American Bar Association

rd
33 Annual Forum on Franchising

Starting a Franchise System:

Practical Considerations, Planning and Development

Jim Meaney
Zaino & Humphrey

Max Schott, II
Gray Plant Mooty

October 13 – 15, 2010

The Hotel Del Coronado
San Diego, CA

©2010 American Bar Association

 STARTING A FRANCHISE SYSTEM:
PRACTICAL CONSIDERATIONS, PLANNING AND DEVELOPMENT

I. INTRODUCTION ............................................................................................................ 1

II. PRE-MEETING PREPARATION .................................................................................... 1

A. Gather Information Regarding Potential Start-Up Franchisor............................... 1

B. Develop Initial Checklist ...................................................................................... 2

C. Conduct Internal Conflict Inquires........................................................................ 3

III. INITIAL CLIENT MEETING ............................................................................................ 4

A. Location of Meeting ............................................................................................. 4

B. Key Areas to Cover at Meeting............................................................................ 4

1. Background and History........................................................................... 4

2. Is Franchising the Best Expansion Approach? ......................................... 5

3. Is the Concept Franchise-able? ............................................................... 5

4. Trademark Status .................................................................................... 6

5. Financial Statements ............................................................................... 6

6. Initial Development Plan .......................................................................... 7

7. Use of Franchise Consultants and Other Professionals ........................... 8

8. Overall Budget ......................................................................................... 9

a. Your Legal Fees; Engagement Letter........................................... 9

b. Fees For Franchise Consultants and Other Professionals.......... 10

9. Franchise Program Development Questionnaire.................................... 10

10. Other Areas ........................................................................................... 10

IV. FURTHER CLIENT MEETINGS ................................................................................... 11

A. Entity Selection: Will Existing Entity Suffice or Should New Entity Be

Formed?............................................................................................................ 11

B. Previous Expansion Efforts ............................................................................... 13

C. What is the Grand Development Plan?.............................................................. 15

i
 D. Reservation of Rights to Start-up Franchisor ..................................................... 16

E. Profit Margin Available to Future Franchises in Light Of Fees, Costs and

Royalties ........................................................................................................... 17

F. Potential Fees and Costs – Initial Franchise Fee, Royalties, Advertising

Requirements Etc.............................................................................................. 18

G. Reviewing and Analyzing Data Regarding Competitors..................................... 19

H. Are There Any Special Industry Laws or Regulations? ...................................... 20

I. Attributes Required of the Ideal Franchise Candidate........................................ 20

J. Analyze Current Management Teams’ Strength, Weaknesses and

Background ....................................................................................................... 22

K. Reviewing and Verifying Client Information ....................................................... 23

L. Training Plans, Training Manuals and Other Training Materials......................... 24

M. Development of Operating Manual .................................................................... 25

N. Products, Services and Approved Suppliers...................................................... 27

O. Advertising Requirements and Advertising Funds ............................................. 28

P. Initial Capital Investment ................................................................................... 29

Q. Financing Alternatives for Franchisees.............................................................. 30

R. Discuss Client’s Specific Sales Strategy............................................................ 33

S. Dispute Resolution Alternatives, Choice of Law, Venue Etc. ............................. 34

T. Inclusion of Financial Performance Representation (“FPR”) in Item 19.............. 37

U. Preparation of Agreements Other Than Franchise Agreement .......................... 39

V. Additional Trademark and IP-related Issues ...................................................... 40

V. FINAL MEETINGS AND PREPARATIONS .................................................................. 40

A. Finalizing the FDD............................................................................................. 40

B. Reviewing Financial Statements and Accountant’s Consents............................ 41

C. Submission of State Filings ............................................................................... 41

D. Providing General Franchise Sale Compliance Training and Tools to

Start-up Franchisor............................................................................................ 42

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VI. CONCLUSION.............................................................................................................. 42

APPENDICES

A. Franchise Program Development Questionnaire

B. Franchisee Application/Questionnaire

C. Due Diligence Questionnaire (For Entire Franchise Team)

D. Due Diligence Questionnaire (For Individual Franchise Team Members)

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 STARTING A FRANCHISE SYSTEM:
PRACTICAL CONSIDERATIONS, PLANNING AND DEVELOPMENT

I. INTRODUCTION1

Starting a franchise system is a collaborative, symbiotic process. Business owner and

legal counsel each possess special knowledge, unique skills and a talent for their craft. Nothing
is more rewarding than seeing a franchise system blossom from a seed of an idea. It is a
special experience in the life of a franchise lawyer; an opportunity to participate in the
entrepreneurial process and help a company grow. While this process will draw on all of a
lawyer’s knowledge, experience and business savvy, it begins with the client.

Each client is unique. Each client is an expert in its own right. Each client takes pride in
its business. Your job, from the outset, is to gather from your client and outside sources as
much information as you can about the client and its business. This should be the focus of your
initial meeting with your potential franchisor client and your pre-meeting preparation. That is,
before you start the franchise analysis and education process, listen to and learn about your
client. You know franchising; your client knows its business. Let your client tell you in its own
words about its business and expansion plans. This type of practical advice is the focus of our
paper and presentation.

While this paper will center on representing a start-up franchisor, and touch on many
aspects of developing a new franchise system, we do not offer an exhaustive treatise on the
subject. We will, however, concentrate on the most pertinent issues encountered when
representing a fledging franchisor and, when possible, refer to more detailed works on this
broad subject and its constituent parts.2 In addition, in the Appendices, we offer a number of
practice aids, including sample questionnaires and a franchise application/questionnaire.
Finally, we also will discuss the limits of the franchise lawyer’s advice, the recommendation and
involvement of other knowledgeable professionals, and ways a lawyer should protect him or
herself.

II. PRE-MEETING PREPARATION

A. Gather Information Regarding Potential Start-Up Franchisor

As we mentioned, the initial focus of the franchise system development process is

learning as much as you can about your client and its business. After you receive that

1
The authors wish to thank principal Elizabeth Dillon and associate Erin Stein of Gray Plant Mooty for their valuable
contributions to this paper.
2
A number of quality papers, articles and books have been written on this subject. The following is a list of some of
them: Kenneth F. Darrow, Mark Siebert and Phyllis Alden Truby, The Structural Elements of a Franchise System and
TH
Their Economic and Legal Implication for Start-up and Existing Systems, A.B.A. 30 ANNUAL FORUM ON FRANCHISING,
Tab W2 (2007); James R. Conohan, Kevin P. Hein and Cheryl L. Mullin, Starting a Franchise System: Special Issues
RD
and Considerations, A.B.A. 23 ANNUAL FORUM ON FRANCHISING, Tab W11 (2000); Rocco Fiorentino, Marisa Faunce
and Michael Seid, Helping Franchise Systems Succeed: Avoiding the Pitfalls Encountered in the Early Stages of
ST
Franchising, INT’L FRANCHISE ASS’N 41 ANNUAL LEGAL SYMPOSIUM, Ch. 7 (2008); Michael Seid and Dave Thomas,
FRANCHISING FOR DUMMIES (2d ed. 2000);FUNDAMENTALS OF FRANCHISING (Rupert M. Barkoff and Andrew C. Selden,
eds., 3d ed. 2008); Harold Kestenbaum and Adina M. Genn, SO YOU W ANT TO FRANCHISE YOUR BUSINESS (2008);
David J. Kaufmann and David W. Oppenheim, INTRODUCTION TO THE LAW OF FRANCHISING (2d ed. 2008).

1
introductory call or request to meet with the client, you should do all you can to satisfy your
curiosity about the client’s business. Exploration of its website is easy enough. It certainly
should acquaint you with the business, how it is presented to the public and, in some instances,
provide a history of the company, introduce the founder and officers and offer a flavor of the
“style” of the business. This is a good time to see if the client has “jumped the gun” by making
statements on the website about licensing, business opportunities or franchise offerings.

Other sources include Hoovers, press releases and, of course, a general Google search.
Not to be overlooked is your client’s secretary of state or corporations commissioner, which
should provide you with the means to search for the formal registration of the client’s business,
as well as any state trade name or trademark registrations. The United States Patent and
Trademark Office (“USPTO”) allows you, through its website,3 to search pending and registered
trademarks (using the Trademark Electronic Search System or TESS), or search patent
databases, if the concept involves an existing patented product or has the potential to obtain
patent protection. Similarly, the United States Copyright Office maintains a website that allows
you to search for federally registered copyrights.4 If there are existing franchise systems within
your client’s industry (or a similar industry), it also may be helpful to review the Franchise
Disclosure Documents (“FDDs”) for these systems. The California Department of Corporations
makes available on its website through its Cal-EASI database5 all franchise documents filed with
its offices. This means that you can quickly access the FDDs of all franchisors that register in
California and do not submit exemption filings. Other franchise registration states may also
allow you to review FDDs in their offices or offer to copy or email them to you for a fee. Private
sources, like FRANdata or UFOCs.com, also sell past and current UFOCs/FDDs. Further,
depending on your client’s business, there may be various industry or feasibility studies publicly
available for your review. The point is to gather as much intelligence as you can.

B. Develop Initial Checklist

Based on the information you gather, we recommend that you develop an initial, pre-
meeting checklist that includes the following:

o Basic information about the company, including its business, principal place of
business, entity structure and industry.
o Prior period of operation, length of time in industry.
o Current management team.
o Previous expansion efforts.
o Any existing “licenses,” “joint ventures” “partnerships,” or “business opportunities”
granted, that may be unintended franchises.
o What is prompting interest in franchising the existing business?
o What are the company’s general expansion plans?
o Registration status of primary trademarks.
o Investigation of industry background, competitors, other franchise systems etc.
o Any unique proprietary property (patents, copyrights, trade secrets, manuals,
etc.).

3
United States Patent and Trademark Office, www.uspto.gov (last visited Jul. 31, 2010).
4
United States Copyright Office, www.copyright.gov (last visited Jul. 31, 2010).
5
California Department of Corporations, www.corp.ca.gov/CalEASI/caleasi.com (last visited Jul. 31, 2010).

2
 In your preliminary calls with the client, you also may want to determine the client’s
sophistication level by inquiring about its current professional advisors (accountants, consultants
and attorneys), composition of the management team, existence of a business plan, knowledge
of franchising, current financial statements and the basic operational nature and structure of the
business. This will allow you to add to your checklist:

o Current professional advisors.

o Current financial statements and overall financial condition.
o Relationship with current vendors, customers and other stakeholders.

In addition to simply securing preliminary information you will need for your work, you
are preparing to demonstrate to the client, at the appropriate time, your interest in its business,
your independent knowledge and your access to resources. Remember though to keep this
information and the questions it may bring in check until the client has had a full opportunity to
educate you about its business.

C. Conduct Internal Conflict Inquires

In addition to gathering external information about your potential franchisor client and its
business, it is also important to perform some internal inquiries before your initial meeting. We
recommend that you conduct a preliminary conflicts check using all of the persons and entities
you know or suspect are associated with the client. In addition, if you or your law firm represent
other franchisors in the same industry as your potential franchisor client, you may want to
consider whether this will create a problem. While it may not pose an immediate ethical conflict,
your potential franchisor client, as well as your existing clients and your colleagues who work
with them, may object. Some law firms even go so far as to represent only one franchisor in a
particular industry or segregate attorneys working for different franchisor clients in the same
industry. Further, if you also represent franchisees, you may want to consider whether this
representation creates any conflicts with your potential representation of the start-up franchisor.6
Plenty of franchise attorneys represent both franchisors and franchisees, while others make it a
point of representing one or the other.7

Once you have gathered all the information you can about your client, prepared a
checklist and conducted appropriate internal inquiries, you are now ready for your initial
meeting. While your client’s completion of a detailed questionnaire will be a critical piece in the
development of its franchise program, as further explained in Section III.B.9, we recommend
that you do not provide a questionnaire to your client until at least the end of your initial meeting.

6
See Gary R. Duvall, Switch-Hitting Franchise Lawyers: Representing Both Franchisees and Franchisors, 12 THE
FRANCHISE LAWYER (Fall 2009).
7
For an up-to-date analysis on these and other ethical issues franchise attorneys face, see Rupert M. Barkoff and
RD
Andrew C. Selden, Ethical Issues for Attorneys and Other Professionals in Franchise Counseling, A.B.A. 33 ANNUAL
FORUM ON FRANCHISING, Tab W13 (2010).

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III. INITIAL CLIENT MEETING

A. Location of Meeting

Before we focus on what should be accomplished during the initial meeting, first a word
on where the meeting should take place. This is simple but important. In a perfect world, all
initial client meetings would be face-to-face. A face-to-face meeting, however, may not always
be practical or economical, especially if a lawyer is not located in the same city or surrounding
area as the prospective franchisor client. As a result, the “initial meeting,” as well as subsequent
meetings, may actually be conducted via telephone or videoconference. As a practical tip,
Skype Technologies S.A.8 offers software that allows its users to make free or low cost video
and voice calls. Keep in mind our references to meetings may include videoconferences and
teleconferences.

Where a face-to-face meeting with a prospective franchisor client is possible, however,

by all means take advantage of it. And, if that meeting can be at the client’s place of business,
all the better. Nothing is more important to the client than its business and, by meeting the client
on its turf, you will begin to develop a broader understanding of the client and their business
operations. Therefore, unless the client specifically requests a meeting at your office for privacy
sake or just to be away from its office, the best place to conduct the initial meeting, if possible, is
at the client’s business. If you do not meet at the client’s place of business initially, do make a
point of getting there as soon as you can during the development process. Client visits:

o Send a message to your client that you are truly interested in its business.
o Create a comfort-level for your client.
o Offer you a visual impression of your client’s business.
o Provide you with a first-hand opportunity to observe the actual operations of the
business.
o Give you a chance to meet others on the management team.
o Provide you with possible access to existing documents, registrations, vendor
agreements, etc.

In our experience, client visits significantly enhance a lawyer’s overall understanding of

the franchisor’s concept and ability to draft accurate and meaningful legal documents.

B. Key Areas to Cover at Meeting

There are a number of key areas that should be covered at the initial client meeting.

1. Background and History

Understanding the background and history of your potential franchisor client is essential.
A client is usually happy to share with you the details of its business and you should get them to
tell you about it early on in the meeting. Use your pre-meeting checklist to confirm, correct and
supplement the information you have previously gathered. Before you move on to other topics,
make sure you have a firm grasp of the client’s business and operations, how long the client has
been in business, prior expansion efforts, the experience of its management team, the client’s
market and competitors, and what has caused the client to consider franchising. A solid and

8
Skype, www.skype.com (last visited Jul. 31, 2010).

4
compelling history is a real plus for a start-up franchisor and may prove to be an important sales
tool for initial franchise sales.

2. Is Franchising the Best Expansion Approach?

Before you get too far along, you should address whether franchising is the best
approach for the client’s expansion and whether the concept is “franchise-able.” While related,
these are really two separate questions. The first focuses on whether the franchise model fits
with the client’s plans and goals. At this point, we recommend a quick discussion on the
elements of a “franchise,”9 the pros and cons of franchising in general,10 and potential
exemptions or exclusions that may apply to a particular franchisor.11 This discussion should also
go on to explore non-franchise alternatives that may be available to the client, including
licenses, business opportunities, dealerships, distributorships, partnerships, joint ventures and
management arrangements.12 You should be prepared to discuss, analyze and advise your
client on all the alternatives and the legal implications and complications of each. This is likely
not a one-time discussion. As the franchise flower blooms and complications emerge, the client
may want to revisit the alternatives. This will become more apparent as you move forward in the
process.

3. Is the Concept Franchise-able?

Even if franchising is in line with a client’s plans and goals, it does not mean that their
concept is “franchise-able.” This is a separate analysis that should occur in the initial stages of
the process. While much of this analysis is grounded in common sense, the following is a list of
some of the factors that you and your client will definitely want to consider:

o Ease with which the concept can be duplicated and adapted to different markets.
o Current and future demand for the client’s products and services.
o Competition.
o Success of company-owned units.
o Unit economics/return on investment (“ROI”) (further discussed in Section IV.E).
o Strength of trademarks and other critical intellectual property (“IP”) (further
discussed in Section III.B.4).
o Skills and adaptability of management team (further discussed in Section IV.J).
o Capital (further discussed in Sections III.6, III.8 and IV.P).13

9
16 C.F.R. § 436.1(h) (2007). See also Mary Ann O’Connell, Robert A. Smith and Scott Weber, What is a Franchise?
RD
What Are The Various Types of Franchise Relationships?, INT’L FRANCHISE ASS’N 43 ANNUAL LEGAL SYMPOSIUM, Tab
26 (2010); Kenneth R. Costello, Beata Krakus and Kristy L. Zastrow, From License Agreement to Regulated
ND
Relationships: The Accidental Franchise, A.B.A. 32 ANNUAL FORUM ON FRANCHISING, Tab W11 (2009).
10
See Darrow, supra note 2; Kestenbaum, supra note 2, at 3.
11
See Karen B. Satterlee and Leslie D. Curran, Exemption-Based Franchising: Are You Playing in a Minefield?, 28
FRANCHISE L.J. 191 (Spring 2009); Earsa Jackson and Karen Satterlee, Navigating the Exemption/Exclusion Maze
ST
Under the Amended FTC Rule and State Laws, A.B.A. 31 ANNUAL FORUM ON FRANCHISING, Tab W11 (2008).
12
See Darrow, supra note 2; Conohan, supra note 2; Costello, supra note 9.
13
For a further description of these and other factors, see Kay Marie Ainsley, Debra A. Harrison and David W. Koch,
The Evolving Franchise System: How To Guide an Emerging System From “Baby Steps” To A “Grown-Up” System,
RD
INT’L FRANCHISE ASS’N 43 ANNUAL LEGAL SYMPOSIUM, Ch. 10 (2010); Darrow, supra note 2; Conohan, supra note 2.

5
 It is important that you discuss this topic with your client at the initial meeting to at least
make a preliminary assessment as to the franchise-ability of the concept. Just because the
concept passes this threshold test, however, does not mean your analysis ends there. You will
definitely want to further explore these factors and, depending on the skill-set of the client’s
management team, will likely want to encourage your client to involve a franchise consultant
who can assist it in assessing the business potential of the concept. We discuss the use of
franchise consultants and other professional in Section III.B.7.

As franchise counsel, it is incumbent on us to help our prospective franchisor clients

conduct this analysis before they embark down the franchise path. Recent data indicates that of
the new franchise brands that began franchising in 2009, over 80% of them had less than one
year of business experience (fewer than 10% had more than five years business experience),
and an estimated 14% of them had no company-owned units at the start.14 This data is
somewhat alarming and begs the question of whether a number of existing start-up franchisors
should not be franchising. While we recognize that this may be more of a moral than a legal
issue, we also believe that franchise attorneys ultimately should be striving to put their clients in
a position to succeed - not fail.

4. Trademark Status

Given that a franchisor’s trademark will become the heart of its franchise concept, you
must assess early on in your meeting the strength of the client’s proposed primary trademark
and the status of any related federal and state registrations or applications. Oftentimes clients
are not aware of the importance of this crucial element in the franchise development process.
Many have been led to believe that a state registration or simple common law “TM” designation
is sufficient. Upon review, however, you may determine that the trademark the client wants to
use, or is using with its company-owned units, is already registered with the USPTO or with
certain states to another party, is currently being used by other parties, or is weak and not likely
to be registered by the USPTO. In this case, the client may have to select a different trademark
to file with the USPTO. Because trademark protection must logically precede a franchise
program roll out, it is imperative that issues related to this essential item be addressed
immediately. Also, if other IP is critical to the franchise concept, like a patent, copyright or trade
secret, you will want to assess the strength, ownership, registrations and protections relating to
those items.

5. Financial Statements

Another top-of-the-list item is to take stock of the current financial statements that are
being prepared for the company, if any, and to alert the client from the outset what financial
statements it will need to prepare as a franchisor. Clients new to the franchise arena are
frequently surprised by the requirements and ultimate costs in the area of financial disclosure.
This discussion also figures into an analysis of whether a new, separate entity should be formed
exclusively for franchise operations, a topic we discuss in Section IV.A.

A start-up franchisor may phase-in the use of audited financial statements under the
FTC Franchise Rule, provided it is new to franchising, is not a spin-off, affiliate or subsidiary of a

14
Phil Zeidman, Darrell Johnson, John McDonald and Brian Schnell, A Look Back to Better Understand Our Future,
RD
INT’L FRANCHISE ASS’N 43 ANNUAL LEGAL SYMPOSIUM, PowerPoint presentation, May 16, 2010.

6
franchisor, and has not previously prepared audited financial statements in the ordinary course
of business.15 If available, this deferral allows the franchisor to avoid the cost and effort of the
preparation of audited financial statements for the first year. Some states, however (like
Minnesota),16 do not allow a franchisor to use unaudited financial statements, while other states
(like California and Illinois) allow for the use of unaudited financial statements only if the
financial statements are subject to an independent review.17 Using the audited financial
statements of a client’s parent or affiliate also may be an option, provided the parent or affiliate
is willing to disclose its financial information to the public and guaranty the obligations of the
franchisor under its franchise agreements. As further explained below, in some cases, a
franchisor also may be obligated to include in its FDD the audited financial statements of certain
of its parents.

