EXPORTING YOUR FRANCHISE TO THE UNITED STATES
By Carl J. Kosnar
The greatest growth in franchising over the past decade has been outside the United States. After examining the 2010 Asia-Pacific Franchise Guide and reviewing national franchise association Websites, it is obvious that franchising is increasing in popularity throughout the world. Despite their ever-increasing number, it is surprising that very few foreign franchise systems have extended their franchising programs to the United States.
This article is intended to provide practical advice for non-United States companies that are considering franchising in the United States. Although each company’s particular situation will be different, the following are some general considerations with regard to establishing a franchise system in the United States.
One of the major reasons foreign franchise companies have avoided the United States market has been the cost of conforming to old FTC Rule 436. The Amended Rule has made it substantially easier to do business in the United States.
Amended Franchise Rule Exemptions
Three new exemptions to the Rule enable many foreign-based franchise companies to avoid the franchise disclosure process altogether. The Amended Rule exempts franchise offers made to “sophisticated investors,” companies that have been in business for at least five years and have a net worth of at least $5 million. Only one member of an investor group needs to meet the requirement for the exemption to be applicable. Therefore, franchises may be granted to companies with established regional or national businesses without the need for a disclosure document, audited financial statements, or other documents usually required by the Amended Rule.
Also exempt are franchises requiring investments exceeding $1 million, excluding the cost of investments in unimproved land and any financing provided by the franchise organization. In calculating the investment, franchise companies may include the expenses and fees associated with establishing franchised outlets under multi-unit franchise agreements, such as area development agreements and master franchise agreements. Multi-unit franchising programs are the norm in international franchising and are therefore likely to satisfy the $1 million investment threshold in many retail and hospitality franchise offerings. Prospective franchisees who agree to convert existing business operations to a franchise also may include the value of their business assets in the calculation of the amount they are investing in a franchise.
Finally, franchises sold to officers, owners or managers of a franchise system which have been employed by the franchise company for at least two years before purchasing the franchise will be exempt. This will allow a joint venture formed to enter the United States market to be sold as a franchise if one of the franchise company’s management staff owns a 50 percent interest in the venture without the need for FTC disclosures. An entity “which is at least 50 percent owned by a person who, within 60 days of the purchase of the franchise, has been, for at least two years, an officer, director, general partner, individual with management responsibility for the offer and sale of the franchise system’s franchises or the administrator of the franchised network” qualifies for the disclosure exemption. The same exemption applies to a person who has owned at least a 25 percent interest in the franchise system for a two-year period, ending no later than 60 days before the franchise sale. Thus, if a member of a franchise firm’s management or ownership team could acquire a 50 percent “ownership interest” in a United States franchisee, and operate it as a prototype unit in the United States, the exemption would be available. The Amended Rule does not prohibit the other owners from having voting control over the franchisee entity, nor from investing a majority of the capital needed to acquire the franchise and launch the franchised business.
Financial Audit Requirement Changes
The Amended Rule relaxes the audit requirement somewhat, and allows foreign companies to use statements prepared under their country’s Generally Accepted Accounting Principles, so long as the statements also satisfy criteria published by the United States Securities and Exchange Commission for the use of foreign financial statements in United States securities offerings. Foreign franchise companies can usually find accounting firms willing and able to modify existing statements to meet the SEC criteria in a cost-effective way.
State Regulations Remain in Place
The Amended Rule applies to all franchises offered for locations in the United States and its territories. However, franchise sales laws in 15 states also regulate offers and sales of franchises by their residents to their residents, and sometimes to non-residents if franchised locations will be established in those states.
Market Research
Before entering the United States market, the first step is to determine the United States consumer market for the products or services. Is there demand for the products or services? What is the competition? What is the pricing? What are the costs of production and distribution considerations?
In addition, a company should conduct research on the market for franchises to sell the same products or services. Are there already systems which offer similar franchises? What are the initial fees and royalties? What type of training or support do they provide?
How to Get Started
A non-United States company should open at least one “company-owned” location (owned by the franchising entity) in the United States, before it begins to franchise in the United States. It needs to have this experience, so that it will know what is involved in opening a store in the United States, in terms of start-up costs, fees, build-out, government permits, supplies, and other aspects of the operations. This will also give it experience in determining the demand for the products and services in the United States, as well as the right form of marketing and pricing.
The experience of opening and operating a store in the United States will also give the foreign company the opportunity to “Americanize” the services and products, trying different business methods, branding, and pricing for the United States market. Only after it has this first-hand experience in the United States, will the company be ready to start offering franchises in the United States.
Corporate Structure
Normally, we advise foreign companies to form a United States affiliate company, which will issue the franchises in the United States.
This accomplishes a number of things: 1) limits potential liability of the “Mother” company if franchising in the United States does not go well; 2) avoids the possibility that a United States taxing authority may declare the”Mother” company must report all of its income to the United States taxing authority; and, 3) makes it less expensive to prepare audited financial statements for the franchising entity.
Trademark Registration
Trademark rights are generally determined in the United States by priority of use, and not priority of registration. Nevertheless, a company that is considering franchising in the United States should register its trademark as soon as possible. Registration serves a number of useful purposes, including putting the world on notice that the owner considers it a protected trademark, and also providing additional remedies if someone uses the trademark.
United States trademark law allows an applicant to file an application for trademark registration even before the applicant has started using the trademark in the United States (an “intent-to-use” application), provided that the applicant files a certification within three years after the application is approved confirming that it has in fact started using the trademark in the United States.
Training, Communication and Support
To succeed in any country, a franchisor must provide good training, support and communication.
Because it is normally unrealistic for franchisees to travel to a foreign county for training, the company must have staff in the United States to provide the training and support, either through the United States affiliate or master franchisees.
And most important for the long-term, the franchisor must have a good communication system, such as a Skype video telephone system, to allow the franchisor to communicate frequently with the franchisees, including providing rapid updates of the operations manual and approved supplier lists, as well as sharing solutions to common problems faced by franchisees throughout the system.
As most potential foreign franchise companies know, franchising in the United States presents a tremendous opportunity. The best way to get started will be different for each company, because each company’s situation is unique. Doing it properly can provide tremendous rewards.
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