What is the True Definition of a Franchise? What You Need to Know

At some point, every business owner says “I would like to franchise my business” and begins to entertain the idea of franchising. The simple truth is that any business and any idea can be franchised. Legally, all that is required of a business in order to franchise is the completion and filing of the proper documents. If franchising is to be used as the springboard for branding, market expansion and growth; then it is important to understand the true definition of a franchise relationship.

Under the Federal Trade Commission (or FTC) Franchise Rule (16 CFR Part 436, referred to from now on as the “FTC Rule”) a franchise is defined to include a relationship that has these three elements:

  • The buyer (franchisee) must use a common trademark, or to offer, sell or distribute goods, services or commodities that are identified or associated with the common trademark. In other words, the buyer must do business under the same name as everyone else in the system;
  • The buyer must operate the business in the same format as the seller of the business dictates. Basically the seller of the business (franchisor) has significant control over the method of business operations while providing ongoing operational and marketing assistance; and
  • The person purchasing the business is required to make ongoing payments to the seller of more than $500 per year as a condition of commencing operation of the business (otherwise known as a royalty). This required payment does not include any payments for the purchase of goods and/or products purchased from the seller. As a side note, in most circumstances (for consistency, quality and control) the seller (franchisor) requires the buyer (franchisee) to sell certain products that must be purchased either directly from them and/or approved vendors or suppliers.

Each of these three elements must be present for the FTC Rule to apply. When all of these elements are present, then the business relationship is defined as a franchise regardless of any disclaimers, waivers, releases or acknowledgments that may have been creatively crafted explaining that the business relationship is not a franchise. In fact such things have proven to be counter-productive and dangerous because they may disclose evidence that the seller of the business had some insight or knowledge of the likeness of the business relationship to the definition of a franchise. Further information regarding the FTC Rule can be found at https://www.ftc.gov/enforcement/rules/rulemaking-regulatory-reform-proceedings/franchise-rule.