We think it prudent to advise start-up franchisors to meet with their accountants sooner
rather than later to prepare for the future. This inquiry will not only help prevent later delays, but
will likely result in the franchisor receiving guidance from its accountants as to how to trim
inefficient and incompatible bookkeeping practices while implementing audit-friendly
procedures.

6. Initial Development Plan

Once you have covered the areas discussed above, we suggest that you ask the client
to describe its initial development plan. Although you are likely to have more experience than
your client in this area, the “listening and learning” approach should still be in play. Allowing the
client to outline its franchise expansion plan in its own words and concepts may expose you to a
new approach that is best for the company. Also, a client who has built its own business is
typically used to doing things its own way – so hold on, there is plenty of time to mold the
franchise offering into a more legally acceptable approach; allow the client to freely outline their
development plan.

If at the end of their explanation, however, your client has not covered all of the
essentials, prompt them with appropriate questions. You need to make sure that your client has
considered and included the following in its initial development plan:

o Method(s) of development (i.e., single unit, multiple unit, development agent,

master franchising).
o Area of development.
o Number of franchised and company-owned units to be developed, and the
schedule for that development.

15
16 C.F.R. § 436.5(u)(2) (2007); The Amended FTC Rule Statement of Basis and Purpose, 72 Fed. Reg. 15445-
15544 (March 30, 2007) (“Statement of Basis and Purpose”) at 15511. See also W ASH. ADMIN. CODE § 460-80-140
(2010).
16
MINN. STAT. § 80C.04(g) (2006) and MINN. R. § 2860.1400 (1995).
17
California will allow a start-up franchisor to use unaudited financial statements if the franchisor submits a “Review”
report balance sheet. State of California, Department of Corporations, “Guidelines for Franchise Registration,” avail.
at http://www.corp.ca.gov/forms/pdf/310111UFDD.pdf. Illinois will allow a start-up franchisor to use unaudited
financial statements only if prepared by an independent certified public accountant in accordance with GAAP. 83 ILL.
CODE R. § 200.600 (2002).

7
 o Planned growth of internal staff and infrastructure to support its development
plan, and sources of capital to fund that growth.

While often overlooked, we also recommend that you discuss with your client at this
early stage their long-term goals and intended exit strategy. While some start-up franchisor
owners plan to be in the franchise business for the long haul, others plan to grow their system to
a certain point and then sell it or take it public. As a good franchise lawyer, you should make a
point of knowing your client’s future goals and plans, and using them as a guide during your
representation of the client.

7. Use of Franchise Consultants and Other Professionals

Because franchising is a regulated industry, there are a number of legal components

involved in the preparation of a new franchisor’s start-up program. The preparation of a new
franchise program, however, also involves a multitude of non-legal, business issues. While as
franchise lawyers we are well-suited to assist our clients with the legal aspects of franchise
development, we may not be as qualified to give business advice. In addition, even if you have
the requisite background, knowledge and experience to provide business advice, you may want
to consider whether your malpractice insurance covers this type of advice. In most cases it will,
if it is within the scope of your legal work, although it may not be a bad idea to know the
limitations of your coverage in this area.18 Further, you should be mindful of the potential
limitations of the attorney-client privilege when providing advice that is predominantly business
rather than legal in nature.19

This is not to say, however, that you should completely abandon your client on these
issues. Instead, you should stress the importance of having knowledgeable and experienced
individuals address the business issues, and alert the client that there are franchise consultants
available to help it with these business issues if it does not internally possess the appropriate
level of knowledge and experience. There are many franchise consultants offering a variety of
services, including determining whether the existing business even has a chance of success
using the franchise model. In addition, consultants specialize in manual drafting, sales
brokering, marketing, training development, e-learning, software development, accounting
systems, advertising programs, and insurance plans, just to name a few. Over time, you will
most likely get to know and work with a number of franchise consultants, and can draw on these
relationships for referrals. You also can seek quick referrals through the ABA Forum on
Franchising ListServ.20 Further, lists of franchise consultants and other professionals can be
found using simple Google searches or by accessing various publications, like the International
Franchise Association’s Franchising World, that annually publish lists of franchisor suppliers.21
As a franchise lawyer, you owe it to your new client to inform it of the availability of these
services.

18
See Michael H. Seid and Leonard D. Vines, The Respective Roles of the Franchise Consultant and the Franchise
TH
Lawyer in Structuring the Franchise System, A.B.A. 30 ANNUAL FORUM ON FRANCHISING, Tab W18 (2007).
19
Id.
20
ABA Forum on Franchising, List Serv http://new.abanet.org/Forums/franchising/Pages/ListServ.aspx (last visited
Jul. 31, 2010).
21
Franchising World, IFA’s 2010 Supplier Source Book (Oct. 2009).

8
 Your client will likely already be working with an accountant. It is important, however,
that your client confirm that its accountant understands franchising, or is willing to learn what is
required, so that there are no delays in obtaining the necessary financial statements and
accountant’s consents when they are needed. In addition to the preparation of financial
statements mandated by FDD Item 21, an accountant experienced with the company, may also
offer insights into the development of FDD Items 5 (Initial Fees), 6 (Other Fees), 7 (Estimated
Initial Investment), 8 (Restrictions on Sources of Products and Services), 10 (Financing) and 19
(Financial Performance Representations);22 thus assisting with the long-range financial planning
for the sustainability of the system. Further, your client may already have in place other
attorneys to assist it on non-franchise issues, such as trademark registrations, general
corporate work, employment matters and litigation. While your client may transfer some of this
work to you, it is not uncommon that the client will hire you only for the franchise work. What this
whole structure means, is that you will most likely be working with your client, along with
franchise consultants and other professions it hires, to develop and launch its franchise
program. Although this can create some scheduling and communication issues, these other
parties often provide valuable information and, in some cases, detailed reports, which can be a
big help in preparing the FDD and other franchise documents.

8. Overall Budget

Before you get too deep into the process, it is imperative that you have a frank
discussion with your client regarding your fees, as well as the potential fees of any franchise
consultants and other professionals. As explained above, your fees will not be the only fees that
the client will incur in the preparation of its franchise program, and the client should be
encouraged to establish an overall budget. This is important in determining how much capital
your client will need and, ultimately, whether the franchise approach makes good economic
sense. The investment necessary to set up and launch a franchise program the “right way,” is
fairly significant. While smaller, cash-strapped companies may be able to cut corners and get
franchise documents prepared on the cheap, they may very well be dooming themselves and
their franchisees because of their failure to properly vet the concept and protect their interests.

a. Your Legal Fees; Engagement Letter

From the outset, you need to agree upon the services you will provide and your fee for
those services. In the current economy, franchise lawyers (like everyone else) are being asked
to do more for less. The preparation of FDDs is also being seen more and more as a
commodity, rather than an art. Accordingly, prospective start-up franchisor clients are often
requesting flat or capped fees, and looking for the absolute lowest price – regardless of
reputation, expertise or past experience. Given this environment, a franchise lawyer must stress
his or her expertise to the client and the value this brings to the equation. Doing things right from
the beginning should be of paramount importance to all start-up franchisors. The lawyer must
then come up with a fee that is acceptable to the lawyer and his or her client, consistent with the
overall budget, and still allows the lawyer to put in the time necessary produce quality
documents tailored to the client. This can be a careful balance. Weighing into the analysis is the
fact that some franchisor lawyers may be willing to treat FDD preparation a as loss leader;
investing in what they hope will be a long term relationship with the start-up franchisor. Whether
you decide to engage in this practice is your choice, although we recommend you proceed with
caution as the future success of your client is never certain.

22
See 16 C.F.R. §§ 436.5(e)-(h), (j) and (s).

9
 Whatever fee arrangement you ultimately agree upon, we strongly recommend that you
memorialize it in your engagement letter with the client. To ensure that there is no confusion,
include in your engagement letter a schedule of the services that are covered, and the services
that are not covered. We also advise that you clarify whether any flat fee or cap covers things
like preparing software license agreement or other documents other than the franchise
agreement, state filing fees, photocopies, overnight deliver services and responding to comment
letters.

b. Fees For Franchise Consultants and Other Professionals

In most cases, you will have little control over the fees your client pays its other lawyers,
franchise consultants and accountants. It is important, however, to have a general sense of the
other third parties involved and how the work being performed by these parties may impact your
work and fees. At the end of the day, the fees being paid to outside suppliers are all coming
from the same pot.

9. Franchise Program Development Questionnaire

It is tempting in the initial meeting to press on to a discussion of the FDD and its 23
categories of information, but, in most cases, we recommend setting up a follow-up meeting to
commence the FDD preparation process. The end of the initial meeting, however, is a good time
to provide a quick overview of the FDD and to provide your client with sample FDDs, if it is not
familiar with the format and general content. It also is a good time to introduce and deliver to the
client the questionnaire you plan to use. We have included a sample franchise program
development questionnaire as Appendix A, although you will want to tailor it to fit your own style.
Whatever the form, the use of a questionnaire is a must. The preparation of an FDD can be a
long and arduous process. Extracting information from clients is often tedious. A questionnaire
will keep you and the client on track and will serve as a great organizational tool. Even if your
client uses a franchise consultant with its own form questionnaire, we still recommend that you
send the client your questionnaire. This will help ensure that you receive all information you
need to prepare the franchise documents.

By doing more with the questionnaire at the initial meeting than simply introducing it,
however, you run the risk of overwhelming the uninitiated client. Both of you need to absorb the
information provided and do a little homework before moving forward. For some clients, you
may want to ask them to complete the questionnaire as best as they can and return it to you.
For others, it may make more sense to walk them through the questionnaire after they have had
a chance to review it. It really depends upon the sophistication of the client and your preference,
and whether the client intends to use a franchise consultant. Either way, the questionnaire will
help your client acquaint itself with the information you will need for the FDD and franchise
agreement, which will likely cause the client to encounter issues it has not yet considered. While
we do not recommend providing a questionnaire to your client before you have worked through
the issues described above in this Section III.B, if you feel compelled to introduce a
questionnaire earlier in the process, use it initially as a tool to guide discussion and not as a
document that is to be completed and returned to you.

10. Other Areas

While you may have inundated your client with questions and information at this point in
the initial meeting, you also may want to consider briefly touching on the following other areas:

10
 o How the “franchised business” will be different from the business the company
currently operates.
o Overall franchise sales requirements – FDD preparation and disclosure, state
registrations, timelines and general do’s and don’ts.
o Homework assignments for client before the next meeting (i.e., gather additional
information, complete questionnaires, provide trademark registrations and
corporate records, etc.).

The initial meeting is meant to lay the groundwork for your client’s new franchise
program. It is through subsequent meetings and discussions that the franchise program will
begin to take shape.

IV. FURTHER CLIENT MEETINGS

Assuming you have solidified your relationship with the client, conducted any additional
conflicts checks, determined that the concept can be duplicated through the franchise model,
eliminated alternative expansion methods, and entered into an engagement letter, you are
ready to begin the process of structuring the franchise entity and developing the FDD, franchise
agreement and other agreements. But, where to begin?

Unless the client has read numerous FDDs (some have) or been previously employed
by a franchise system, it will be obvious that there are many aspects of franchise development
that the client may simply be unaware of or may have overlooked. Further, even if the client has
focused on some of the essentials, the client may be initially unprepared to deal with the
questions and issues that arise as you dig deeper to understand the business mechanics and
educate it on franchise nuances. This is where the completed questionnaire can be of value and
when it is appropriate to begin the client education process. Just like anything else, focus on the
low-hanging fruit of known information. By this time, you should have a fairly good idea of what
information is ready and available, so start there.

A. Entity Selection: Will Existing Entity Suffice or Should New Entity Be

Formed?

A fundamental threshold issue is whether the existing legal entity will serve as the
franchisor or should a new entity be formed?

Many factors will come into play here, mostly based on the ownership and history of the
existing entity. As franchise lawyers, we must strain the company’s history through the franchise
filter. Most importantly, how will this history (current ownership and management included) look
in the context of FDD Items 1 (The Franchisor, any Parents, Predecessors and Affiliates), 2
(Business Experience), 3 (Litigation), 4 (Bankruptcy), 8 (Restrictions on Sources of Products
and Services), 13 (Trademarks), 14 (Patents, Copyrights, and Proprietary Information), 18
(Public Figures), 19 (Financial Performance Representations) and 21 (Financial Statements)?23
At the same time, the client needs to consider the business aspects of these issues: for
instance, how will its initial marketing of franchises proceed if its Business
Experience/Litigation/Bankruptcy picture is severely clouded?

23
See 16 C.F.R. §§ 436.5(a)-(d), (h), (m), (n), (r), (s) and (u).

11
 Keep in mind in establishing your client’s new corporate structure that, even if the client
elects to form a new entity to act as the franchisor, the franchisor entity may still have disclosure
obligations relating to its predecessors, parents and affiliates. Critical to this analysis is whether
a parent’s audited financial statements are still required to be disclosed in Item 21 even if a
franchisor includes its own audited financial statements.24 FTC FAQs 4 and 16 make clear that
a parent’s financial statements are not only required to be included in Item 21 if the parent
“guarantees the franchisor’s obligations,” but also if the parent “commits to perform post-sale
obligations for the franchisor.”25 In addition, FTC FAQ 30 establishes that a parent’s financial
statements are required to be included in Item 21 if the parent “is the sole supplier of a good or
service without which a franchise cannot be operated.”26 The above examples illustrate the
importance of taking into account the disclosure obligations under the FTC Franchise Rule
when establishing a client’s new corporate structure and determining which entities will provide
products and services to its franchisees. Generally, there are far fewer disclosure issues relating
to affiliates than there are with parent entities.

In addition to the franchise aspects, other practical issues may be involved: (1) If there
are multiple owners, do they all want to be owners of the franchise entity?; (2) What liability
concerns arise regarding the primary assets if a franchise dimension is added?; and (3) Are the
client’s current officers and managers the right people to develop and sustain a franchise
system?

Yes, this is a lot to process. This is why it is crucial to have a thorough understanding of
the client’s existing business and to plan to carry on the discussion of the “entity issue” beyond
an initial session.

Theories and approaches abound on the best way to determine whether to use an
existing entity or form a new one. And further, if your client elects to form a new entity to act as
the franchisor: (1) How should the ownership be structured (a commonly-owned affiliate,
subsidiary or perhaps new parent)?; (2) What type of entity should be used (a corporation,
partnership, limited liability company or partnership, or other entity); and (3) Where should the
entity be formed? Naturally, the answers lie in the facts and circumstances presented and a full
discussion of this topic would detain us far too long. We do, however, offer a few of our own
views.27

There is a lot to be said for starting with a relatively clean slate. Even when the franchise
filter reveals no obvious disclosure or marketing barriers, we believe that the balance should tip
in favor of forming a new entity. Asset protection of the existing business (as well as the new
entity), ownership re-structuring and a fresh start with new financial statements are chief among
the reasons. Also, most of the objections to starting a new entity (loss of continuity, loss of
history, current IP ownership, undercapitalization and start-up financial statements) can be
overcome through creative but permissible disclosures, licensing or assignment of IP
ownership, and a strategic capitalization plan. In addition, as the system progresses, if the

24
16 C.F.R. § 436.5(u)(i)(v).
25
The FTC’s Frequently Asked Questions, known as “Amended Franchise Rule FAQs” (“FTC FAQs”), avail. at
http://www.ftc.gov/bcp/franchise/amended-rule-faqs.shtml.
26
Id. at FTC FAQ 30.
27
See also Conohan, supra note 2, at 27-29.

12
entities are separated, financial accounting, reporting and tracking will be simplified for each
entity and may assist with cleaner financial reporting. Of course, if the existing entity has
compelling legal and historic attributes and existing ownership is not concerned with issues of
confidentiality and increased liability exposure, utilizing the existing entity may be preferable.

In the mix of this discussion, and a factor that again weighs in favor of separate entities,
is the simple fact that operating a franchise system may differ widely from the client’s existing
operations. If a franchise consultant has not been retained and the client plans to go-it-alone (or
if a consultant is involved but has not addressed this topic), it seems appropriate to discuss this
business issue and its impact on future operations. Part of what you bring to the table is the
ability to look ahead and plan for the future. Too many clients believe that operating a franchise
system will be a simple extension of their existing operations. Of course, if there is a slow ramp-
up, there may be time to adjust to the new burdens. But, new franchise operators often
underestimate the added pressure on operations, training, marketing, accounting, real
estate/construction personnel and intermediate managers. Beginning this discussion and at
least getting the client to begin the planning, forecasting and budgeting to operate a different or
additional business will bring another entity-determinant into better focus. Another resource that
should be consulted during this discussion is the client’s accountant. Planning for an expansion
of services, new employees and franchise-oriented services will impact the accounting, auditing
and tax-planning process. Involvement of the client’s accountant will also perhaps bring to light
other important considerations that you and your client may have overlooked or of which you
were unaware. Typically, accountants are advocates for the creation of a new entity, as it
generally removes complexities and complications from the mix while putting the new entity on
the right path for audit planning and the like.

B. Previous Expansion Efforts

In addition to company-owned units, some potential franchisors may have previously

experimented with “non-franchise” expansion. Occasionally some of these attempts or
experiments may have succeeded, resulting in joint ventures, partnerships, limited partnerships,
distributorships and, yes, even licenses and business opportunities duplicating the concept. A
host of reasons trigger these non-franchise efforts: business relationships with family and
friends, ignorance of what constitutes a franchise, bad legal advice from non-specialists,
reliance on past business customs and “standard” industry practices. Seldom do we see
intentional attempts to circumvent the law. And, as we noted, some non-franchise expansions
are perfectly legitimate, if done the right way. More often than not, however, these non-franchise
expansions are arguably franchises sold in violation of applicable federal and state franchise
law. This is by no means uncommon among start-up franchisors. Any franchise lawyer
practicing in the area for very long has no doubt had the experience of cringing as its start-up
franchisor client mentions the “licenses” it has already granted.

From the outset, you must make yourself aware of all non-franchise arrangements,
determine which ones are legitimate and which ones are potentially unlawful, and come up with
a strategy for dealing them. As part of your analysis, you will want to consider how many
possible franchises were granted, where they were granted (are any franchise registration
states involved?), when they were granted (have applicable statutes of limitations run?), the
level of success and satisfaction of each possible de-facto franchisee, whether your client was
truly unaware of the potential violation of applicable franchise laws or was reasonably relying on
the bad advice of counsel, your client’s past compliance history, and any related governmental

13
actions.28 In almost all cases, non-franchise arrangements under the same or similar
trademarks will have to be disclosed in a start-up franchisor’s FDD, and will likely catch the eye
of any state franchise examiner.

Accordingly, you will need to discuss with your client how best to address any past
violations where the applicable statutes of limitations have not run. If a franchise registration
state is involved, you may want to proactively contact the state to explain the situation and the
remedy the client is willing to provide to the licensee/franchisee. In our experience, state
examiners are much more lenient with start-up franchisors that bring potential issues to their
attention, assuming the violation was not intentional and not indicative of a past pattern of
violations.29 Offering to rescind the agreement and pay back any net losses is a common
remedy; one that is specifically described in the laws of several of the franchise registration
states, including Illinois.30 Illinois and California also have provisions in their franchise laws that
allow a franchisor to provide a notice of violation to licensees/franchisees and reduce the time
period within which the licensees/franchisees can bring a claim for such violation to 90 days
following receipt of the notice.31 Fines and other penalties also may be assessed against your
client, although, again, these are often less if the client brings an unintentional violation to the
attention of the applicable regulating authority.

Aside from potential disclosure and registration implications, company-owned and non-
franchised units also must be analyzed from a sales and system perspective. While company-
owned units that present operational prototypes for future franchise units may be a big plus, a
hodgepodge of poorly run, inconsistently designed “independent” operations can cause havoc –
presently and down the road. In addition, depending on the scope and nature of the company’s
non-franchised expansion, intervention may be necessary. That is, addressing and, perhaps,
cleaning up the non-franchised units should be a consideration. As we know, one franchise
mantra is “uniformity.” And, the common belief is that franchisees are generally happier when
they understand that they are being treated equally and equitably compared with others in the
system. Hence, although it is not always possible or practical to achieve complete uniformity,
starting off with a variety of deals (franchised and non-franchised) can create an immediate
systemic challenge.

One approach to address pre-existing non-franchised units is for a start-up franchisor to

convert them to franchised units by persuading the owners to execute franchise agreements
that mirror the terms that others will be offered. The caveat to this approach, however, is that
the franchisor must be prepared to disclose these pre-existing deals in the FDD and to divulge
the nature of the conversion. Assuming, of course, that the franchisor can get over the hurdle of
convincing the pre-existing units to convert. This typically requires some type of carrot or, at a

28
See Kevin Hein, Troy Bader and Timothy J. Bryant, How to Say “Yes” to Sales without Saying “No” to Best
RD
Practices, INT’L FRANCHISE ASS’N 43 ANNUAL LEGAL SYMPOSIUM, Ch. 21 (2010), citing Leonard D. Vines, Gina D.
Bishop and Rupert M. Barkoff, Damage Control for Violations of Registration and Disclosure Obligations, 24
FRANCHISE L.J. 191 (Winter 2005).
29
Id.
30 TH
815 ILL. COMP. STAT. § 705/26 (2009); see also Natalma M. McKnew and Eric H. Karp, A.B.A. 30 ANNUAL FORUM
ON FRANCHISING, Restoring the Status Quo Ante: Rescission and Restitution, Tab 23 (2007) and Charles S. Modell,
TH
Leonard B Vines and Kim Goodhard, Rescission of Franchise Agreements, Law and Policy, A.B.A. 29 ANNUAL
FORUM ON FRANCHISING, Tab 13 (2002).
31
815 ILL. COMP. STAT. § 705/27; CAL. CORP. CODE § 31300 (2008).

