor possess protected intellectual property that would make it difficult or impossible to start the business on your own? If so, then franchising may be your only alternative to break into a particular market.

Time and time again I see people invest their life savings into franchising.  Some of these people achieve great results while others do not. There is no validity to the claim that franchise operations fail less than independent business opportunities. Be sure to examine franchise opportunities carefully and conduct your due diligence. The due diligence should include extensive interviews with the franchisor's management team and as many franchisees as possible. Get advice from a franchise lawyer, accountant and a banker regarding the opportunity. Educate yourself and be willing to walk away from the negotiations to get the best deal possible from the franchisor.

In conclusion, there are many other issues to consider when evaluating franchise opportunities but if the franchise opportunity doesn't have one of the four things above, it's been my experience you can probably just move on to the next opportunity.

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IASourceLink.com is a new online resource available to help small business owners and entrepreneurs across Iowa. I haven't had a ton of time to explore the site but I impressed with the information available on my initial review.

One neat feature is the Iowa Business Concierge service available in collaboration with MyEntre.Net. The business concierge service allows business owners to ask questions to get pointed in the right direction. 

For those in Central Iowa, you'll want to check out CISourceLink.com for business resources in the Central Iowa region. 

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In a recent review of a franchise disclosure document (FDD), I spotted a provision from a franchisor requiring the franchisee to pay any state taxes imposed on the franchisor as a result of the franchise operations within the state. Franchisees (particularly here in Iowa) should think twice before agreeing to this type of provision due to the Iowa Supreme Court's decision against KFC Corporation in December of 2010.

As I have touched on before in posts on this blog, the Iowa Supreme Court ruled that KFC Corporation could be taxed on revenues received from the state of Iowa even though the company had no physical presence within the state but rather received royalty revenues resulting from intangible property (i.e. the use of trademarks and license fees) within the state. It was probably the most significant franchise case to occur nationally over the past couple of years and understandably franchisors are concerned about it.

However, I doubt most franchisees understand the potential liability at stake. It's certainly not something most franchisees would anticipate paying in their business plan.  It could seriously cut into profitability. Given the court ruling on the subject in Iowa, tax payment shifting from a franchisor to the franchisee is not something to take lightly.

My advice for franchisees is that I would not agree to pay the franchisor's tax. Obviously a franchisor isn't agreeing to pay the franchisee's tax obligations. I have a hard time understanding how such a provision would be fair for a franchisee. 

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 In my last post I shared my ABI Quick Bits Interview on Wage & Hour Lawsuits. In that interview I discussed how I often hear employers reference "1099 employees". I cautioned that you should make sure not to confuse independent contractors and employees. They are separate worker classifications and it's important the your workers are classified correctly.

A recent post from Epstein Becker & Green builds on that thought by stating that Independent Contractor Misclassification Should Remain a Key Area of Concern for Employers. The post discusses on the Department of Labor will continue to work with state and federal agencies, including the IRS, to share information and jointly investigate worker misclassification. 

With the re-election of President Obama, employers can expect more awareness around worker misclassification issues by federal agencies in particular because of the Affordable Care Act ("ACA") 50-employee threshold. Federal and state agencies will likely have a watchful eye on employers teetering on that mark.

The penalties and expenses for misclassification of your workers are significant. It is recommended that you conduct a wage and hour audit periodically to make sure your business is in compliance.

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I recently sat down for an interview with Leisa Fox of the Iowa Association of Business & Industry to discuss wage and hour lawsuits. For a blog post I wrote on the topic see here.

Be sure to check out the other Quick Bits videos on a variety of business topics from ABI.

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