Getting your legal house in order is paramount for new franchisors, writes Bruce McFarlane and Nick Rimington.
Ensuring that you are legally protected is crucial to creating a new franchise, let alone becoming the next Grill’d or Schnitz to take on the world.
Even seemingly insignificant decisions go towards laying the groundwork for success, and poor choices can come back to bite you. Common mistakes include setting up a company without proper legal advice and implementing agreements involving your intellectual property (IP) that fail to properly protect your interests.
New franchisors often face budgetary restraints in getting their ideas off the ground, so it is worth bearing in mind that some legal issues do not require immediate attention and can be managed over time. It pays to know, which issues must be addressed urgently and, which can wait. You can then plan an appropriate time frame for dealing with each of them in turn.
This is where a legal roadmap is critical to the success of a new franchise. Having a roadmap helps you to navigate the issues one step at a time, dispersing the costs. It allows you to look at the main areas of risk first and to consider legal issues which don’t cost much now, however, which may be expensive down the track if not properly addressed.
When embarking on the journey into franchising, you need to get three fundamental things right: your business, your market and your relationships.
1. Your business
The corporate structure needs to be suitable for a successful franchise business. A common mistake many new franchisors make is to set up their corporate structure without first seeking legal advice. This creates a number of difficulties later on when they realise the structure they’ve committed to doesn’t suit their business.
When they finally do seek legal advice (because they have to), it ends up costing them much more than it would have at the start.
Different corporate structures entail different responsibilities. They will influence how your business is taxed and your level of asset protection, among other things. The structure is critical for accommodating and attracting investors, and may influence your ability to achieve a successful sale of the business at some point in the future.
Registering your trademark is the next key business decision. As part of the registration process, you will find out if there are any conflicting trademarks on the register. If there are, you may need to rebrand.
For that reason, it is best to address this early in your franchise’s life rather than face a legal challenge later, when it can become particularly messy and costly. Moreover, you will avoid inadvertently contributing to someone else’s (possibly a competitor) business goodwill by mistakenly using their trademark.
Other intellectual property needs to be considered, such as the company brand and the operating systems.
A quality operations manual needs to be developed with help from a consultant; this may need to be adjusted from time-to-time, but is an essential element in quality control.
Franchisors must then ensure that they own all other intellectual property in logos, materials and their company website. The best way for them to do so is by executing contracts with service providers that adequately protect their IP interests; never leave it to trust and chance alone.
2. Your market
What kind of market are you entering? Is there room for your idea in the marketplace?
When thinking about the marketplace for their new franchise, there are several steps franchisors must take.
First, they must assess the competition. Thoroughly understanding your competitors is not only important in creating a successful business, it’s expected by future investors and potential business partners.
Secondly, franchisors must be careful not to use ideas already incorporated into competitors’ businesses. Even accidentally copying a competitor’s idea may leave you susceptible to a claim. Research into competitors’ businesses at an early stage is key to avoiding this issue.
Thirdly, a successful franchise requires an innovative and unique approach – something that sets you apart in the marketplace. The only way to know what’s not in the marketplace is to know what is.
Finally, in preparing for entry into the market, a franchisor will need to develop a strategic growth plan to avoid ad hoc and unsustainable growth. To do this properly, you will need to know the marketplace back-to-front.
3. Your relationships
Franchisors can’t afford to be casual with their relationships. As your business grows, any agreements must be strong, realistic and underpinned by sound legal advice. The key relationships you should consider include:
Key supply contracts are critical to ensuring product consistency and a reliable supply chain to franchisees.
Any unique recipes and processes require tight confidentiality and intellectual property protections. Franchisors may consider putting in place approved or compulsory third-party suppliers, which could create an extra source of revenue through rebates. Supplier exclusivity can keep good products out of the hands of your competitors.
However, franchisors should be wary of the ‘third line forcing’ provisions in the Competition and Consumer Act 2010 (Cth). In the franchising context, this is relevant where the franchisor wishes to force its franchisees to obtain other goods or services from an unrelated third-party supplier. Third line forcing is per se illegal, but franchisors can seek protection from these laws by lodging a third line forcing notification with the ACCC.
Well-drafted employment contracts are critical to a successful franchise business. Their most important function is to attract and retain key employees, but including appropriate clauses (such as restraints of trade, intellectual property protections and confidentiality) to protect your business’ assets is equally critical in maintaining an advantage over your competitors.
The recent examples provided by Subway and Pizza Boys demonstrate the significant damage a franchisor-franchisee dispute can do to the reputation (and business) of a franchise chain.
Harmony between franchisors and franchisees — so critical to the long-term success and sustainability of a franchise — is built on strong policies and procedures, which fairly protect both parties’ interests.
Crucial to that harmony is having a good franchise agreement in place. Franchise agreements set certain standards and expectations around performance. These will involve internal policies for recruiting and dealing with franchisees, including policies around poorly performing franchisees and terminating the relationship.
When considering termination, franchisors must ensure there are solid grounds. If the breaches are not clear-cut, it can come down to establishing a chain of evidence illustrating the franchisee’s poor performance over time.
That can be a difficult and laborious process but will be avoided if the franchise agreement clearly sets out the parties’ obligations and rights to terminate (if any).
Franchisors need to ensure they can comply with their disclosure obligations. The new Franchising Code of Conduct (Code), which is due to take force on 1 January 2015, will allow the ACCC to seek civil penalties of up to $51,000 per contravention of certain provisions of the Code, and to issue infringement notices of up to $8,500 per contravention without seeking a court order. Franchisors therefore need to ensure they follow the correct disclosure process and provide a disclosure document to all franchisees.
Seeking specialist advice early in your journey is a sound investment for future success and protects the business from avoidable risks. What you spend in the early days is an investment that will return dividends in the long run.
Bruce McFarlane is a partner (pictured left) and Nick Rimington is a lawyer (pictured right) at Hall & Wilcox Lawyers.
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