14
minimum, some favorable disparate treatment than that provided to “new” franchisees. Again,
while disclosure of this distinction is recommended (if not required) and may well raise
questions in the franchise sales process, it is better to deal with and resolve these variations
upfront than allow them to fester as the system grows.

C. What is the Grand Development Plan?

A topic that can greatly impact your approach and your client’s overall development
strategy is: How does the client realistically plan to sell franchises? Many times, the seed of the
franchise idea sprouts with a simple encounter. A customer walks in the door and asks: “Is this
a franchise?” or “Are you selling franchises?” The light goes on and the owner is off to the
races, oftentimes with the notion that more prospects will just walk in the door ready to buy.
Client education is important here; as well as explaining the development costs associated with
selling and managing franchises.

As with the choice of entity analysis and decision, one size does not fit all; no single
answer is appropriate for every situation. Novice entrepreneurs should start slowly and
deliberately, testing the waters as they go. More sophisticated businesses (those with a large
company-owned-based organization or who started a system-to-be-franchised) may want or
need to be far more aggressive.

Single-unit development is the slowest and simplest approach and, in many cases, will
be the best choice for most start-up franchisors (at least initially). It involves the development of
franchises on a unit-by-unit basis under a separate franchise agreement signed for each unit.

However, if a more aggressive approach is in order, your client also may want the option
of expanding through multiple unit development. While the nomenclature varies within the
franchise community, the three most common forms of multiple unit development are: (1) area
development, which generally involves the grant of a designated territory within which a
franchisee can develop multiple units under separate franchisee agreements and pursuant to a
development schedule; (2) development agent (a.k.a., area representative/director), which
generally involves the grant of a designated territory within which a franchisee can develop
multiple units for its own account under separate franchise agreements or refer prospective
franchisees to the franchisor pursuant to a development schedule, and provide certain pre- and
post-sale services to franchisees within the designated territory for a fee from the franchisor;
and (3) master franchising, which generally involves the grant of a designated territory within
which a franchisee (master franchisee) can develop for its own account, or subfranchise others
to develop, multiple units under separate franchise agreements (between the franchisor and
master franchisee) or subfranchise agreements (between the master franchisee and its
subfranchisees) pursuant to a development schedule.32

While master franchising is typically reserved for international situations, area

development and development agent arrangements are fairly common domestically. To be

32
For a further discussion of these and other multi-unit expansion options, see Leslie D. Curran, Craig S. Prusher
ND
and J. Westlake, Growth Through Multi-Unit Franchising, A.B.A. 32 ANNUAL FORUM ON FRANCHISING, Tab W5 (2009);
TH
Amy Cheng and Andrew F. Perrin, Multiunit Franchising - The Risks and Benefits, A.B.A. 28 ANNUAL FORUM ON
FRANCHISING, Tab W5 (2005); Will Woods, Jacqueline Vlaming and John Dring, Three-Level Franchise Systems: Area
ST
Reps and Development Agents: Do They Make Sense for the Systems You Represent?, INT’L FRANCHISE ASS’N 41
ANNUAL LEGAL SYMPOSIUM, Ch. 11 (2008); John W. Fitzgerald and Max J. Schott, II, Expansion Options: Multi-Unit and
Third-Party Arrangements, FRANCHISING W ORLD, at 16-18 (April 2008).

15
competitive and attract large, multi-brand franchisees, your client may feel that they need to
include one or both of these multi-unit expansion models as part of their initial offering. Given
that your start-up franchisor client will not have sold any franchises, however, it may be wise for
them to grant a few single-unit franchises before even considering multi-unit development,
especially through development agents.

It is incumbent upon you to educate your client as to these options, and the added
complexity and cost that come with the preparation of additional, multi-unit agreements. The
establishment of fees, schedules and territories, as well as the relationship between the multi-
unit documents and the other base documents, are among the issues that you will need to
discuss with your client if multi-unit development becomes a part of the process. You also will
need to analyze how this decision will impact the client’s disclosure/registration plan and
strategy. Note that in addition to your client’s obligation to include information in its FDD about
multi-unit expansion, your client’s multi-unit franchisees also may be subject to federal and state
disclosure and registration requirements if they fall within the applicable definition of a
“subfranchisor.”33 Finally, the desired sales approach will lead to the inevitable discussion and
selection of personnel. That is, how will the sales process be staffed and handled? Many
systems start with an internal sales person, while others are inclined to employ an outside
franchise sales broker or network of brokers. Whatever the call, discussion of the sales plan is
instrumental to the overall plan of action.

D. Reservation of Rights to Start-up Franchisor

In assisting your start-up franchisor client with its development plan, you also must look
to the future in an effort to predict where its business may take it. It is important from the start
that a franchisor generally reserve to itself those rights not granted to its franchisees and, where
possible, specifically state what those rights may be. FDD Item 12 helps the franchisor focus on
this issue by requiring the following disclosures: whether a franchisee receives an exclusive
territory, a non-exclusive territory or no territory at all; the restrictions on the solicitation and
acceptance of customers within any territories; and the rights of the franchisor and its affiliates,
and its franchisees, to use “other channels of distribution, such as the Internet, catalog sales,
telemarketing, or other direct marketing sales.”34 In our opinion, the more specific you can be
about the alternative channels of distribution the better. For example, the franchisor of a QSR
restaurant franchise may want to specifically reserve the right to package and sell its branded
ice cream or food at grocery stores and other retail outlets, or to open restaurants in non-
traditional locations like airports, sports areas, hospitals or universities, regardless of whether
these activities take place within a franchisee’s territory. We recommend that you also include
this same type of language in the grant of rights/reservation of rights sections of your client’s
franchise agreement. While your client may never exercise these rights or ultimately choose to

33
While development agents are not included within the definition of subfranchisors under the FTC Franchise Rule,
they may constitute subfranchisors under a number of state franchise laws and thus be subject to disclosure and
registration requirements. See 16 C.F.R. § 436.1(k); FTC FAQ 9; see e.g., W ASH. STAT. § 19.100.010(9); HAW. STAT.
482E-2 (2008). See also David L. Cahn and Jeffrey S. Fabian, Washington Ruling Raises Area Representative
Disclosure, 13 THE FRANCHISE LAWYER (Winter 2010); Eleanor E. Vaida Gerhards, When Is a Development Agent or
Similar Third Party a Franchisor?, 29 FRANCHISE L.J. 106 (Fall 2009). In comparison, master franchisees are
subfranchisors under the FTC Franchise Rule and state franchise laws and therefore must comply with applicable
disclosure and registration requirements. See 16 C.F.R. § 436.1(k); see, e.g., VIR. CODE § 13.1-559 (2009); N.Y. GEN.
BUS. LAW § 681 (1989); 85 ILL. COMP. STAT. § 705/3 (2009); MINN. STAT. § 80C.01 (2006); and W ASH. ADMIN. CODE
§ 19.100.160 (1994).
34
16 C.F.R. § 436.5(l)(6).

16
license them to franchisees or other licensees, by reserving these rights from the outset, you will
give your client the flexibility to take advantage of future growth opportunities.

E. Profit Margin Available to Future Franchises in Light Of Fees, Costs and

Royalties

Clients new to franchising may overlook the potential inherent additional costs that
franchisees will incur that are not necessarily imposed on them: initial franchise fees, royalties,
advertising fees and the like. These costs and fees dig into franchisees’ profit margins. This, of
course, affects the overall success of individual franchisees and the system as a whole.
Working on the franchisee’s economic model is another important first step.

In many instances, not enough emphasis or attention is placed on the importance of this
process. As lawyers we tend to focus on the “legal” and drafting aspects of the deal and leave
the economics to the client and its numbers people. However, this is one “business” issue that
franchise counsel should get behind. Even if you cannot play a direct role in analyzing the
financial aspects of this process, you need to stress the significance of getting this right. This
discussion should involve the client’s chief financial officer, outside accountants and, if
applicable, a franchise consultant. Make sure the client involves the right people, is able to
accurately report current basic costs and expenses and covers all potential costs and expenses
that a franchisee may incur.

While this analysis and process will also assist in developing FDD Items 5, 6, 7 and 8
(and may impact considerations concerning Items 10 and 12) it should go well beyond just a
franchisee’s start-up phase. Developing a healthy franchisee profit margin strategy transcends
legal considerations and sales strategy. It is the essence of the system. Further, though scant
attention seems to be paid to this, what will be the franchisee’s ROI? Take time to focus the
client’s attention on all aspects of the franchisees’ economics. Typically, franchisors make their
money not on the initial fees they receive, but on royalties paid by and, in some cases,
purchases made by successful franchisees over time.

An adjunct to this analysis is a discussion of what attributes an ideal franchise candidate

may possess. Franchising is about making money, for both the franchisor and the franchisees.
Selection of the right candidates starts with knowing the short-term and long-term costs and the
potential ROI. We will focus more on this later but in order to select suitable candidates the
client must nail down the economics of the deal and match them to candidates’ financial
wherewithal.

This section focuses on the importance of stressing to your client that they take into
account potential unit profitability and franchisee ROI in structuring their franchise program. This
is not to suggest, however, that franchisees are only concerned with these items. Greg Nathan,
a registered psychologist and Managing Director of the Franchise Relationships Institute, found
through his research that “franchisee profitability, while important, is only one of the drivers of
franchisee satisfaction.”35 He discovered that other indices of franchisee satisfaction include:
brand development and marketing support from the franchisor; competent, trustworthy and
forward-looking franchisor leadership; a feeling that the franchisee is a respected part of the

35
See Greg Nathan, How to Create Healthier Franchise Relationships and Happier Clients, 13 THE FRANCHISE
ND
LAWYER (Winter 2010); see also Greg Nathan, Engineering Healthy Franchise Relationships, A.B.A. 32 ANNUAL
FORUM ON FRANCHISING, Tab P1 (2009) [hereinafter Nathan].

17
franchise system; and a sense that the franchisor is concerned for the well being of the
franchisee.36 This confirms what many of us in the franchise community have long known:
franchising is all about building relationships. It comes as no surprise that at the heart of many
of the most successful franchise systems, are healthy franchisor/franchisee relationships. We
recommend that you to pass on this wisdom to your clients from the start and emphasize to
them the importance of building strong, open and mutually beneficial relationships with their
franchisees.

F. Potential Fees and Costs – Initial Franchise Fee, Royalties, Advertising

Requirements Etc.

Discussion of franchisees’ profit margin and ROI naturally leads to a discussion of the
development of the system’s potential overall costs, fees, royalties, advertising fees and more.
Although we are typically guided, almost by default, by the particulars of FDD Items 5, 6 and 7,
our discussion must start well before we fill in the blanks of the mandated charts.

Developing system costs and fees compels an analysis of three distinct economic
segments: the franchisor’s experience and financial needs, the franchisees’ tolerance, and the
competition’s offerings. Assessment of these competing economic interests must inevitably lead
to an acceptable balance that enables the franchisor and its franchisees to succeed while taking
on the competition on two fronts: franchise sales and market-based sales.

Just as a franchisee needs to earn a profit and achieve a healthy ROI, so does the
franchisor. The franchisor must develop a successful economic strategy and model that may be
part of a business plan or overall budget. In addition, there are two phases of the franchisor’s
economic planning that should receive attention: start-up costs (legal and accounting fees,
operation manual development, website and other information technology development costs,
initial marketing materials, etc.), and ongoing expenses (franchise sales commissions, training
materials and personnel, continuing development of marketing materials, trade show
attendance, and so forth). Thus, preparing a budget for each area and activity before any
franchise fees are realized is a necessity and will provide a basis for assessing the level of initial
and ongoing fees that must be charged.

Staffing and labor is one of the most immediate costs to assess. For the new franchisor,
however, this basic overhead item will be difficult to predict. Systems planning a slow-growth
approach will likely work with existing staff - but how long will this last? A more aggressive
growth plan may require new staff immediately. Initial additional salaries may need to be figured
in from the start. Staff salaries and the budgeting issues associated with this inherent cost is just
one example of the work ahead of your franchise client in arriving at a sustainable cost
structure.37 But, what is the franchise lawyer’s role here?

Of course, the easy answer is that as lawyers we need the information to “fill in the
blanks.” True enough, our job does require that we obtain the financial information needed to fill
in FDD Items 5, 6 and 7, but does it end there? Our view is that it is truly just the beginning of
the direction and counseling that is necessary to develop and secure accurate cost information
from the client. While you do not need to be directly involved in the cost development process,

36
Id. See sources cited supra note 35.
37
For discussion of staffing, see Darrow, supra note 2 at 26-29.

18
you should provide guidance and direction. If the client is not capable of professionally directing
this process, you should encourage the use of a franchise consultant, an outside accountant or,
at a minimum, an internal financial staff member. Your duty starts here because you do not just
want the information, you want accurate information that will assist the client in developing
competitive but profitable fees and cost estimates that will sustain the system and comply with
the law. At bottom, the essence of the disclosure and anti-fraud statutes is the provision of fair
and accurate information to potential franchisees.38 As franchise counsel you must drive this
process to secure fair and accurate information.

Although various FDD Items require assorted cost and fee disclosures, Item 7 is the
most comprehensive. It represents a franchisee’s estimated initial investment. While the
expenses included in Item 7 vary from system to system, seven expense categories must be
disclosed: initial franchise fee, training expenses, real property (leased or purchased), FFE Plus
(equipment, fixtures, other fixed assets, construction, remodeling, leasehold improvements and
decorating costs), opening inventory, security deposits and other prepaid expenses and
additional funds for any other required expenses that may be incurred before operations begin
and for the initial period of operation (a minimum of three months or a reasonable period for the
industry).39 The last item, additional funds for the initial period, must also carry a general
description (usually placed in a footnote) of “the factors, basis, and experience that the
franchisor considered or relied upon in formulating the amount required for additional funds.”40

As noted earlier, thoroughly engaging your client in this process is crucial to completing
the work of gathering and developing accurate cost estimates.

G. Reviewing and Analyzing Data Regarding Competitors

It is critical that your client conduct a thorough review and analysis of data regarding its
and its franchisees’ potential competitors. This information is not only pertinent to the initial
decision of whether or not to franchise, but also likely will dictate to a certain extent the terms of
the franchisor’s franchise agreement, including the fee structure, length of the initial term,
renewal rights, protected territory (if any), and training, financing and other support offered.

If there are other franchisors within the same industry who will be competing with your
client for franchisees, your client should obtain and dissect a copy of their FDDs. See
Section II.A for tips on obtaining FDDs. These FDDs will obviously contain a wealth of
information about the competing offerings and systems. Your client should pay particular
attention to any financial performance representations (“FPR”) included in these FDDs, not only
for the information they contain, but also because of the competitive edge they may provide the
competitor if your client elects not to include a FPR in its FDD. More on this issue in
Section IV.T.

38
As an example, see California Franchise investment Law, California Corporations Code § 31001, which states in
part: “It is the intent of this law to provide each prospective franchisee with the information necessary to make an
intelligent decision regarding franchises being offered. Further, it is the intent of this law to prohibit the sale of
franchises where the sale would lead to fraud or a likelihood that the franchisor's promises would not be fulfilled, and
to protect the franchisor and franchisee by providing a better understanding of the relationship between the franchisor
and franchisee with regard to their business relationship.” CAL. CORP. CODE § 31001 (2008).
39
16 C.F.R. § 436.5(g).
40
16 C.F.R. § 436.5(g)(1)(iii).

19
 In addition to FDDs, your client should also gather additional information from other
available sources regarding both franchisor and non-franchisor competitors, and the client’s
industry in general. This is where a franchise consultant can really bring value. Franchise
consultants are familiar with existing franchisors and industries, and can help analyze the
current landscape of a given market and what that market will bear. Regardless of whether your
client uses a franchise consultant, it is important that you ensure that it has conducted this type
of analysis as part of the franchise development process. Otherwise, your client’s franchise
sales efforts may be doomed from the start.

H. Are There Any Special Industry Laws or Regulations?

As we know, franchising is a method of doing business rather than an industry unto

itself. By its very nature and application the franchise model cuts across many industries and
concepts: lodging, restaurants (fast-food, casual-dining, full-service), automobiles (sales, rental,
parts and repair), gasoline, travel, real estate brokerages, financial services, tax and accounting
services, pet care, senior care, medical and dental services, visions care, specialty retail shops,
home improvement and vitamins, just to name a few. Each business brings its own laws and
regulations. Exploring these with the client and through your own due diligence is important for a
number of reasons.

Some industries such as the gasoline, automobile and farm implement sectors may have
specialized franchise laws. Certain professional areas such as law, medicine and accounting
may have ethical and legal restrictions; these may include licensing requirements, trademark
use restrictions, advertising restrictions, fee-splitting regulations or prohibitions, limitations on
enforceability of covenants against competition, and ownership structure limitations.41
Investigating the impact of these laws, regulations and ethical limitations is a clear priority.
Determining that your client’s business may have serious restrictions on duplication can be a
deal killer.

Another reason this area must be reviewed is that FDD Item 1 requires a general
disclosure of “… any laws or regulations specific to the industry in which the franchise business
operates.”42 Although the disclosure requirement is important, it is clearly trumped by an
industry or professional restriction that prevents duplication of the concept. Be alert to this
potential crucial impediment and discuss it early with your client.

I. Attributes Required of the Ideal Franchise Candidate

We touched on this briefly in Section IV.E as part of our discussion of the profit margin
available to future franchises in light of fees, costs and royalties. Again, while this topic may be
perceived as a business item, franchise counsel is well advised to focus his or her client’s
attention on this significant aspect of franchise development. As we noted, this starts with the
client knowing its system’s economics, realistic franchisee costs and the potential ROI. The

41 TH
See David A. Beyer and Leonard D. Vines, Matter of Honor: Franchising in the Professions, A.B.A. 26 ANNUAL
FORUM ON FRANCHISING, Tab W9 (2003); Deborah L. Gersh and Karen K. Harris, Healthcare and Franchising: The
Regulatory Maze, AMERICAN HEALTH LAWYERS ASSOCIATION (1999).
42
16 C.F.R. § 436.5(a)(6)(v).

20
economic model will be a good starting point but much more needs to be identified before the
client is ready to search for candidates.

One technique to jumpstart this process is to encourage the early development of a

franchisee application/questionnaire. Although this may be seem premature, this hands-on task
will force the potential franchisor to begin shaping its concept of the ideal candidate and,
perhaps, adjusting some of the goals, requirements, fees, experience and other attributes the
client seeks for its system. Further, this process will truly involve the client in the development
process, immersing it in the reality of what it is planning to undertake. And, once the sales
process begins this will have been time and effort well spent as the client will be ready with the
franchisee application/questionnaire and have a firm grasp on the desired attributes. In addition,
the client will quickly learn that distribution and completion of the franchisee
application/questionnaire before FDDs are provided is an essential time-saving tool as it will
separate the tire-kickers from sincere, viable candidates.

We include an example of a franchisee application/questionnaire as Appendix B. As with

all form documents, you are cautioned to review and analyze applicable law (particularly those
relating to privacy, data collection, security and credit reporting, which are ever-changing) to
ensure that the document your client is using is in compliance. The ideal franchisee
application/questionnaire also should be customized to address system and industry specifics.
For instance, casual and full-service restaurant systems may emphasize previous restaurant
operation experience, whereas a hotel system may focus more on investment wherewithal.
Some of the items that should be included are:

o Personal background information.

o Educational background.
o Employment and/or investment history.
o Prior experience in the industry or field.
o Prior or current franchise experience.
o Reason for interest in this franchise.
o Financial history/net worth and financing capabilities.
o Management plan and proposed partners/managers.
o Working capital capabilities.
o Existing banking and professional relationships.
o Bankruptcies, criminal/civil litigation history.
o Existing/planned operating business entity.
o Desired location and territory, if applicable.
o Interest in multiple location development.

Like a litigator who crafts a closing argument first when preparing for a trial, the client
that develops the franchisee application/questionnaire early in the process begins with the end
in mind and will have a good roadmap of where it is headed and what it needs to get there.

We would be remiss here if we did not briefly discuss the primary purpose of the
franchisee application/questionnaire: selection of the best franchise candidates. Too often, new
franchisors are overly eager to make those first few sales. This can be a big mistake. The
foundation of any enterprise is vitally important to its success. A franchise system is no different.
If weak franchisees (financially and operationally) are selected initially, the chances for success
are lessened and, indeed, may bring down the entire effort. You should make sure your client
understands that turnover from hasty sales to under-qualified franchisees will show up in its
FDD Item 20, drawing further attention to the issue. Encourage your client to resist the

21
temptation of just “getting some deals done” and focus on the attributes and criteria that were
the basis for the development of the franchisee application/questionnaire. Successful
franchisees can quickly become a new franchisor’s best sales tool.

J. Analyze Current Management Teams’ Strength, Weaknesses and

Background

Analyzing the strengths and weaknesses of current management and their future
franchise roles is a vital but sensitive exercise. This is the team that will take the concept to
market and on which the success of the franchise effort is pinned; sensitive because decisions
and choices have to be made in matching the right person to new or expanded roles.

It is not uncommon to launch a franchise system with the existing management team,
few of whom may have any franchise experience or background. Small- and medium-sized
businesses may not have an economic choice but to go with the current team. Larger
businesses may be able to attract some franchise specialists or former franchise executives. An
established, mature company with multiple company-owned units operating in varied
geographical areas will likely be in a better personnel and experiential position than a new
company with few locations.

Although the client must put or keep the right people on the bus, franchise counsel must
deal with the practical disclosure requirements of FDD Items 2, 3 and 4. Addressing the topics
of each director’s, principal officer’s and other franchise-management personnel’s five-year
business history as well as their 10-year litigation and bankruptcy history while potentially
sensitive must begin sooner rather than later. Some revelations in these areas may cause a re-
shuffling of positions and personnel before finalizing the FDD as the primary officers determine
the positive and negative aspects of certain disclosures. As a reminder, just because a person
is not a formal director or principal officer of the franchisor, does not mean that he or she does
not need to be disclosed in Items 2, 3 and 4. Any individual who will have management
responsibility relating the sale or operation of franchises must be disclosed.43

This is an area that is definitely conducive to the use of questionnaires. First, you need
to establish the universe of individuals who will be a part of your client’s business. To
accomplish this task, we recommend that you have an executive officer of the franchisor
(preferably the CEO or president) complete a questionnaire that lists all of the following
individuals (the franchise team): (1) all of the directors, trustees, general partners and members
of the franchisor; (2) all of the officers of the franchisor; (3) all other individuals who will have
management responsibility relating to the sale or operation of franchises; and (4) any franchise
sellers (both internal and external). Once completed, the executive officer should be required to
sign the questionnaire confirming that the list is complete and correct. We have included a
sample due diligence questionnaire (for the entire franchise team) as Appendix C.

In addition to this questionnaire, we also recommend that you require each of your
client’s franchise team members to complete and sign a separate questionnaire based on his or
her own background. The questionnaire should solicit the following information: (1) five-year
employment history; (2) 10-year litigation and bankruptcy history; (3) ownership interest in any
of franchisor’s approved suppliers (just officers); (4) whether the individual will engage in
franchise sales; and (5) whether the individual is aware of any matters that may be material to a

43
16 C.F.R. § 436.5(b).

22
prospective franchisee, which are not already included in the franchisor’s FDD. You will not only
need this information for the preparation of FDD Items 2, 3 and 4, but also the franchise seller
disclosure forms required by a number of the franchise registration states. We have included a
sample due diligence questionnaire (for individual franchise team members) as Appendix D.

We strongly endorse the use and retention of the above-referenced due diligence
questionnaires as part of the preparation of your client’s first FDD. We also suggest that you
require your client’s franchise team to annually complete and sign new due diligence
questionnaires as part of the renewal process, and establish a system that obligates all new
franchise team members to complete and sign a due diligence questionnaire before they are
hired.

K. Reviewing and Verifying Client Information

By its very nature, the preparation of an FDD requires franchise lawyers to rely on the
information they receive from their clients. To what extent, however, should franchise lawyers
conduct their own due diligence? We think that some level of due diligence is in order,
especially when dealing with a start-up system or new personnel. Some have learned the hard
way that it is ill-advised to just gather this information verbally or casually. Improper disclosure
can quickly lead to civil fines and unwanted enforcement actions that can tarnish the company’s
reputation for years to come as it is republished in the FDD.

At the risk of over-emphasizing the use of questionnaires, this is an another area where
we strongly recommend the use of them. First, make sure that the completed franchise program
development questionnaire discussed in Section III.9 is signed by an executive officer of your
franchisor client (preferably the CEO or president) confirming that it is complete and correct. In
addition, once the FDD is in final (or close to final) form, require that an executive officer of your
client (again the CEO or president, if possible) review the FDD and verify that it is complete and
correct, and that the officer is not aware of any matters that may be material to a prospective
franchisee which are not already included in the FDD. Apart from questionnaires, we also are
aware that some law firms conduct independent background checks of clients as part of their
intake process. There are a number of reasons for these precautions; some are for client
protection and others for mere self-protection.

Let’s start with client protection. Because civil fines or even criminal action could be
imposed or undertaken, utmost care should be taken. Further, an FDD that results in a civil
enforcement action and order must be disclosed for 10 years. Finally, if a franchisee or
prospective franchisee has been harmed, the omission or misstatement could serve as the
basis of a suit. As explained above, the use of simple written questionnaires may avoid all three
consequences and others that may arise.

It also is important to protect yourself. If you as counsel rely on the verbal assurances or
representations of the franchise development official or chief officer, what proof do you have in
the future that this was the source of the potentially inaccurate information? When questions
arise and the spotlight is turned on a blemished FDD, you can be sure that finger-pointing will
occur. Also, this can turn into an embarrassing situation with state examiners. Even though the
FDD is registered in the company’s name, the examiners deal with counsel, many times for
many years on behalf of the same or different companies. So it is your reputation and
established goodwill that can be damaged as much as the franchisor’s. In addition, your client
may pursue the dreaded claim of malpractice against you. Finally, your client’s franchisees may
bring claims against you, like negligent misrepresentation, relating to your role in preparing the

23
client’s FDD. The good news for franchisor attorneys is that, absent a lone reported case over
20 years ago,44 these claims have historically not been successful against franchisor attorneys,
unless the franchisee can demonstrate fraud or intentional misrepresentation by the attorney.45
Again, the use of simple written questionnaires may help you avoid all of these consequences.

L. Training Plans, Training Manuals and Other Training Materials

The importance and need for training in a system that wishes to clone or duplicate itself
is self-evident. Training should embody the essence of the system and be the client’s highest
priority. Uniformity is a key element to almost all franchise systems and training seeks to
implement the desired consistency. Yet, many new franchise systems have no clear, organized
plan. FDD Item 11 essentially presumes that the franchisor has an organized training program.46
If a new franchisor does not, one look at Item 11 should serve as compelling motivation.

On the topic of training, Item 11 requires the franchisor to:

o Disclose the franchisor’s training program as of the franchisor’s last fiscal year-
end or a more recent date.
o Describe the training program in a specified tabular chart.
o Place in the chart the subject matter, hours of classroom training, hours of on-
the-job training and the training location of each subject.
o Specify the frequency and overall location of training.
o Specify the type of instructional materials and the instructor’s experience,
including the length of the instructor’s field experience and with the franchisor.
o Disclose any charges and the responsibility to pay for travel and living expenses.
o Specify who must attend, how long after franchise execution training must take
place and whether franchisees must complete training to the franchisor’s
satisfaction.
o If training is not mandatory, state the percentage of new franchisees who have
enrolled during the preceding 12 months.
o State whether additional training is required.47

If the client does not have an existing training regimen or organized approach, sharing
this list with your client and its team will bring the requirements into sharp focus. Many clients
are assisted by seeing an actual completed chart from a previously drafted FDD – with careful
redaction or client-permission you should seek to provide a working prototype.

Training costs can be significant for franchisor and franchisee alike. The franchisor’s
investment includes staff, materials, facilities, presentations, equipment and other costs. A

44
See Courtney v. Waring, 237 Cal. Rptr. 233 (Cal. Ct. App. 1987).
45
See Conohan, supra note 2; Arthur L. Pressman and Gregg A. Rubenstein, Lawyers Who Prepare FDDs Do Not
Take On Potential Liability to Franchise Buyers, Absent Complicity in a Knowingly False Statement, 12 THE
FRANCHISE LAWYER (Fall 2009); Howard E. Bundy, Are Franchise Lawyers Liable to their Clients' Franchisees for
Negligent Misrepresentation?, 12 THE FRANCHISE LAWYER (Summer 2009); Alexander M. Meiklejohn, UFOCs and
Common Law Claims Against Franchise Counsel for Negligence, 25 FRANCHISE L.J. 45 (Fall 2005).

46
16 C.F.R. § 436.5(k)(7).
47
Id.

24
franchisee may have considerable travel, lodging and salary expenses involved. Everyone is
paying for training. And, it is an area of great expectations for franchisees. We have heard more
than once that franchisees are under whelmed by a franchisor’s initial training programs. Hence,
new franchisors are well-advised to concentrate on the development of a seriously organized
and professionally staffed training program. This is truly the franchisee’s “first impression” of the
level and quality of support and service it can expect to receive. While this topic falls across the
legal-advice-to-business-advice line, encourage your client to focus on developing a credible
training program; it may avoid a later lawsuit that has its origins in training dissatisfaction.

If the client balks at making a significant investment in traditional “bricks and mortar”
training, explore other options. Technological advances offer numerous alternatives: video,
teleconferencing, web-conferencing and e-learning. Indeed, today’s tech-savvy franchise buyer
may expect time-saving and travel-saving technology to be an essential part of the franchise
system. The same holds true for training materials: going paperless and electronic will save
money in the short-term and long-run as mailing or delivery costs are reduced or eliminated and
updates and revisions can be implemented instantaneously. Similarly, this same thinking should
be applied to the development of the system’s operating manual that we address in the next
section.

Encourage your client to put its best training foot forward to achieve one of their most
important tasks.

M. Development of Operating Manual

Arguably this topic may take precedence over the client’s training plans. For, if we do not
have a solid, uniform system infrastructure defined and articulated, what is it that we are
training? Though it is fairly clear that a system’s procedures, standards, specifications, recipes,
design elements and the like go hand-in-hand with training, if an operating manual has not been
developed, working on both tasks simultaneously may be beneficial. But we get ahead of
ourselves.

As with the FDD training disclosure requirement, FDD Item 11 presumes that an
operating manual exists as the franchisor is instructed to disclose the table of contents or offer
prospective franchisees the opportunity to view the manual before purchase.48

If your client already has a written operating manual you may be off to a good start … or
maybe not. Upon review, you may determine that the existing manual for general internal
operations or company-operated locations is not adequate for franchise instruction and
enforcement. Chances are that considerable effort will need to be devoted to create a
comprehensive operating manual. This is no simple task.49

48
16 C.F.R. § 436.5(k)(6).
49
For a discussion of the legal aspects relating to the preparation of operations manuals, see Amy Cheng, Craig
ST
Dietz and David W. Oppenheim, Operating Manuals – The Devil is in the Details, A.B.A. 31 ANNUAL FORUM ON
FRANCHISING, Tab 6 (2008); Brian Cole, Kenneth E. Treat and Dara Solan, Fixing Things Manually: Updating and
TH
Modernizing Franchise Systems Through the Operations Manual, INT’L FRANCHISE ASS’N 40 ANNUAL LEGAL
SYMPOSIUM, Ch. 17 (2007); Scott G. McLester, Susan H. Morton and Karen B. Satterlee, Operations Manual –
Essential to Success, 24 FRANCHISE L.J. 31 (Summer 2004).

25
 Drafting an operating manual must begin with the client and their staff; a process that
must start with the “subject matter experts.” The knowledge must be extracted, culled and
refined so that it can be delivered in a useable form. Some areas may be merely instructional
while others are mandatory. Some may be recommendations and others directives. For the
most part, the client will determine these distinctions. To protect a start-up franchisor client from
vicarious liability claims, however, a lawyer should make sure that the client does not cross the
line of arguably controlling the day-to-day operations of its franchisees’ businesses. The lawyer
should also stress the importance of only providing recommended (and not mandatory)
standards in certain areas, like employment and security. While this topic goes beyond the
scope of this paper, there are a number of informative articles that offer practical advice on how
to best position your client to defend vicarious liability claims.50

From a subject matter perspective, it is difficult to comprehensively address this topic

here given the broad application of the franchise concept. However, we would be remiss if we
did not discuss the interrelationship between the topics addressed in the franchise agreement
and those covered in an operating manual. This also compels us to address the extent of the
lawyer’s role in developing the operating manual.

As with discussions with other clients new to the world of franchising, franchise counsel
must begin as teacher, with client as student. Few clients come to the table knowing the
demarcation between the obligations customarily placed in a franchise agreement and those
appropriate for the operating manual.

Because FDDs containing franchise agreements are fundamentally public documents,

the most immediate concern is giving away the store. That is, systems seek to protect their
intellectual knowledge from competitors and knock-off artists. Putting too much in the FDD and
franchise agreement risks unnecessary exposure. Another factor is the need for operational
flexibility. By its nature and purpose, a franchise agreement is a fixed, static arrangement.
Franchise agreements can typically last 10 years or more. Much can happen in 10 years.
Franchise systems need room for suggestions, change and improvement. In our fast paced
world, change is typically required more than every 10 years. Hence, specific proprietary
operational items are better placed in the operating manual, subject of course to the disclosure
requirements under the FTC Franchise Rule and state laws. This enables the system to protect
its acquired knowledge while remaining flexible. So, leave the specifics to the client or a
professional hired by the client while making sure the franchise agreement is flexible enough to
accommodate the terms of the operating manual. Also, taking time to review the completed
operating manual for vicarious liability concerns and other issues before publication is
recommended.

Before we leave this topic, it is important to mention that a franchisor has the option of
disclosing the operating manual’s table of contents in Item 11 or offering its prospective
franchisees the opportunity to view the entire manual before buying a franchise.51 The
50
See Heather Carson, Sarah Yatchak and Gordon M. Hadfield, Franchisor Liability for Acts of the Franchisee, 29
FRANCHISE L.J. 174 (Winter 2010); Fredric Cohen, Marc Merriweather and Amy Powers, Keeping Your Distance: How
ND
to Avoid or Survive Vicarious Liability Claims While Enforcing System Standards, INT’L FRANCHISE ASS’N 42 ANNUAL
LEGAL SYMPOSIUM, Ch. 14 (2009); Cynthia M. Klaus, Jason M. Murray and Heather Smedstad, Vicarious Liability,
ST
A.B.A 31 ANNUAL FORUM ON FRANCHISING, Tab W10 (2008); Michael D. Joblove and William L. Killion, Defending
TH
Your Life: Protecting Your Unit and Your System in Vicarious Liability Litigation, A.B.A. 26 ANNUAL FORUM ON
FRANCHISING, Tab W10 (2003).
51
16 C.F.R. § 436.5(k)(6).

26
advantages and disadvantages of these options should be discussed with your client. Our
observation is that most franchisors simply opt to place the table of contents in the FDD.
However, a number of considerations may weigh against this practice. First, given the public
nature of FDDs, a certain amount of proprietary information (albeit likely generic) may leak out.
Second, with an evolving start-up system, frequent changes in the operating manual should be
anticipated. This means frequent, at a minimum annual, updates to this portion of the FDD or
relevant exhibit. Third, savvy buyers may ask to see the manual before purchase in any event.
While FDD guidelines do not mandate the disclosure, is it a good business/sales practice to
deny this request? Finally, any concerns about franchise prospects “stealing” ideas from an
operating manual review can be addressed with a “review-only, no-copy” policy, a controlled,
secured environment and a previously executed non-disclosure agreement.

Similar to training, development of a quality operating manual is an important “first

impression” relationship-building tool with franchisees. New franchise systems are wise to invest
the time and effort to craft this essential cornerstone of their business. And, using new
technology to create, publish and update the operating manual should not be overlooked. An
interactive electronic manual with embedded video, e-learning modules and web-links can
pump-up the learning environment for the entire system.

N. Products, Services and Approved Suppliers

Every system has an established method of doing business. Typically, this focuses on a
unique combination of delivered goods and services, something that differentiates one brand
from another. The new franchisor is considering expansion because it believes it has a unique
product or service or a new twist on an existing one. So it is no surprise that the franchisor has
developed a certain look, design, logo, product, service, presentation, method and/or procedure
that it wants its franchisees to emulate. In order to take full advantage of these unique elements,
franchisors often require their franchisees to purchase at least some key products, services,
equipment, signage or supplies from approved suppliers, while allowing them to purchase other
more mundane items from any source.

Gathering current information is the first step. Who are the franchisor’s suppliers? Are
there any unique, patented, custom-made or trade secreted products or ingredients? Are there
any system price-breaks or buying cooperative opportunities? Are there generic items? Are
there alternative suppliers? Once you have gathered this information, you must work with your
client to discuss not only the restrictions it wants to impose on the products and services offered
by franchisees, but also the restrictions it wants to impose on the products and services
purchased by franchisees, including the sources of those products and services, and how the
revenue that may be generated as a result of the purchase of those products and services fits
within your client’s business plan and model.

To insure a uniform image and uniform quality of services and products throughout the
franchise system, it is not uncommon for a franchisor to reserve the right to approve the brand,
manufacturer, supplier and/or distributor of certain supplies (like proprietary products or
ingredients, equipment, signage, advertising and marketing materials, uniforms and logoed
materials), and to require franchisees to purchase certain of these supplies from approved
suppliers. In some cases, a franchisor also may want to reserve the right to designate the sole
supplier (which may be the franchisor or one of its affiliates) from whom a franchisee must
purchase certain supplies. For other supplies, the franchisor may only describe the
specifications and/or standards the franchisee must meet, without reference to a particular
brand, manufacturer, supplier and/or distributor. It is imperative that you discuss this issue with

27
your client and reserve in the franchise agreement the franchisor’s rights necessary to allow it to
shape (initially and in the future) the purchasing of relevant supplies within its franchise system.
You also will need to ensure that you disclose these rights within the context of FDD Item 8.

If your client reserves the right to require its franchisees to purchase from approved or
designated suppliers, you must discuss with the client whether these purchases will generate
any revenue and, if so, how that revenue will be spent. For some larger franchisors, the direct
and indirect purchase of supplies by franchisees can be a significant revenue producer. Some
franchisors reserve the right to keep or spend these revenues as they see fit, while others
obligate themselves to contribute these revenues to the ad fund or distribute them to
franchisees.

If franchisees may be required to purchase supplies directly from your client or its
affiliates and the client or its affiliates may make a profit on these purchases, we recommend
that you include in the franchise agreement an acknowledgement of this fact. Your client also
will be required to disclose this revenue in Item 8 of its FDD.52 In addition, if your client or its
affiliates may receive fees, payments, rebates, commissions or other consideration from third
party manufacturers, suppliers and/or distributors as the result of purchases by franchisees, we
suggest that you include in the franchise agreement a description of this arrangement and how
the consideration received may be spent. This information also is required to be disclosed in
Item 8 of your client’s FDD.53 Because the amount of consideration a start-up franchisor will
receive as the result of purchases by its franchisees from manufacturers, suppliers and/or
distributors may be unknown at the time of the preparation of the FDD and may change over
time, we often include a broad range of the anticipated percentage of each purchase a
franchisor may receive from these third parties. Regardless of what you decide in this area, the
most important thing is that you have presented the issues to your client and have made
decisions with an eye to the future.

O. Advertising Requirements and Advertising Funds

Unless the client has successfully implemented an organized, sustained and effective
marketing program capable of being adapted to multiple markets, getting the advertising piece
correct right out of the box will be difficult. This is one area where lawyers should play more of a
back seat role. That is, marketing and advertising have become so specialized, so nuanced in
so many varied media that it requires professional treatment. If the client has not retained a
marketing firm, now may be a good time. However, many FDD “technical” matters remain for
the lawyer’s attention and the client’s education. While this section focuses on advertising at the
unit level, you should not lose site of the fact that your client will likely also be preparing
marketing materials and programs geared towards selling franchises. You will need to make
sure that your client prepares and registers these materials and programs in accordance with
applicable federal and state laws, and does not run afoul of requirements relating to the use of
FPRs and “general media representations.”

Advertising is an area that usually requires more conceptualization than other

development tasks. Item 11 requires an extensive disclosure describing the advertising
program. The process of responding to the FDD requirements may introduce your client to

52
16 C.F.R. § 436.5(h)(6).
53
16 C.F.R. § 436.5(h)(8).

28
some unfamiliar terms and concepts. More education is in order here and the client may need
time to absorb notions such as advertising cooperatives, national advertising funds, advertising
councils, allocations, contributions and so on.54 Moreover, as noted, the client will be asked to
think years into the future, to predict how the marketing/advertising program should be funded,
what media will be used, how the program will operate, who will participate, whether
“independent” advertising can occur, and whether commitments can be made to fund certain
markets.

Even so, the client must have an existing marketing approach or at least given some
thought to the available promotional options. Starting here or with the guidance of a marketing
professional will get the ball rolling. The emphasis the FDD places on the typical complexities of
establishing advertising funds (national, regional, cooperatives, etc.) and the customary
approach taken by many systems (multiple advertising, promotional and production funds), may
seem to be overkill for a fledging, start-up system and may tend to push new franchisors into
premature decisions in uncharted waters. So, before you overwhelm your client with thoughts of
the success of a national advertising program, focus their attention on developing and
articulating basic promotional approaches that can realistically propel new franchisees and the
system.

This go-slow-start-local approach does not mean you should avoid planning for the
future. So provide for the potential establishment of a national advertising fund and regional
advertising cooperatives, if appropriate, in the franchise agreement but recommend against
immediate implementation. Unless there are some special circumstances or the start-up
involves a well-known but previously non-franchised brand or concept, immediate
implementation of regional or national advertising funds will only dampen early franchisee
success by diverting resources to areas that may bring few results. Hence, marketing programs
that concentrate on local advertising or promotion should be encouraged and devised first. In
addition, when addressing the to-be-implemented future funds, consider the interrelationship of
franchisees’ costs and resources. Unless franchisees are wildly successful, stacking a national
percentage and a regional or co-op percentage on top of a local spending requirement can be
burdensome. Offer some relief from local advertising expenditures or requirements when future
regional and/or national contributions kick in. Finally, national and regional funds should have
set prescribed limits; these are typically expressed as a percentage of gross sales.

Another consideration for the new system is the distinction between a “national
advertising fund” and a “production fund.” Some systems confuse or mislabel the two. A
production fund is commonly used to develop and create promotional items and materials that
can be used at all levels; whereas a “national advertising fund” suggests the development of
national media opportunities and expenditures. So while it may be premature to implement a
“national advertising fund” it may not be premature for franchisees to begin contributing to a
“production fund” from which they may receive a more direct benefit. Reviewing these
approaches with your client will give it the opportunity to select the best method for the future
while keeping the current marketability of franchises in mind.

P. Initial Capital Investment

It is critical that your client has sufficient capital to support its franchise development
plans. While the FTC Franchise Rule does not require a start-up franchisor to possess a specific

54
16 C.F.R. § 436.5(k)(4).

29
level of capital before franchising, many of the franchise registration states will either not allow a
franchisor to sell franchises in their state, or will impose additional requirements that must be
met before a franchisor may sell franchises in their state, if they believe that a franchisor is
undercapitalized.55 While these requirements vary among the states, franchisors who are found
to be undercapitalized will be not be allowed to sell franchises in these states unless they
comply with certain conditions, which may include posting a bond, escrowing initial fees, or
deferring the collection of initial fees until the franchise opens or the franchisor has complied
with all of its pre-opening obligations.56 State examiners also may mandate the inclusion of risk
factors relating to your client’s financial condition in their FDD. Given this reality, we recommend
that, prior to the preparation of the financial statements that will be included in your client’s FDD,
you discuss with the client how it or its parent’s (if a parent’s financial statements are being
used) “net worth” (or “stockholders equity”) may impact their franchise sales in registration
states.

So what amount of capital is required in the registration states to avoid fee deferral or
other similar conditions? The State of Washington has historically taken the position that a
franchisor or its parent (if a parent’s financial statements are being used) must have a “net
worth” of at least $100,000 in order to avoid the imposition of additional requirements. Recently,
however, one of our clients was required to defer collection of its initial fees in Washington even
though it met the $100,000 net worth threshold. We have heard rumblings that Washington may
now be imposing additional requirements on all start-up franchisors regardless of their financial
situation. As for the other registration states, in our experience, none of them have set a
minimum amount. Instead, they generally look at each situation on a case-by-case basis and
focus on the Franchisor’s Costs and Source of Funds document,57 that franchisors must submit
as part of their filings, together with the projected openings for the next fiscal year listed on
Table 5 in Item 20 of the franchisor’s FDD.58 States also may look at the estimated initial
investment required for each franchise, as disclosed in FDD Item 7.59 You and your client will
definitely want to factor in this issue as you finalize your client’s franchise sales strategy.

Q. Financing Alternatives for Franchisees

One thread that should permeate everything you discuss with your client is their ability to
sell franchises. If the new system’s cost-of-entry is out of sync with existing competitors, or the
contractual provisions are too onerous, few sales will result. Consequently, keeping the “sale-
ability” of franchises front and center during the development process is critical.

In addition to keeping close watch on franchisee start-up costs, an obvious aid to

franchise sales is offering franchisees financing alternatives and resources. Very few

55
See, e.g., CAL. CORP. CODE § 3113 (2008); 815 ILL. REV. STAT. § 705/15 (2009); VIR. REG. § 5-110-65 (2009) and
VA. CODE ANN. § 13.1-561 (2009).
56
Id.
57
North American Securities Administrators Association, Inc. (“NASAA”) 2008 Franchise Registration and Disclosure
Guidelines (amended and Restated UFOC Guidelines) (“NASAA FDD Guidelines”), available at
http://www.nasaa.org/content/Files/2008UFOC.pdf, at Form B.
58
16 C.F.R. § 436.5(t)(3).
59
16 C.F.R. § 436.5(g).

30
franchisors offer direct financing or seek to arrange it and many third-party financing sources
have faded away.60 One avenue that remains is The Franchise Registry, a web-oriented
partnership between the U.S. Small Business Administration (“SBA”) and FRANdata that offers
franchisees expedited loan processing through the SBA.61 In explaining the SBA-FRANdata
partnership, it is noted on the website that “FranchiseRegistry.com is a site that allows
franchisees to see which systems are participating in the program, SBA lenders to see details of
the SBA approval, and franchisors to submit applications.”62 The Franchise Registry is not a
pre-approval for SBA financing on particular deals or for a specific system’s franchisees. It may
simply expedite the processing of a qualifying loan.

The essence of the Franchise Registry program is streamlined loan processing. This is
accomplished through a centralized review of franchisor-worksheets and franchise agreements;
eliminating the need for independent review at one or more of the 69 local SBA offices.
Franchisors complete a single worksheet, certify that their franchise agreements comply with
SBA’s Eligibility Guidelines, submit the information to FRANdata with e-copies of all franchisee-
related agreements and pay a $2,500 application fee.63 In a minimum of 10 weeks, FRANdata
conducts an initial review and forwards a recommendation to the SBA.64 The SBA makes the
final determination which results in the issuance of a certification form that franchisees present
to potential lenders and a listing of the franchisor on the Franchise Registry public website.
Further, FRANdata places an e-copy of the franchisor’s approved documents on a private
website that only the “SBA, SBA Participating Lenders and Certified Development Companies”
may access.65

Once a franchisor is SBA-approved, no further review is required (unless revisions are

made to the submitted documents) and participating lenders may rely on the certification and
website listing. Notwithstanding the certification, as noted above, lenders must still
independently financially qualify each franchisee-borrower in light of the terms of the deal. But,
franchisees can qualify for expedited franchise eligibility review by presenting an application for
assistance that includes either a “Certification of No Change or Non-Material Change” or a
"Certification of Material Change" from the franchisor’s counsel.66 More information about these
procedures can be found on the FranchiseRegistry.com site.

One reported issue with the program is the SBA’s mandated revision of certain
“standard” or “common” franchise agreement provisions. Fueled by a SBA regulation that
franchisees must maintain “the right to profit from its efforts and bears the risk of loss

60
See Tim Miller, Scott Pressly and Charlene York, Franchisor as Finance Coach: Finding Options and Solutions for
RD
Franchisee Funding in Today’s Market, INT’L FRANCHISE ASS’N 43 ANNUAL LEGAL SYMPOSIUM, Ch. 11 (2010).

61
The Franchise Registry, http://www.franchiseregistry.com (last visited Jul. 31, 2010).
62
Id. at http://www.franchiseregistry.com/partnership.asp.
63
Id. at http://www.franchiseregistry.com/faqs.asp.
64
Id.
65
Id. at http://www.franchiseregistry.com/Partnership.asp.
66
Id. at http://www.franchiseregistry.com/Forms/.

31
commensurate with ownership,”67 the SBA can require addenda modifying the franchise
agreement that address how royalties are collected (not allowing a franchisor to estimate royalty
funds), the franchisor’s consent on transfers (cannot be unreasonably withheld) and the amount
of time a franchisor can operate the franchised business upon a franchisee’s death or disability.
Given today’s economic challenges, however, the SBA Franchise Registry-approved process
may be one of few financing sources.

Some other sources and programs include: (1) the International Franchise Association’s
VetFran program (“[t]o honor those men and women who have served in the U.S. military, the
Veterans Transition Franchise Initiative…was developed to help them transition to civilian
life”),68 which offers voluntary discounts or financial incentives from nearly 400 participating
franchise companies;69 (2) drawing on a qualified retirement account (borrowing funds from a
401(k) plan or an IRA using a “ROBS” transaction (Rollovers as Business Start-ups));70 and
(3) franchise finance lenders (GE Capital, Franchise Finance is one example).71 Although some
of these resources may not be appropriate for or available to franchisees of a start-up system,
your client should be made aware of these options and conduct an independent review.

FDD Item 10 offers guidance concerning required disclosure of financial assistance

offered or arranged by a franchisor. If your client wishes to offer financing directly or indirectly,
Item 10 should be closely reviewed. “Financing arrangements” under Item 10 can include direct
loans, leases, installment contracts, written agreements between a franchisor or its affiliate and
a lender for the lender to offer financing to franchisees, an arrangement in which the franchisor
or affiliate receives a benefit from a lender, as well as a franchisor’s guarantee of a note, lease
or other franchisee financial obligation.72 Whatever the arrangement, a franchisor must disclose
all relevant information about the source, purpose and terms of the financing arrangement. This
information may be presented in a table or chart.73 Further, sample financing contracts must be
included as an attachment to the FDD.74

While financing can be a valuable addition to a franchise sales program, FDD disclosure
detail requires a well-formulated program with ready-to-use documents. A franchisor’s intention
may be to offer a clean and simple program but financing arrangements can quickly become
more complicated than desired. In addition, legal fees may have to be adjusted upward to

67
SOP 50 10 5(a) http://www.sba.gov/idc/groups/public/documents/sba_homepage/serv_sops_50105a.pdf; 13
C.F.R. 121.103(i).
68
VetFran Directory Introduction, http://www.franchise.org/Veteran-Franchise.aspx.
69
Id.
70
See Jeff Elgin, Finance Your Franchise With Retirement Funds, ENTREPRENEUR MAGAZINE, April 23, 2010, avail. at
http://www03.entrepreneur.com/franchises/buyingafranchisecoachjeffelgin/article206310.html.
71
See About GE Capital, Franchise Finance, https://www.geffcenter.com/DoingBusinessWithGEFatwire.action (last
visited Jul. 31, 2010).
72
16 C.F.R. § 436.5(j)(1).
73
Id. at (j)(1)(i)-(x).
74
Id. at (j)(1)(i), fn. 7; 16 C.F.R. § 436.5(v).

32
accommodate unanticipated financing agreements. If you quote a flat fee, make sure your fee
agreement is clear about the agreements that are included in that fee.

Moreover, unless the start-up has substantial resources or a well-proven company-

operated system, it will be extremely risky to develop a direct financing program or one that
involves franchisor-guaranteed financing. Normally, a new system is eager, if not desperate, to
receive initial fees and royalty payments. Carrying financing usually means delayed and missed
payments, something a fledging system cannot tolerate for too long. If a client is considering
some type of direct financing, make sure it seeks additional professional advice to develop a
realistic and manageable program.

Working with lenders who can offer franchisee financing may be the better course. But,
the recent economic downturn has all but dried-up third-party franchisee financing.75 And,
according to some industry observers, lenders are now more heavily focused on the strength of
the franchisor as opposed to the borrowing franchisee. What are the franchisor’s current system
performance, brand appeal, overall unit economics and financial status as well as the level of
management experience in managing a franchise system (not just the business of the
concept)?76 In a risk adverse environment it is easy to understand why lenders will look for a
more stable, mature infrastructure than that offered by a start-up.

The reality is, however, that even in good economic times, a start-up system may find it
nearly impossible to secure an interested lender – with no proven franchise system track record
or unit-level economics, a lender will have very little with which to work. If a cooperative lender
can be found however, a realistic program should be developed to maximize franchise sales.
This may start off modestly. For instance, if the franchise operation involves inventory,
equipment and trade fixtures, perhaps an interested lender can devise a program to offer
securitized loans against the hard assets of the venture. That is, if the client is interested in
developing a financing program, start with pieces and parts that can be used as security for the
loans. Real estate is another area where lender financing can be developed. Nevertheless,
being realistic, any third-party financing program will be a long-shot for a start-up.

Three final suggestions, however, may increase the odds of securing some third-party
franchisee lending sources: (1) include an Item 19 FPR in the FDD; (2) prepare a Lender’s Non-
disclosure Agreement for disclosure of the franchisor’s current unit economics and other
performance indicators (even if an Item 19 FPR is not made); and (3) provide a franchise
consultant’s strategic and/or analytical report to a potential lender. These strategies may be of
value only if the franchisor has substantial or impressive pre-franchise system
financials/economics or is in a rapidly developing market with solid projections. While we
separately discuss some of these topics more fully in other areas of this paper, their
interrelationship to the development of franchisee-lending sources is pertinent here.

R. Discuss Client’s Specific Sales Strategy

Above we explored the client’s “grand development plan,” but as your client gets closer
to developing the system and you are drafting the FDD, you also need to focus the client on a
specific geographical strategy. In other words: where will the franchisor first offer franchises? No

75
See Miller, supra note 60.
76
Telephone interview of Darrell Johnson, President and CEO of FRANdata (May 24, 2010).

33
single answer or strategy will cover all situations or opportunities. This is truly driven by the
capabilities and opportunities of each system. Yet a number of practical and legal factors will aid
in the development of a cohesive strategy – and a cohesive strategy is the goal.

First, let us discuss what a new system should avoid doing:

Rule One: Do not react to would-be deals.

Rule Two: Do not forget about Rule One.

There is a very practical business reason for Rule One: the client should be driven by a
firm, well thought out business strategy that takes into account the following elements: training,
operational assistance and control, the scope of franchisor’s supply chain, vendors’ supply
chain limitations, critical mass and brand identity through narrow regional development and,
finally, cost control. Getting the first franchisees off to a roaring start is crucial. New franchisors
should do everything possible to make them successful. Satisfied franchisees are a new
system’s best sales tool. Too many new systems indicate that they need franchise registrations
in multiple states merely because somebody’s brother-in-law is reputedly interested in buying a
franchise. The practical reality is that new franchisors simply do not have the capacity and
experience to successfully operate a scattered, disjointed system. Encourage the new system to
devise a geographic sales plan and to stick to it. The management team needs to drive your
client’s strategy rather than react to would-be opportunities. Plan, do not react.77

This approach may be the best legal strategy as well. As alluded to in other sections
above, due to a start-up franchisor’s initial level of capital investment and limited history, some
of the franchise registration states may impose additional disclosure and other requirements,
like fee deferral. Knowing this and the fact that only fourteen states require registration (fewer
really if we do not count the file-with-no-review-states), it may make economic sense for your
client to initially file in only those registration states in which it truly expects to sell franchises.

S. Dispute Resolution Alternatives, Choice of Law, Venue Etc.

Though this is more the lawyer’s domain, client involvement in the dispute resolution
mechanisms and approach is important. This is when the lawyer has the opportunity to learn
about the client’s business dispute experiences and gauge its attitude towards business
problem-solving, mediation, arbitration and litigation. Some may be keen to taking a business-
solution approach to commercial conflicts while others are hardened from scorch-the-earth
experiences. Often a client’s stance is influenced by its recent won-loss record as well as its
prior experiences with business and litigation counsel. It may be difficult to change entrenched
attitudes and hopefully you will not need to do so. However, seasoned franchise counsel
realizes that conflict avoidance is an art that the start-up franchisor should seek to perfect. The
last thing a start-up system needs is a string of lawsuits, especially those that make it into the
FDD.

Conflict resolution is more than how, when and where – it is an attitude that must be
honed or checked from the inception of a franchise program.78 An attitude of mutual respect and

77
For additional guidance on the sales process and to obtain some great sales tips, see Hein, supra note 28.
78
See Nathan, supra note 35.

34
caring will fuel a healthy franchisor-franchisee relationship much more quickly than threats and
intimidation. Thus, if your client tends towards the negative side of conflict resolution a
discussion about the need to care for franchisees, maintaining a flexible attitude and keeping an
open mind may be in order. Unless you plan to generate most of your fees through litigation
(which will not last too long with a start-up), counseling the new franchisor in business-solution
conflict resolution is invaluable.

Once you have the client in the right frame of mind, it is time to get down to the details.

While we do not seek to duplicate or recount the numerous articles and presentation
devoted to these related topics,79 we stand upon the shoulders of our colleagues in offering
some practical guidance for the new franchise system. As we noted above and have stressed in
other areas, conflict avoidance should be the priority;80 but when conflict results, mechanisms
should be put in place to reduce the cost of resolution. Naturally, however, the need to protect
the system and take prompt appropriate action cannot be sacrificed purely for the sake of
saving a few dollars. This requires a balanced approach that we believe is best implemented by
categorizing the nature of disputes and matching them to an appropriate dispute resolution
mechanism.

Experience and common sense instruct that not all disputes are the same nor require
the “nuclear option” for resolution. For instance, as franchise lawyers, we know that the
improper use of a franchisor’s trademark or other intellectual property, especially in rogue
franchisee situations, cannot be tolerated; while a failure to use current POS materials or submit
timely reports, especially for the first-time violator, should bring a measured, curative response.
Thus, we think it wise to consider the various levels of disputes and specify an appropriate
mechanism or path for each level. Because some commentators and courts may view this
approach as one-sided, unconscionable or unenforceable – giving a perceived advantage to the
drafting franchisor – we do advise caution in this area. Going too far in certain instances may
result in a ruling that compels litigation. Even so, the worse that can happen is that a matter
designated for an alternative dispute approach ends up at the courthouse.

Nevertheless, we believe it is best for the new franchise system to develop, at a

minimum, a two-step (mediation81 and arbitration/litigation) process to resolve most problems.
And, if your client is dedicated to a conflict avoidance approach and seeks to be more creative,
you may wish to explore early intervention programs such as mandatory communication,
ombudsman program, franchisee advisory boards or peer panels.82 Again, however, we feel it is
necessary for franchisors to protect certain “sacred areas” with equitable and injunctive powers
(unauthorized trademark use, theft of trade secrets, establishment of competitive businesses

79
Visit the ABA Annual Forum on Franchising’s Index of Program Materials from 1991–2009 at
http://new.abanet.org/Forums/franchising/Pages/CLEPrograms.aspx and see the Articles under the topic heading of
FRANCHISOR / FRANCHISEE RELATIONSHIPS.
80
For more expansive and creative conflict avoidance techniques, see Dean T. Fournaris, Sherin Sakr and Sue
Vandittelli, Establishing Effective Early Intervention Programs to Manage Day-to-Day Disputes, System Standards
ND
Compliance and System Changes, A.B.A. 32 ANNUAL FORUM ON FRANCHISING, Tab W17 (2009).
81 ND
See Peter Klarfeld, Michael Lewis and Peter Silverman, Mediating Franchise Disputes, A.B.A. 32 ANNUAL FORUM
ON FRANCHISING, Tab W12 (2009).
82
Fournaris, supra note 80.

35
and the like), but counsel that other defaults and violations may be better managed in mediation
and arbitration settings. Keep in mind, however, that while we may recommend certain
mechanism and avenues of resolution, those most suitable for your client, the nature of the
franchise system and other intangibles may take precedence.

Much has been written, debated and opined about the pros and cons of arbitration and
litigation of franchise disputes.83 We can only amplify what has already been articulated.

Arbitration, especially with renewed interest in the Federal Arbitration Act84 in the late
1980’s and early 1990’s, was reputedly favored by many franchise systems in the late 90’s and
early 2000’s, and according to some commentators, this interest has not waned significantly.85
From the franchisor perspective, the benefits of arbitration are said to include: cost and time
savings, more control over the proceeding, more control over venue of proceeding, limited or
streamlined discovery, ability to limit class action proceedings, no jury, limited judicial
intervention and finality with limited appellate review. The shortcomings of binding arbitration
are: judicial intervention concerning the enforceability of mandatory arbitration clauses,
unpredictable procedural rulings, unanticipated expense and costs that may equal the cost of
litigating and uninformed arbitrators or rulings that stray from established law or custom in the
industry. The pluses and minuses of arbitration should be carefully reviewed with the client.

On the other hand, if arbitration is not required by the franchise agreement or voluntarily
agreed to by the parties, all disputes will be resolved in court. Litigation still remains the
preferred means of dispute resolution for many franchise systems and their counsel.86
Numerous reasons support this choice: comfort, tradition, perceived certainty, early court
intervention when injunctive relief is required, thorough and extensive discovery, no upfront
arbitration fees or payment for the judge’s service, and the ability to appeal. Of course, as we
noted above, litigation costs can be expensively draining for a new system, the time investment
can be a distraction from the core business and, depending on the subject of the dispute, an
unrewarding and unproductive experience. In addition, litigation does not offer the same ability
to limit class action proceedings as arbitration does, which may prove critical as the franchise
system grows. Nevertheless, litigation may be the preferred route especially if the new
franchisor is well capitalized and works with efficient counsel.

Finally, a discussion of dispute resolution would not be complete without a word about
venue selection and choice of law. While a discourse here about the pros and cons of both
subjects may prove interesting, it is not of great relevance when counseling the new franchisor.

83
Christopher R. Drahozal and Quentin R. Wittrock, “Is There a Flight from Arbitration?”, 37 HOFSTRA L. REV. 71
(2008); Julianne Lusthaus, Mary Leslie Smith and Quentin R. Wittrock, Is Franchising Abandoning Arbitration?
ND
Current Trends in Arbitrating Franchise Disputes, A.B.A. 32 ANNUAL FORUM ON FRANCHISING, Tab W16 (2009);
ST
Bethany L. Appleby, Richard L. Rosen and David L. Steinberg, Inside a Franchise Arbitration, A.B.A. 31 ANNUAL
FORUM ON FRANCHISING, Tab W22 (2008); Edward Wood Dunham and Michael J. Lockerby, Shall We Arbitrate? The
TH
Pros and Cons of Arbitrating Franchise Disputes, A.B.A. 28 ANNUAL FORUM ON FRANCHISING, Tab L3 (2005); Audra
ST
Terrell, Charles Miller and Jonathan Perlman, Advanced Issues in Arbitration, INT’L FRANCHISE ASS’N 41 ANNUAL
LEGAL SYMPOSIUM, Ch. 14 (2008).
84
The Federal Arbitration Act, 9 U.S.C. § 1-16 (2010).
85
Drahozal, supra note 83; Lusthaus, supra note 83.
86 ND
See Michael D. Joblove and Robert Zarco, Fundamentals 201: Franchise Litigation, A.B.A. 32 ANNUAL FORUM ON
FRANCHISING, Tab W4 (2009).

36
Few, if any, franchisors voluntarily select the venue of their franchisees’ locations, but instead
choose a venue within the state in which they are located. There are many reasons for this but
the bottom line is simple leverage: to deter the initiation of disputes to begin with, keep disputes
close to home if they arise and reduce the cost of travel and expense of out-of-state counsel.
Franchisors also tend to establish the law of the state in which they are located as the governing
law, the thought being that they and their counsel know the law and want to gain whatever
perceived advantage it may provide. Franchisors located within registration states, however,
may seek to avoid the application of their state’s franchise law by selecting the law of the state
in which their franchisees are located. Thus, if your client is located in a registration state you
may want to explore this alternative. Otherwise, when counseling a new franchisor, go with the
flow; select its locale as the venue and the law of its state as governing law.

T. Inclusion of Financial Performance Representation (“FPR”) in Item 19

An important issue to discuss with your start-up franchisor client that will impact the
sales process is whether it wants to include a FPR in Item 19 of its FDD. A FPR is defined
under the FTC Franchise Rule as “any representation, including any oral, written, or visual
representation, to a prospective franchisee...that states, expressly or by implication, a specific
level or range of actual or potential sales, income, gross profits or net profits.”87 A FPR can be
based on the historic performance of existing outlets or a forecast of future potential
performance (although franchisors rarely, if ever, provide FPRs based on forecasts).88 While
franchisors are not obligated to include a FPR in Item 19 of their FDD, they must do so if they
want to provide any FPR information to prospective franchisees.

Throughout the 1990s, most franchise lawyers were wary of advising their clients to
include earnings claims in their Uniform Franchise Offering Circulars (“UFOC”).89 The concern
was that by including an earnings claim in its UFOC the franchisor would open itself up to claims
from its franchisees based on the content of the earnings claim. In reality, however, most claims
brought by franchisees during this period relating to earnings claims were the result of alleged
unlawful earnings claims (i.e., earnings claims not included in a franchisor’s UFOC) being made
by a franchisor’s sales team. This is not all that surprising given that earnings claim/FPR
information is exactly the type of information prospective franchisees want to see before
purchasing a franchise. As a result, over the past decade, more and more franchisors have
been including earnings claims/FPRs in their FDDs, although still only about 35% of franchisors
currently make use of FPRs.90

We are proponents of preparing FPRs, where possible, and using them as a valuable
sales tool. This is especially true for start-up franchisors given that prospective franchisees do
not have the ability to get FPR information from any other source, like existing franchisees.
Essentially, if a start-up franchisor does not include a FPR in their FDD, they are asking their

87
16 C.F.R. § 436.1(e).
88
16 C.F.R. § 436.5(s)(3)(i).
89
“Earnings claims” are the predecessor to FPRs under the FTC Franchise Rule. Uniform Franchise Offering Circular
("UFOC") Guidelines (1993). For a thorough description of the evolution of FPRs and current requirements relating to
their preparation and use, see FINANCIAL PERFORMANCE REPRESENTATIVES: THE NEW AND UPDATED EARNINGS CLAIMS
(Stuart Hershman & Joyce Mazero, eds., 2008).
90
See Johnson, supra note 14.

37
prospective franchisees to invest in a franchise based solely on their own due diligence and
faith in the fledgling franchisor and brand. This is a difficult sell.

Therefore, we recommend that you review with your client what operational data they
have from existing units owned by the franchisor or the franchisor’s affiliates. FTC FAQ 8,
clarifies that “the [FTC Franchise] Rule does allow franchisors to use affiliate information as a
basis for a performance claim in certain narrow circumstances – specifically, when the
franchisor lacks an adequate operating experience of its own.”91 This will likely be the case if
your client has created a new entity to act as the franchisor. Once you have gathered the
relevant operational data, you need to analyze whether it provides a “reasonable basis,” for the
preparation of a FPR.92 If so, you are free to work with your client to prepare a FPR that best fits
their business and the data they have collected. In preparing an FPR, you need to make sure
that you take into account all of the information contained in FDD Item 19, the FTC Compliance
Guide and FTC FAQs 8, 27 and 33, and include all appropriate and allowable disclaimers to
protect your client.93 There are a number of quality resources that can help you with this
process.94

Whatever form you choose, it is crucial in FPRs based on franchisor-owned or affiliate-

owned units that you disclose how these units may differ materially from the franchised units
being offered.95 For example, a franchisee may be required to pay royalties and other fees to
the franchisor that franchisor-owned or affiliate-owned units are not required to pay. You also
need to make sure that your client can provide written substantiation for any FPR upon a
prospective franchisee’s reasonable request.96 While a FPR can be comprehensive and include
a complete pro forma of each franchisor-owned and affiliate-owned unit, a FPR also can be
simple and include just average gross sales, or average gross sales, average cost of goods sold
and average gross profits of the existing units. A franchisor has a fair amount of flexibility in
determining the content of its FPR, as long as it has a “reasonable basis” and is not
misleading.97 While a prospective franchisee must be cautioned in Item 19 that its “individual
financial results may differ from the results stated in the financial performance representation,”98
we recommend that you confirm with your client that any FPR it includes in its FDD has the
potential of being achieved by new franchisees either initially or over time, as applicable.

91
FTC FAQ 8.
92
16 C.F.R. § 436.5(s)(3).
93
16 C.F.R. § 436.5(s); Franchise Rule Compliance Guide at 85-94; FTC FAQs 8, 27 and 33.
94
See Hershman, supra note 63; Anne Connelly, Brian B. Schnell and Andrew Selden, Financial Performance
ST
Representations – Shield or Sword?, A.B.A. 31 ANNUAL FORUM ON FRANCHISING, Tab W16 (2008); Joyce Mazero,
Rebekah Prince and Peggy Shanks, Advanced Financial Performance Representations: Preparing & Using FPR’s,
ND
INT’L FRANCHISE ASS’N 42 ANNUAL LEGAL SYMPOSIUM, Ch. 7 (2009); Darrell Johnson, Kay Ainsley and F. Joseph
Dunn, Beyond Gross Sales: Creative Approaches to Financial Performance Representations, INT’L FRANCHISE ASS’N
TH
40 ANNUAL LEGAL SYMPOSIUM, Ch. 18 (2007).
95
16 C.F.R. § 436.5(s)(3).
96
Id.
97
Id.
98
Id. at § 436.5(s)(3)(iv).

38
 Further, it is important to remember that, under the FTC Franchise Rule, cost and
expense information does not constitute a FPR, unless it is “coupled with additional sales or
earnings figures.”99 This means that a franchisor can provide to a prospective franchisee
average labor and rent costs of its affiliate-owned units, but may not provide average labor or
rent costs as percentage of gross sales or gross profits unless this information is included in
Item 19 of its FDD. In addition, blank pro forma do not constitute a FPR,100 so your client may
want to prepare one as an additional aid to prospective franchisees. You should ensure,
however, that your client understands that they run the risk of turning a blank pro forma into a
FPR if they assist a prospective franchisee in completing it or review and comment on it after it
is completed.

Through the use of a FPR, cost and expense information and a blank pro forma, a start-
up franchisor can at least provide some items to a prospective franchisee that will allow it to
begin to assess the franchise being offered. While the preparation of a FPR may add to the cost
and complexity of the FDD, it will likely help your client’s franchise sales. It may even be
considered a necessity if your client is up against other franchisor competitors who have a FPR
in their FDDs. In addition to the sales aspect, the inclusion of a FPR in your client’s FDD also
may assist their franchisees in obtaining financing. Regardless of what you and your client
decide regarding the FPR issue, we cannot over-emphasize the importance of educating the
client as to the implications of this decision on the sales process.

U. Preparation of Agreements Other Than Franchise Agreement

While the franchise agreement is obviously the key document between a franchisor and
its franchisees, there may be other agreements relating to the relationship you will need to
prepare. For example, if your clients makes use of one or more of the of the multi-unit
expansion options described in Section IV.C, you will be obligated to draft the appropriate
agreements. In addition, depending on the nature of your client’s business, you may be required
to create other documents including the following: technology-related agreements,
leases/subleases, construction/renovation agreements, financing and security agreements,
supply agreements, telephone number assignments, marketing co-op agreements, national
account participation agreements, test agreements and management agreements.101 Most
likely, all of these documents will need to be included as exhibits to the FDD and referenced in
FDD Item 22.102 If you and your client elect to prepare and use any other agreements that will
be signed before the franchise agreement, like letters of intent, commitment agreements, site
selection agreements and franchise applications, be careful to draft them in a way that avoids
the creation of a franchise relationship until intended, and does not violate any applicable
disclosure and registration requirements.103

99
Franchise Rule Compliance Guide at 131; see also NASAA Commentary at 19.1.

100
NASAA Commentary at 19.2.
101 TH
See Nancy G. Gourley and David W. Koch, The Other Contracts in the Franchise Relationship, A.B.A. 29 ANNUAL
FORUM ON FRANCHISING, Tab W24 (2006).
102
16 C.F.R. § 436.5(v).
103
Kevin M. Shelley and Jonathan J. Toronto, Preliminary Agreements: How to Avoid Unintended Contractual
Obligations, 25 FRANCHISE L.J. 47 (Fall 2005).

39
 In addition to these documents, there may be other agreements that your client and its
affiliates will enter into with other third parties, which relate to the franchise system. These
agreements may include: IP license agreements, manufacturing agreements, approved supplier
agreements, financing agreements and lease agreements.104 While not required to be included
as exhibits in your client’s FDD, the existence and terms of these agreements may impact some
of the information required to be disclosed.

V. Additional Trademark and IP-related Issues

As you get closer to finalizing your client’s FDD, we recommend that you make sure its
IP house is in order. At this stage, your client should have settled on the primary trademark or
trademarks to be used in the franchise system and filed applications with the USPTO for these
trademarks. Remember that if a primary trademark has not been registered with the USPTO,
your client must include a specific disclaimer in Item 13 of its FDD.105 You also may want to
consider whether other disclosures are in order if your client’s primary trademark is not simply a
word mark, but a logo containing a word mark. Further, we suggest that you confirm with your
client that all necessary trademark license agreements have been signed by the franchisor and
its affiliates so that the trademark ownership and licensing structure described in Item 13
reflects the true ownership of the trademarks. Trademark assignments should also be filed with
the USPTO, as appropriate.

In addition to your client’s trademarks, we recommend that you inquire as to the status of
any other IP that is critical to the franchise concept, like patents, copyrights or trade secrets. As
with trademarks, you will want to check on applicable registrations and what steps your client
has taken to protect these items. You also will want to confirm that the disclosure in Item 14 of
your client’s FDD regarding these items is accurate, including the ownership and licensing
structure.

V. FINAL MEETINGS AND PREPARATIONS

At this point in the process, you are in the home stretch. The purpose of the final
meetings and exchanges are to fine-tune and finalize the FDD, and prepare for the submission
of the initial filings. While these topics are the focus of other programs and papers (as
referenced below), we offer a few insights.

A. Finalizing the FDD

It is your role as the franchise attorney to make sure that, based on the information
provided, the FDD includes all of the disclosures required under the FTC Franchise Rule and
applicable state law, including state-specific risk factors and cover pages.106 Although it is

104
See Gourley, supra note 101.

105
16 C.F.R. § 436.5(m)(4).
106
See Joseph J. Fittante, Susan Meyer and Craig Tregillus, Fundamentals 201: Drafting a Disclosure Document,
ND
A.B.A. 32 ANNUAL FORUM ON FRANCHISING, Tab W3 (2009); Robert Sawyer, Jr., Joseph Nugent and Maureen
O’Brien, Disclosure (Under the Revised FTC Franchise Rule and State Franchise Disclosure Laws), INT’L FRANCHISE
ND
ASS’N 42 ANNUAL LEGAL SYMPOSIUM, Ch. 30 (2009); Judith M. Bailey and Dennis E. Wieczorek, Franchise Disclosure
Issues, in Fundamentals of Franchising, 95-132 (Rupert M. Barkoff and Andrew C. Selden, eds., 3d ed. 2008).

40
common sense, we suggest that you have the CEO or other key officer of your client review the
final version of the FDD and its exhibits, and verify that is complete and correct, as further
described in Section IV.K. While your client may generally begin using its multi-state FDD to
offer franchises in non-registration states once finalized, make sure it understands that you may
want/need to revise the FDD based on comments you receive from state examiners. This is
especially true for start-up franchisors filing for the first time.

B. Reviewing Financial Statements and Accountant’s Consents

By the time you are finalizing the FDD, you will likely have had contact with your client’s
accountant to make sure the accountant will be able to provide the appropriate audited financial
statements. Most accountants will want to review your client’s FDD before providing their
consent, although we have found that the extent of the review and length of time necessary to
complete it varies. Be sure that you or your client discusses this issue with the accountant so
you can plan accordingly. You should also confirm that the accountant will provide a consent in
a form that will be acceptable to the registration states.107

Oftentimes the audited financial statements and accountant’s consent are the last pieces
needed before submitting filings. We recommend, however, that you take the time once you
receive them to ensure they are consistent with your and your client’s expectations, and the
related disclosures in FDD Items 8, 20 and 21. Although not mandated under the FTC
Franchise Rule, keep in mind that some franchise registration states require the inclusion of
unaudited, interim financial statements if your client’s initial filing is more than 90 or 120 days
after its most-recent fiscal year end.108

C. Submission of State Filings

Your client’s initial development plan will dictate the states in which you will need to
prepare and submit filings. Obviously, if your client wants to offer and sell franchises within or to
residents of the 14 franchise registration/notice states,109 you will need to submit initial
registration or notice filings in these states. Keep in mind that most of these states require you
to file franchise seller disclosure forms for each franchise seller who is offering and selling
franchises in that particular state. In addition, seven of these states require the filing of certain
franchise advertising before the franchisor uses it.110 Most likely, your client will also be required
107
For a proposed form document, see NASAA FDD Guidelines at Form F.
108
See, e.g., 815 ILL. ADMIN. CODE § 200.603 (2002); MD. CODE REGS. § 02.02.0812 (1998).
109
CAL. CORP. CODE § 3100, et seq. (2008); HAW. REV. STAT. § 482E-1, et seq. (2008); 815 ILL. REV. STAT. § 705/1, et
seq. (2009); IND. CODE § 23-2-2.5-1, et seq. (2008); MD. CODE ANN. § 14-201, et seq. (2010); MICH. COMP. LAWS
§ 445-1501 (1989); MINN. STAT. § 80C.01, et seq. (2006); N.Y. GEN. BUS. LAW § 680, et seq. (1989); N.D. CODE 51-19-
01 (2001); R.I. GEN. LAWS § 19-28-1.1 (1989); S.D. LAWS § 37-5B-1 (2008); VIR. CODE § 13.1-557 (2009); W ASH. CODE
§ 19-100-010 (1994); and W IS. STAT. § 553.01 (2008). For more information on state registration requirements, see
Joseph J. Fittante, Theresa Leets and Rebekah K. Price, Unique and Often Overlooked Provisions of State Franchise
RD
Registration and Disclosure Laws, A.B.A. 33 ANNUAL FORUM ON FRANCHISING, Tab W10 (2010); Dale E. Cantone,
ND
Halima Madjid and Leonard D. Vines, Best Practices for State Franchise Registration, A.B.A. 32 ANNUAL FORUM ON
FRANCHISING, Tab W8 (2009); David Kaufmann, Timothy O’Brien and Theresa Leets, Registration: How to Swiftly
ND
Secure Initial, Amendment and Renewal Disclosure Document Registrations, INT’L FRANCHISE ASS’N 42 ANNUAL
LEGAL SYMPOSIUM, Ch. 29 (2009); Rochelle B. Spandorf and Mark B. Forseth, Franchise Registration, in
Fundamentals of Franchising, 125-81 (Rupert M. Barkoff and Andrew C. Selden, eds., 3d ed. 2008).
110
See CAL. CORP. CODE § 31156 (2008); MD. CODE ANN. § 14-225; MINN. STAT. § 80C.09 (2006); N.Y. CODE § 200.9
(2002); N.D. § 51-19-10 (2001); R.I. GEN. LAWS § 19-28.1-12 (2009); and W ASH. CODE § 19.100.100 (1994).

41
to submit one-time exemption notice filings in Kentucky, Nebraska and Texas,111 and annual
exemption notice filings in Florida and Utah,112 before selling franchises in these states. Further,
if your client does not have a federally registered trademark, you may need to comply with
certain additional disclosure or registration requirements under other business opportunity laws,
including Connecticut, Georgia, Louisiana, Maine, North Carolina and South Carolina.113

D. Providing General Franchise Sale Compliance Training and Tools to Start-

up Franchisor

After bringing your start-up franchisor client through the franchise development process,
you should set it on the right path as it begins selling franchises. Accordingly, we strongly urge
you to build into your representation some general franchise sales compliance training for your
client’s franchise sellers, including such basics as the timing of disclosure, method of disclosure
(electronic or otherwise), collection of receipts, document retention requirements, limitations on
use of FPRs and the ongoing duty to update the FDD. As part of this training, we recommend
that you equip your client with charts, checklists, forms and other tools to help them stay
organized and comply with ongoing disclosure and registration requirements.114

VI. CONCLUSION

Developing a start-up franchise program is a complex and multifaceted process,

requiring the considerable legal and organizational skills of franchise counsel. As the scope of
the process reveals, client involvement, as well as the inclusion of other professionals
(accountants, franchise consultants, knowledgeable management), is essential. Directing and
coordinating the franchise development team to produce a workable, saleable and sustainable
system falls to franchise counsel. Start by learning as much as possible about the client’s
business and determine how best to duplicate and translate its core business into a thriving
franchise system.

We have outlined and discussed the essential considerations from start to finish. There
is no substitute for the hands-on experience of working with a number franchise start-ups, but
we have endeavored to offer a detailed roadmap for the first-time practitioner while also offering
enough substance for experienced counsel. Despite the endless possibilities of the application
of the franchise model to innumerable business concepts, there is much guidance to be found.
We only hope to have added to this excellent body of work in a meaningful way.

111
KEN. REV. STAT. ANN. § 367,807 (1996); NEB. REV. STAT. § 59-1722 (2003); and TEX. BUS. & COM. CODE
§ 51.003(b)(8) (2009).
112
FLA. STAT. § 559.802 (2009).
113
CONN. GEN. STAT. ANN. § 36b-60, et seq. (2009); GA. CODE ANN. § 10-1-410, et seq. (2002); LOU. REV. STAT. ANN.
§ 1821, et seq. (2001); ME. REV. STAT. ANN. tit. 36, § 4691, et seq. (1991); N.C. GEN. STAT. § 66-94, et seq. (2003);
and S.C. CODE ANN. § 39-57-10, et seq. (2009).
114
See Susan Grueneberg and Dawn Newton, Best Practices For Establishing a Franchise Compliance Program,
RD
A.B.A. 33 ANNUAL FORUM ON FRANCHISING, Tab W19 (2010).

42
 APPENDIX A

Franchise Program Development Questionnaire1

For Use By

(“Franchisor”)

Date:

GENERAL INFORMATION

1. Name and telephone number of the person primarily responsible for strategic planning

and development of the company’s franchising program:

Name:

Title:

Phone:

Fax:

2. Meeting Schedule

A. Date: Time:

Place:

Purpose:

Persons Attending:

1
Based on a document provided by Max Schott, II and Gray Plant Mooty.

A-1
 FRANCHISOR AND RELATED ENTITIES

3. Legal name of the Franchisor:

4. Franchisor’s address:

5. Franchisor’s telephone: ( )

6. Franchisor’s facsimile: ( )

7. Franchisor’s e-mail Address:

8. Has the Franchisor been formed (either as a corporation, limited liability company (LLC)
or other entity)?........................................................................................Yes ___ No ___
A. Date of formation
B. State of formation
C. Please provide copies of the Articles of Incorporation/Organization, Bylaws,
Minutes of meetings of Shareholders and Directors and shareholder ledger or
any other applicable entity formation documentation.
D. Please provide a diagram of the structure of the Franchisor entity. If the
Franchisor is the parent company, please provide a list of shareholders/members
and the wholly-owned subsidiaries of the franchisor. If the Franchisor is a wholly-
owned subsidiary, please provide the names of intervening subsidiaries up to the
holding company and a list of all subsidiaries of the holding company. Please
include the names of shareholders/members of the parent company.

9. Have the Franchisor’s outside accountants reviewed the proposed

structure of the Franchisor? ..................................................................... Yes ___ No ___

Comments

10. Does the operating company have at least 3 years of audited financial
statements? .............................................................................................Yes ___ No ___

Comments

11. What is the target effective date for the franchise program?

A-2
12. Describe the Franchisor’s other business activities (if any):

Comments

13. Description of Founder/Predecessors:

A. Describe the individual or entity (referred to as a “predecessor”)

that founded the concept (if other than the Franchisor), the date the
concept was founded and the date of any subsequent transfer of assets
related to the concept:

Comments

B. Identify any other individual or entity that, within the past 10 years,
has owned a majority of the assets representing the concept (including
date of acquisition of assets and sale of assets and current status of
each such entity or individual):

Comments

14. Prior business experience of the Franchisor and related entities:

A. Describe the length of time the Franchisor has conducted a business of the type
that the Franchisee will operate.
B. Describe the length of time each predecessor or any affiliated entity has
conducted a business of the type that the Franchisee will operate.
C. Has the Franchisor or any related entity of offered franchises in any similar or
other line of business?
....................................... ....... ....................................................... Yes ___ No ___

15. Will Franchisor’s Parent guarantee the obligation of Franchisor or does Franchisor have
an affiliate that has offered or sold franchises in any line of business within the last 10
years? Yes ___ No ___

16. We will need to disclose certain litigation information involving any of the following
individuals: the Franchisor; the Franchisor’s parent; the Franchisor’s affiliates; the
Franchisor’s predecessor; and the Franchisor’s officers, directors or individuals with
management responsibility relating to the franchisees (the “Parties”). As part of this
questionnaire, we are asking for more information than may need to be disclosed but we
want to get an accurate picture to ensure that we make proper disclosures.

A-3
A. Pending Litigation. Are any of the Parties:

(1) A defendant in a pending criminal action?.......................... Yes ___ No ___

(2) A defendant to a counterclaim in any pending civil

matter? ............................................................................. Yes ___ No ___

(3) A party to a pending administrative action?........................ Yes ___ No ___

B. Past Litigation. Are any of the Parties:

(1) Been convicted of a felony? ............................................... Yes ___ No ___
(2) Pleaded nolo contendere to a felony?................................ Yes ___ No ___
(3) Been held liable in a civil action? ....................................... Yes ___ No ___
(4) Been the named party or the subject of a complaint?......... Yes ___ No ___
(5) Been the subject of other legal proceedings? .................... Yes ___ No ___

C. Administrative Actions. Are any of the Parties:

(1) Subject to any currently effective injunctive or

restrictive order or decree relating to franchises?............... Yes ___ No ___

(2) Subject to any currently effective injunctive or

restrictive order or decree under any federal, state or
Canadian franchise, securities, antitrust, trade
regulation or trade practice law as a result of a
concluded or pending action or proceeding brought
by a public agency? ........................................................... Yes ___ No ___

D. Within the last year, have any of the Parties been a party
to a civil action involving a franchise relationship? ......................... Yes ___No ___

E. If the answer to any of the questions in A, B, C or D above is “Yes,” please

provide the following information:
(1) Court, arbitration office or public agency in which action filed:

(2) Date of filing:

(3) Docket number:

(4) General nature of claims asserted:

A-4
 (5) Relationship to defendant or party bringing the action (e.g., former
franchisee, supplier, etc.):

(6) For pending actions, describe current status:

(7) For actions no longer pending, please provide the disposition of the case,
including the terms of settlement.

(8) For orders or decrees, please summarize the nature, terms and
conditions of the order or decree:

Note: You may be asked to provide copies of the pleadings. If there is a

lot of information to report please contact us directly rather than filling out
E.

TRADEMARKS AND SERVICE MARKS

17. Name Franchisee will use for the franchised business:

18. Is this name a currently registered trademark or service mark? ............... Yes ___ No ___
If yes, please provide us with a copy of the certificate(s) of registration with the United
States Patent and Trademark Office (“USPTO”) and any Secretaries of State.

19. List any other trademarks, service marks and/or logos owned by the Franchisor that are
registered with the USPTO or any Secretary of State.

FRANCHISEE

20. What will we call the Franchisee in the Franchise Agreement (e.g., Franchisee, You,
Licensee, etc.)?

A-5
 FRANCHISE PRODUCT/SERVICES

21. What products or services will the Franchisee provide? Please describe the franchised
business in detail:

22. Describe the general market for the products or services that the Franchisee will offer
(for example, is the market developed or developing? Will the goods be sold primarily to
a certain group of customers? Are sales seasonal?).

23. Provide a general description of the competition for the goods and services offered.

TERRITORY

24. Will the Franchisee receive a single location from which it will be
authorized to operate the franchised business? ....................................... Yes ___ No ___

If no, describe where the franchisee will be authorized to operate:

25. Will the Franchisee receive a protected territory in which to operate the
franchised business? ............................................................................... Yes ___ No ___

If yes, please answer Items A-E below:

A. How will the protected territory be defined?

(1) Radius

(2) Population

(3) Competition

(4) Potential Customers

A-6
 (5) Statistical Market Area

(6) Designated Market Area

(7) Number of Businesses

(8) Other

B. Will the Franchisee have the right to open more than one location
within the territory? ....................................................................... Yes ___ No ___

C. Will the Franchisee have the right to relocate within the territory .. Yes ___ No ___

D. Will there be a fee payable by the Franchisee for relocation......... Yes ___ No ___

If yes, amount: $

E. Will there be any minimum sales requirements or other conditions

to maintain exclusivity of the protected territory ............................Yes ___ No ___

Please describe conditions:

**If yes, please see Royalty Fees on page 10 and add these
minimums**

FRANCHISOR’S RIGHTS TO DISTRIBUTE PRODUCTS/SERVICES

26. Will the Franchisor have the right to sell and/or distribute any products or
services to anyone other than the Franchisee?........................................ Yes ___ No ___

If yes, please answer Items A-D below:

A. What products or services? _________________________________________

________________________________________________________________

B. To whom and in what area(s)? ______________________________________

________________________________________________________________

C. Under what name(s)? _____________________________________________

________________________________________________________________

D. Will the Company be competing with the Franchisee? ____________________

________________________________________________________________

A-7
 E. Will the Company use other franchisees to sell products and/or services?
Please describe: _________________________________________________
________________________________________________________________

27. Will the Company have any of the following:

Infomercials Mail Order Catalog

Internet Marketing Special Promotions

Other (describe below)

_______________________________________________________________

_______________________________________________________________

_______________________________________________________________

TERM/FRANCHISEE’S OPTION TO RENEW

28. What will be the length or term of the Franchise Agreement?

29. If the term of the lease for the franchised location is longer than the term
of the Franchise Agreement, will the term of the Franchise Agreement be
extended to coincide? .............................................................................. Yes ___ No ___

30. Will the Franchisee have the option to renew the franchise at the end of
the term? ................................................................................................. Yes ___ No ___

If yes, will there be conditions?

If yes, please answer Items A-F:

A. Will the Franchisee have to pay a fee to the Franchisor to reacquire the
franchise?.....................................................................................Yes ___ No ___

If yes, amount: $
B. Will the Franchisee be required to sign the then-current Franchise Agreement?
…………………………………………………………………………..Yes ___ No ___
C. Will the Franchisee be required to pay the Royalty Fee in the then-current
Franchise Agreement?.................................................................Yes ___ No ___

If no, will the Franchisee pay the existing fee or will the new fee be limited to a
percentage increase over the existing fee? If a percentage, how much?
D. Will the Franchisee be required to pay the Advertising or Marketing Fee in the
then-current Franchise Agreement?.............................................Yes ___ No ___

A-8
 E. Will the Franchisee be required to pay new fees in the then-current Franchise
Agreement not previously paid by the Franchisee in the old Franchise
Agreement?..................................................................................Yes ___ No ___
F. Will the Franchisee be required to modernize the Business?.......Yes ___ No ___

If yes, please describe: ____________________________________________

__________________________________________________________
G. Must the Franchisee sign a release as a condition to renewal?....Yes ___ No ___

INITIAL FEE

31. What is the amount of the Initial Fee payable to the Franchisor by the
Franchisee?

32. If the Initial Fee is a variable based on population or some other criteria,
how will it be determined? ...............................................................................................
.........................................................................................................................................

33. The Initial Fee is due to the Franchisor:

When the Franchise Agreement is signed When the franchisee opens the
_____ franchised business _____

Installments (describe) ________________________________________________________

____________________________________________________________________________

____________________________________________________________________________

34. Will the Initial Fee, or any part of the Initial Fee, be refundable to the
Franchisee? ...........................................................................................Yes ___ No ___

If yes, what amount of the Initial Fee will be refundable? __________________________

If yes, under what circumstances will the Initial Fee be refundable:

Failure to complete training

Financial/personal misrepresentation

Failure to secure a site for the franchised location

If so, within what time period

Failure to open within a certain period

If so, within what time period

A-9
 How will the amount of the refund be determined?

ROYALTY FEE

35. What amount will the Franchisee be required to pay to the Franchisor on a continuing
basis?

A. Fixed Fee Amount:

B. Percentage of Gross Sales: %

(1) Will the Royalty Fee increase during the term of this Agreement?
…………………………………………………………………...Yes ___ No ___

(2) Will the Royalty Fee be dependent upon Gross Sales volume? (e.g.
Royalty Fee decreases at certain sales levels)? ................ Yes ___ No ___

36. Will the Franchisee be required to pay the Franchisor a minimum Royalty
Fee? ....................................................................................................... Yes ___ No ___

If yes, then amount: $ per

37. When will the Royalty Fee be payable?

Monthly define

Weekly define

Other define

38. Will the minimum Royalty Fee be payable from the date the business
opens for operation? ................................................................................ Yes ___ No ___

If no, please indicate when minimum Royalty Fee payments will begin:

39. What is the due date of the Royalty Fee payments? (for example, the first
of the month, Wednesday of each week, etc.)

40. How will the Royalty Fee be paid?

Check Credit Card

Electronic transfer Other

41. Will the Franchisee be required to pay the Franchisor a service charge for
failure to remit Royalty Fees? .................................................................. Yes ___ No ___

A-10
 If yes, indicate amount of service charge:

42. Will the Franchisee be required to pay the Franchisor interest fees for late
remittance of Royalty Fees? .................................................................... Yes ___ No ___

If yes, indicate interest rate:

ADVERTISING/MARKETING FEE

43. Will the Franchisor charge an Advertising or Marketing Fee to the

Franchisee? ...........................................................................................Yes ___ No ___

A. Amount of Advertising/Marketing Fee:

(a) Fixed Fee Amount:

(b) Percentage of Gross Sales: %

(c) With Maximum of: %

B. How should we refer to this Fee (Advertising, Marketing, NMF, etc.)?

C. Describe how and for what the Advertising/Marketing Fee will be spent by the
Franchisor:

D. When will the Advertising/Marketing Fee be payable?

Monthly define

Weekly define

Other define

E. What is the due date of the Advertising/Marketing Fee payments (for example,
the first of the month, Wednesday of each week, etc.)?

A-11
 F. How will the Advertising/Marketing Fee be paid?

Check Credit Card

Electronic transfer Other

G. Will the Franchisee be required to pay the Franchisor a service charge for failure
to remit Advertising/Marketing Fees? .......................................... Yes ___ No ___

If yes, indicate amount of service charge:

H. Will the Franchisee be required to pay the Franchisor interest fees for late
remittance of Advertising/Marketing Fees? .................................. Yes ___ No ___

If yes, indicate interest rate:

I. Will the Franchisor commit to spending part of the Advertising/Marketing Fee in

the Franchisee’s market? ............................................................Yes ___ No ___

(1) How much:

(2) For what type of advertising:

J. Will the Franchisor provide the Franchisee with an annual audit or statement of
the expenditures made from the Advertising/Marketing Fund? ...... Yes ___ No ___

44. Will the Franchisee be required to participate in and contribute to a local

advertising cooperative? .......................................................................... Yes ___ No ___

A. Amount of the Franchisee’s contribution:

(1) Fixed Fee Amount:

(2) Percentage of Gross Sales:

B. Will the Franchisee receive credit toward the Advertising/Marketing Fee payment
to the Franchisor by contributing to the local advertising cooperative?

C. Frequency of payments to the local advertising cooperative:

Monthly define

Weekly define

Other define

A-12
 D. Due date of the Franchisee’s contribution to the local advertising cooperative:

45. Is the Franchisee required to spend an additional minimum amount

toward local advertising?.......................................................................... Yes ___ No ___

If yes, indicate amount per period: $ per

46. Will the Franchisee be required to spend a minimum amount for grand
opening of the franchised business?........................................................ Yes ___ No ___
If yes, indicate amount: $________________

47. Will the Franchisee be required to use approved or designated media

plan or media vendor? ............................................................................. Yes ___ No ___

If yes, please
describe:_____________________________________________

48. Will the Franchisee be required to advertise in the yellow pages, white
pages and/or on the Internet? .................................................................. Yes ___ No ___

If yes, under what listing(s) or URLs?:

_____________________________________________________

INITIAL INVESTMENT OF FRANCHISED BUSINESS

49. Provide a range for the Franchisee’s travel and living expenses for the
initial training program:

50. Provide a range of expenses for real estate acquisition (land and building
if applicable):

51. Provide a range of expenses for interior and exterior signs for the
franchised business:

52. Describe the type and range of expenses for miscellaneous opening
costs (for example, legal fees, accounting fees, and licenses):

A-13
53. Provide a range of expenses for the opening inventory of the Franchised
business:

54. Provide a range of expenses for insurance premiums:

55. Provide a description and a range of expenses for leasehold

improvements:

56. Provide a description and a range of expenses for equipment and

supplies:

57. Provide a range of expenses for a Computer (POS) System:

58. Provide a range of expenses for opening advertising and promotion:

59. Provide a description and a range of expenses for other pre-opening

related items:

A-14
60. Provide an estimated range of expenses needed to operate the
franchised business for a minimum period of three months after store
opening, and identify the types of expense likely incurred:

61. Will you require the franchisee to have minimum capital requirements? Yes ___ No ___

If yes, in what amounts?:

_____________________________________________________

SITE SPECIFICATION, BUILDING PLANS AND SPECIFICATIONS

62. Will the Franchisor provide building plans and specifications to the
Franchisee? .............................................................................................Yes ___ No ___

63. Will the Franchisor approve building plans and specifications prepared by
the Franchisee? ....................................................................................... Yes ___ No ___

64. Will the Franchisor provide construction standards and specifications? ... Yes ___ No ___

65. Will the Franchisee be required to retain a licensed architect?................. Yes ___ No ___

66. Will the Franchisor provide site selection assistance?..............................Yes ___ No ___

If yes, please describe:

67. Is a site evaluation or feasibility study by a qualified third-party required? Yes ___ No ___

If yes, who will be responsible for payment?

SIGNS

68. Are signs leased or purchased from the Franchisor? ..............................Yes ___ No ___

69. Does the Franchisor provide sign specifications and/or names of

approved suppliers for the signs to the Franchisee? ................................Yes ___ No ___

If yes, please provide a copy of the sign specifications.

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 TRAINING

70. Will the Franchisor provide initial training for the Franchisee?.................. Yes ___ No ___

If yes, please answer Items A-F below:

A. Who must attend training?

Franchisee

General/Store Manager

Other

B. Where will training take place?

C. When will training take place?

D. How long will the training program be?

E. What topics will be covered during training (classroom and on-the-job)?

We must develop and include in the FDD a chart that summarizes the training
program as follows:

Subject Hours of Hours of On-the- Location

Classroom Job Training
Training

F. Will the Franchisee be required to pay for any or all of the costs associated with
its employees attending the initial training program? .................... Yes ___ No ___

If yes, check those costs payable by the Franchisee:

Travel Salaries

Lodging Fringe Benefits

Other Expenses (describe)

A-16
71. Will other Franchisees assist or be involved in training? ..........................Yes ___ No ___

72. Will new management personnel subsequently hired by the Franchisee

attend the Franchisor’s training program?................................................ Yes ___ No ___

73. Will the Franchisor charge a training fee for new management personnel?Yes ___ No ___

If yes, amount: $

OPENING ASSISTANCE

74. What type of initial opening assistance will be provided to the

Franchisee?

75. Will the Franchisor furnish a representative to provide opening assistance

at the Franchised Location?..................................................................... Yes ___ No ___

If yes, please answer Items A-B below:

A. How long will representative stay at the Franchised Location?

B. Will the Franchisee be required to pay travel costs and living expenses for
Franchisor’s representative? ........................................................ Yes ___ No ___

76. Will the Franchisor provide a grand opening promotional package? ....... Yes ___ No ___

If yes, please answer Items A-B below:

A. What will the initial opening package include:

Signs Gift Certificates

Coupons Direct Mail Pieces

Press Releases Other (describe below)

B. Will the Franchisee be required to pay the Franchisor for a grand opening
promotional package?

..................................................................................................... Yes ___ No ___

If yes, amount: $

A-17
77. What types of on-going assistance will be provided by the Franchisor to
the Franchisee?

List of necessary products and Basic accounting and business

procedures
equipment

List of approved suppliers Visits to Franchised Location

Updates to Manuals Written reports regarding

Franchisee’s performance and
conformity within the business
system
Other (describe below

78. Will the Franchisor provide additional assistance to the Franchisee on a

consulting basis for a fee? ....................................................................... Yes ___ No ___

If yes, amount of fee: $ per

STANDARDS

79. Does the Franchisee need to obtain pre-approval for all of its advertising?Yes ___ No ___

80. Will the Franchisee be limited to whom it may offer its services? ............. Yes ___ No ___

If yes, please describe limitations:

81. What written materials will the Franchisor provide to the Franchisee to
define quality control, uniformity and standards?

82. Is the Franchisee required to purchase any products or services from

sources designated by the Franchisor?.................................................... Yes ___ No ___

If yes, please complete Items A-B:

A. Description of Product or Service Name of Manufacturer/Vendor/Supplier

A-18
 B. Will the Franchisor derive any income from the designated manufacturer, vendor
or supplier (the “Vendor”)? ...........................................................Yes ___ No ___

If yes, please state the name of the Vendor and source of the income
(e.g. marketing rebate, volume discount, advertising rebate):

83. Has the Franchisor developed any proprietary software specifically for
use in operating the Franchisee’s business?............................................ Yes ___ No ___

If yes, please answer Items A-B below:

A. Will the Franchisee be required to enter into a Software License Agreement?

If yes, will Franchisor sign the Software License Agreement with Franchisor ____
Third Party ___

B. Will the Franchisee be required to pay a Software License Fee to the Franchisor
or a third party? Yes ___ No ___

If yes, amount: $ Payable to: Date

payable

C. Does Franchisor own the software?.............................................Yes ___ No ___

84. Will the Franchisee’s employees be required to wear uniforms? .............. Yes ___ No ___

85. Will the Franchisee’s employees be required to sign confidentiality

agreements?............................................................................................Yes ___ No ___

86. Will the Franchisee be required to obtain the Franchisor’s approval before
any jukeboxes, video games, vending machines, gambling devices,
lottery tickets, pull tabs or other similar devices are used or sold at or near
the Franchised Location?......................................................................... Yes ___ No ___

87. Will the Franchisee’s employees be prohibited from smoking and drinking
alcohol at or near the Franchised Location?............................................. Yes ___ No ___

A-19
88. Will alcoholic beverages be served on the premises of the Franchised
Location? ................................................................................................. Yes ___ No ___

89. Will the Franchisee be allowed to sell promotional or other items which
display the licensed Marks? ..................................................................... Yes ___ No ___

If yes, list the types of items that the Franchisee will be allowed to sell (e.g., t-shirts,
mugs, etc.):

90. Will the Franchisee be required to obtain a security system for its
Business? ................................................................................................Yes ___ No ___

91. Will the Franchisee be allowed to play only approved music selections at
its Business?............................................................................................Yes ___ No ___

92. When the Franchisee’s Business is not open for business, will the
Franchisee be required to utilize an answering service or an answering
machine? ................................................................................................. Yes ___ No ___

93. Will the Franchisee be required to obtain cable, internet or other such
equipment for the reception of certain programming at the Franchised
Location?

94. Will the Franchisee be required to have access to cable or satellite

television at the Franchised Location? ..................................................... Yes ___ No ___

95. What business hours will the Franchisee be required to recognize?

96. Will the Franchisor reserve the right to inspect the Franchisee’s
premises? ................................................................................................Yes ___ No ___

A. If yes, will Franchisor give Franchisee a notice period?................Yes ___ No ___

B. If yes, how long is the notice period? _____ days

A-20
97. What special equipment will the Franchisor require?

Computer 800 telephone lines

Software Fax machines

Dedicated telephone lines ISDN/cable lines

Other technology (describe below

98. Are there any other uniformity requirements?

SPECIAL LICENSES

99. Do any special licensing requirements have to be met by the Franchisee?Yes ___ No ___

Insurance licenses

Real estate licenses

Environmental licenses

Liquor licenses

Other licenses (describe)

INSURANCE

100. Which of the following insurance requirements will apply to the

Franchisee?

A. General Liability Insurance in the amount of

B. Automobile Insurance in the amount of

A-21
 C. Errors and Omissions Insurance in the amount of

D. Property Insurance in the amount of

E. Business Interruption Insurance in the amount of

F. Theft Insurance in the amount of

G. Building Insurance in the amount of

H. Umbrella Liability Insurance in the amount of

I. Other (describe):

LEASE

101. Will the Franchisor approve the Lease for the Franchised Location? ....... Yes ___ No ___

102. Will the Franchisor retain the right to assume the Lease if, prior to
expiration of the Lease, the Franchisee is evicted or the Franchise
Agreement expires or is terminated? ....................................................... Yes ___ No ___

103. Will the Lease for the franchised location be pledged as security for the
Franchise Agreement?............................................................................. Yes ___ No ___

FINANCIAL STATEMENTS

104. Will the Franchisee be required to provide the Franchisor with financial
statements for the Franchisee’s Business?.............................................. Yes ___ No ___

If yes, please answer Items A-D below:

A. How often?

B. Describe information that must be contained in the financial statements:

C. Will the financial statements provided by the Franchisee need to be certified by

an independent CPA? ................................................................. Yes ___ No ___

D. Due date of financial statements:

105. Will the Franchisee be required to provide the Franchisor with copies of
the Franchisee’s income tax returns, sales tax returns and/or payroll tax
returns? ................................................................................................... Yes ___ No ___

A-22
106. Will the payment of fees by pre-authorized bank transfers be provided for
in the Franchise Agreement? ................................................................... Yes ___ No ___

107. If an audit by the Franchisor reveals that the Franchisee has understated
its Gross Revenues by more than ____% or $______________ in a
______ month period, then the Franchisee must reimburse the Franchisor
for all costs incurred by the Franchisor as a result of the audit.

FRANCHISOR’S RIGHT OF FIRST REFUSAL

108. Prior to the sale of the Business to a third party, will the Franchisor
reserve the right of first refusal to purchase the Franchisee’s Business? . Yes ___ No ___

109. If the Franchisee ceases to operate the Business, will the Franchisor
have a right of first refusal to purchase the assets of the franchised
business? ................................................................................................Yes ___ No ___

Comments

ASSIGNMENT

110. Will the Franchisee be required to pay a transfer fee to the Franchisor
upon assignment of the Franchise Agreement? ....................................... Yes ___ No ___

If yes, indicate amount: $______________________

Does this amount include training?.........................................................Yes ___ No ___

Is training mandatory? ............................................................................ Yes ___ No ___

111. Will Franchisor have the option to require the assignee-franchisee to sign
a new franchise agreement? ................................................................... Yes ___ No ___

112. Upon the death or disability of the Franchisee, will Franchisor have the
right to manage the Business until the Franchise Agreement is assigned?Yes ___ No ___

113. Will Franchisor have a right of first refusal if Franchisee sells the
Business? ...............................................................................................Yes ___ No ___

A-23
 TERMINATION BY FRANCHISOR

114. List any grounds for termination that are unique to the franchised
business?

115. What is the length of time that the Franchisee will be allowed to cure most
breaches?

___________________ days

116. What is the length of time that the Franchisee will be allowed to cure for
failure to pay fees?

___________________ days

117. Will the Franchise Agreement be subject to immediate termination by the

Franchisor if not precluded by applicable law?......................................... Yes ___ No ___

TERMINATION BY FRANCHISEE

118. Will the Franchisee have the right to terminate the Franchise Agreement?
................................................................................................................ Yes ___ No ___

If yes, please answer Items A-B below:

A. Under what circumstances?

B. What is the length of time that the Franchisor will be allowed to cure for
breaches?

days

FRANCHISEE’S OBLIGATIONS UPON TERMINATION

119. Upon termination of the Franchise Agreement, the Franchisee must pay
all fees due to the Franchisor within ____________ days.

A-24
120. Describe required modifications to the Franchised Location upon
termination of the Franchise Agreement:

121. Will Franchisor own the customer data during the term of the Franchise
Agreement? ............................................................................................Yes ___ No ___

122. Will the Franchisee be required to transfer to the Franchisor (or its
assignee) the customer lists of the Business? ......................................... Yes ___ No ___

123. Will the Franchisee be required to transfer to the Franchisor (or its
assignee) the telephone numbers and directory listings of the Business? Yes ___ No ___

COVENANTS NOT TO COMPETE

124. During the term of the Franchise Agreement, will the Franchisee be
prohibited from engaging in any business similar to the Franchised
Business? ................................................................................................Yes ___ No ___

125. After termination or expiration of the Franchise Agreement, will the

Franchisee be prohibited from engaging in any business similar to the
Franchised Business?.............................................................................. Yes ___ No ___

If yes, please answer Items A-B below:

A. During what period of time will the Franchisee be restricted?

B. What reasonable mile radius from an existing franchised business will the
Franchisee be restricted? miles

126. Will Franchisor prohibit Franchisee from employing or seeking to employ

any person employed by us or any other franchisee ? .............................Yes ___ No ___
If yes, during what period of time?
__________________________________

DISPUTE RESOLUTION

127. All litigation will be venued in which County and State:

A-25
128. The terms of the Franchise Agreement will be governed by the laws of the
State of:

129. Will the Franchise Agreement contain a nonbinding mediation provision?Yes ___ No ___

130. Will the Franchise Agreement contain an arbitration provision? ............... Yes ___ No ___

If yes, please answer Items A-C below:

A. In which city and state will the arbitration take place?

B. Which disputes would not be subject to arbitration?

C. Will the Arbitration provisions prohibit the Franchisee from participating in any
class action against the Franchisor?............................................ Yes ___ No ___

DEFINITIONS

131. Define Gross Revenues:

132. Define any terms addressed in the Franchise Agreement that are unique
to the franchised business:

A.

B.

C.

D.

A-26
 Franchise Development Team
(include key company personnel, accountants, lawyers, consultants, etc.):

Name/Title Name/Title

Company Company

Address Address

City State Zip City State Zip

Telephone No. Fax No. Telephone No. Fax No.

Name/Title Name/Title

Company Company

Address Address

City State Zip City State Zip

Telephone No. Fax No. Telephone No. Fax No.

Name/Title Name/Title

Company Company

Address Address

City State Zip City State Zip

Telephone No. Fax No. Telephone No. Fax No.

A-27
I confirm that the information in this questionnaire is correct to the best of my knowledge.

___________________________
[NAME OF FRANCHISOR]

___________________________ __________________________
Signature Printed Name

____________________________
Title
[OFFICER OR DIRECTOR OF FRANCHISOR]

____________________________
Date

A-28
 APPENDIX B

Franchisee Application / Questionnaire1

Request for Information From

Potential Franchise Candidate

XYZ FRANCHISE, INC.

Contact Information:

Joe Franchisor
(888) XXX-XXX
[email protected].

1
Based on document provided by Jim Meaney. As with all form documents, you are cautioned
to review and analyze applicable law (particularly those relating to privacy, data collection,
security and credit reporting, which are ever-changing) to ensure that the document your client
is using is in compliance.

B-1
 FRANCHISE EVALUATION PROCEDURE

XYZ FRANCHISE, INC. (“we”) would like to thank you for your interest in becoming a franchise
candidate. Please remember as you review this material that this is merely an application for
evaluation and determination of approval by our executive staff. This Request for Information
(“Request”) is one step in this multi-phase procedure.

Because the development of one of our XYZ franchises is a large undertaking, requiring
significant capital on your part and a significant time investment on our part, it is very important
for us to qualify your ability to own and operate our system. If we did not undertake this review
at this time, proceeding further could waste your time as well as ours. Thus, we thank you in
advance for your cooperation and understanding in completing this application.

Important: Do not incur any expenses relative to the operation of a XYZ franchise as this is
merely an evaluation process and is not a guarantee of awarding a XYZ franchise. Any
expenses that are incurred prior to the formal issuance of a XYZ franchise agreement will be at
your risk.

APPLICATION

The following data is submitted in connection with this Request to provide us with such pertinent
information as is deemed essential to appraise your financial capabilities, business and
operational experience and to evaluate your potential for developing a XYZ franchise.

Please type or print all information using black or blue ink.

If a partnership, corporation, limited liability company or other entity, all partners, directors,
managers, officers and principal owners should complete an application form.

PERSONAL INFORMATION
(To be completed by each principal or majority shareholder)
APPLICANT A
FULL LEGAL NAME
SOCIAL SEC. # DATE OF BIRTH PLACE OF BIRTH:
DRIVER’S LIC # OTHER NAMES USED
SPOUSE NAME

SPOUSE SOC SEC # SPOUSE DATE OF BIRTH SPOUSE DRIVER’S LIC #

ADDRESS
CITY STATE ZIP
E-MAIL PHONE CELL
BUSINESS EXPERIENCE
EDUCATION:

B-2
 APPLICANT A

DESCRIPTION OF EXISTING BUSINESS

CURRENT OCCUPATION:
BUSINESS NAME
BUSINESS ADDRESS
BUS. PHONE # BUS. FAX #:
NO. OF EMPLOYEES IN BUSINESS SINCE TYPE OF BUSINESS
BANK REFERENCES
NAME OF BANK NAME OF BANK
OFFICER NAME: OFFICER NAME:
ADDRESS ADDRESS
ACCT NOS. ACCOUNT NOS.
PHONE PHONE
PREVIOUS ADDRESSES WITHIN THE PAST SEVEN YEARS
ADDRESS, CITY, STATE, ZIP FROM (DATE) TO (DATE)

APPLICANT B
FULL LEGAL NAME
SOCIAL SEC. # DATE OF BIRTH PLACE OF BIRTH:
DRIVER’S LIC # OTHER NAMES USED
SPOUSE NAME
SPOUSE SOC SEC # SPOUSE DATE OF BIRTH SPOUSES DRIVER’S LIC #
ADDRESS
CITY STATE ZIP
E-MAIL PHONE CELL
BUSINESS EXPERIENCE
EDUCATION:

B-3
 APPLICANT B
DESCRIPTION OF EXISTING BUSINESS
CURRENT OCCUPATION:
BUSINESS NAME
BUSINESS ADDRESS
BUS. PHONE # BUS. FAX #:
NO. OF EMPLOYEES IN BUSINESS SINCE TYPE OF BUSINESS
BANK REFERENCES
NAME OF BANK NAME OF BANK
OFFICER NAME: OFFICER NAME:
ADDRESS ADDRESS
ACCT NOS. ACCOUNT NOS.
PHONE PHONE
PREVIOUS ADDRESSES WITHIN THE PAST SEVEN YEARS
ADDRESS, CITY, STATE, ZIP FROM (DATE) TO (DATE)

Personal Background

1. Are all applicants identified above citizens of the United States?

If you answered “NO”, which applicant(s) is/are not?
What is the country of citizenship?

2. My preferred franchise location/territory is

3. What percentage of time do you plan to devote to the XYZ business _______%

4. Will this business be your primary source of income? Yes [ ] No [ ]

5. Briefly summarize your employment and business experience and please attach a
current resume as supporting documentation:

6. Please describe briefly the principal positions (and nature of duties) you have held
during the past five years or, if graduated less than five years ago, since graduation
from college. Specific employers must be identified. Also list any professional

B-4
 licenses or registrations, including bar admissions, accounting certificates, and SEC
or state broker-dealer registrations you hold. What is sought is a sufficient
description to enable us to determine the extent of your experience in financial and
business matters generally, and the business specifically:

7. List any franchise operations in which the applicant or any of the persons listed
above are presently, or have in the past been associated either through employment
or through ownership or holdings:

8. Does the activity in item 6 above subject the applicant to any restrictive covenant?
Yes [ ] No [ ]

9. If any such associations listed in item 6 above have been terminated, state the date
of termination, and reason for termination.:

10. Please list the names and addresses of your attorney and accountant below:
Name Address Phone

11. Names of personnel who will participate in the management of the proposed
franchise on a full-time and continuing basis, and will successfully complete all
phases of the Training Program prior to the opening.
Operating Owner:
General Manager:
*Please attach a résumé or detailed work history

12. If proposed franchisee is an entity, and not an individual or individuals:

a. Please indicate type of entity and percentage of personal ownership:
( ) Corporation ____% ( ) Limited Partnership ____%
( ) Limited Liability Company ____% ( ) Other – Specify: ________________
( ) General Partnership ____%

b. Date of incorporation or organization:__________________

B-5
 c. Country, state or province where incorporated or organized:
__________________

d. Was the entity formed for the specific purpose of purchasing a XYZ franchise?
Yes [ ] No [ ]

e. Dollar value of the entity’s net worth:

( ) $1,000,000 - $1,999,999 ( ) $2,000,000 - $4,999,999
( ) $5,000,000 and over

13. If making application as a partnership, corporation, limited liability company, or other

entity (each an “Entity) please furnish the names of persons owning or having a right
to acquire an interest in the Entity and all officers, directors and managers of the
Entity (indicate percentage of interest).
Name Position Active %Owned

If the proposed franchisee is an Entity, and not an individual or individuals, a

separate Request must be completed by all persons listed above in this item 13. If
the proposed franchisee is an Entity, please attach signed copies of the Entity’s
current financial statements (balance sheets and income statements) and bank
statements or other documentation supporting the liquidity position of the entity.

14. Has applicant or any person listed above been convicted of a felony or
misdemeanor, other than traffic violations? Yes [ ] No [ ]
If yes, please explain:

15. Is there pending against you (or any Entity of which you are or were a partner,
director, manager, officer or owner) any administrative, arbitration, criminal or civil
action alleging a violation of any franchise law, theft, fraud, embezzlement,
fraudulent conversion, restraint of trade, unfair or deceptive practices,
misappropriation of property, violation of securities law, or comparable allegations?
Yes [ ] No [ ]

16. During the previous 10 years, have you (or any Entity of which you are or were a
partner, director, manager, officer or owner) been convicted or pleaded nolo
contendere or been held liable in a civil action by a final judgment, or been the
subject of a complaint, arbitration or other legal proceeding, involving violation of any
franchise law, embezzlement, theft, fraud, fraudulent conversion, restraint of trade,
unfair or deceptive practices, misappropriation of property, violation of securities law,
or comparable allegations? Yes [ ] No [ ]

B-6
17. Are you (or any Entity in which you are or were a partner, director, manager, officer
or owner) subject to any currently effective injunctive or restrictive order or decree
relating to franchises, or under any federal, state or Canadian franchise, securities,
antitrust, trade regulation or trade practice law, as a result of a concluded or pending
action or proceeding brought by a public agency? Yes [ ] No [ ]

18. During the past 15 years, have you been adjudged bankrupt or reorganized due to
insolvency, filed a petition in bankruptcy or had a petition in bankruptcy filed against
you? Yes [ ] No [ ]

19. During the past 15 years, were you a partner, director, manager, or officer of an
Entity at a time when, or within one year of the time when, such Entity was adjudged
bankrupt or reorganized due to insolvency or had a petition in bankruptcy filed
against it?
Yes [ ] No [ ]

20. During the previous 10 years, have you received any medical or psychological treatment as
a result of, or related to, the above of or dependence on drugs, alcohol, or controlled
substances? Yes [ ] No [ ]

21. Have you ever been arrested or had criminal charges filed against you?
Yes [ ] No [ ]

22. Have you ever used or been known by another name? Yes [ ] No [ ]

23. Please indicate any additional information which you think may be helpful in enabling us to
determine that your knowledge and experience in financial and business matters are
sufficient to enable you to successfully operate a XYZ business:

FINANCIAL INFORMATION
SOURCE OF EQUITY

Please attach a signed current financial statement (balance sheet and income
statement), and bank statements or other documentation supporting your
liquidity position, and copies of federal income tax returns for the last five
years.

1. Do you have any contingent liabilities which you reasonably anticipate could cause
the need for sudden cash requirements in excess of cash readily available to you?
Yes [ ] No [ ]

2. Do you have any reason to anticipate any significant decline in income or net worth in the
next three years? Yes [ ] No [ ]

B-7
3. During the previous 10 years, have you (or any Entity of which you are or were a partner,
director, manager, officer, or owner) defaulted in the repayment of any loan?
Yes [ ] No [ ]

4. During the previous 10 years, have you (or any Entity of which you are or were a partner,
director, manager, officer or owner) made an assignment for the benefit of creditors, has a
receiver appointed for any of your property, been declared insolvent, or otherwise been the
subject of any proceedings under any state or federal law relating to debtors and creditors?
Yes [ ] No [ ]

5. During the previous 10 years, have you (or any Entity of which you are or were a partner,
director, manager, officer or owner) been sued for collection of any debt or been sued for
the foreclosure of any collateral securing any debt? Yes [ ] No [ ]

6. During the previous 10 years, have you (or any Entity of which you are or were a partner,
director, manager, officer) been the subject of any “work out” arrangements with any lender
as a result of failure to timely repay any loan in accordance with its original terms?
Yes [ ] No [ ]

7. During the previous 10 years, have you (or any Entity of which you are or were a partner,
director, manager, officer, or owner) given a deed in lieu of foreclosure to any lender, or
otherwise transferred property to a lender to avoid foreclosure or collection action?
Yes [ ] No [ ]

8. If any part of the funds are to be borrowed, please identify the lender, amount of loan and
repayment terms: ___________________________________________________

The source and amount of equity to be utilized in the development of a new franchise
project is an important consideration. We have established a minimum equity amount
that may be greater depending on individual lender requirements, etc. Typically, ___%
to ___% of the total project cost will be required as an equity investment in each project.
With project costs ranging from $________-$________ this estimate roughly amounts
to $________-$________ (___%) to $________-$________ (___%) per franchise. If
you are not in the financial position to pursue this business venture solely, please
provide any relevant information concerning the addition of an “equity partner” or
realistic funding source:

Use the following chart to identify the sources of funds and the taxes, expenses, cost,
penalties, etc. to be deducted to arrive at the net equity amount. The source and gross
amount information should match the financial statement submitted with this Request. If
additional space is required, please use a separate sheet of paper.

B-8
 Taxes or Other
SOURCE Gross Amount Net Equity Amount
Expenses Payable
Cash:

Securities:

Retirement Accounts*

Other:
Other:

TOTAL EQUITY
*Retirement accounts must be discounted at a rate of ___% for use with XYZ projects.

I/we certify that the above represents the source(s) and amount(s) of funds to be used
for the equity portion of this new franchise project.

Date Corporate/Partnership Name

Signature of Applicant or Person Signature of Applicant Person Authorized

Authorized to Sign on Behalf of Applicant to Sign on Behalf of Applicant

Signature of Applicant or Person Signature of Applicant or Person

Authorized to Sign on Behalf of Applicant Authorized to Sign on Behalf of Applicant

MANAGEMENT & OPERATING PLAN

We recognize the significance of the role of management to the successful operation of

a XYZ business. As part of the approval procedure and to assist us in determining who
will be responsible for the operations, please indicate your intentions by checking the
appropriate box. We will require one of the following:

A. The candidate will be an “owner/operator” of the franchise

and will remain active on a day-by-day basis as a “general
manager,” successfully completing the Training Program prior
to the opening of the location

B. The candidate will be an “investor” and not active on a day-to-day basis

B-9
If you have marked “B” please provide us with the following information and note the
following requirements:

 Who will be the Operating Owner/General Manager?

 ________________________________________________________
________________________________________________________

 A written compensation program for the General Manager for the

operation of the franchise, to be developed by you, must be submitted
to us for our approval and be in effect on the day the franchise opens.
The development and implementation of a qualified compensation
program in and of itself is not a guarantee of a successful operation.
The day-to-day activities and performance of management will, in most
situations, dictate the potential success of that operation.

 The Operating Owner/General Manager must attend and successfully

complete the Manager in Training Program prior to the opening of the
franchise.

BUSINESS ENTITY OVERVIEW

Please be particularly careful that information given is accurate and that the individual(s)
or Entity making the application is designated correctly.

The Partnership Agreements or Articles of Incorporation/Organization should be

completed at the time of application. If they are not, the franchise agreement must be
issued to the principles as sole proprietors. Upon completion of the Partnership
Agreement or Articles of Incorporation/Organization, an assignment from the sole
proprietorship to the respective Entity may be accomplished under the terms of our
then-current “Assignment & Consent to Assignment Agreement.”

All owners of an Entity franchise must be bound by a buy-out agreement with respect to
their interest in the franchise.

The use of the name XYZ any derivation thereof or any corresponding trademarks
within the Entity name is strictly prohibited.

Please complete one of the following categories:

INDIVIDUAL

A)
Name Business Address State
B)
Name Business Address State

B-10
 *Please complete supplemental worksheet for
PARTNERSHIP
partnerships
, “a Partnership”
Name of Partnership Business Address, State

CORPORATION
,a Corporation
State in
Name of Corporation which Business Address
incorporated

LIMITED LIABILITY COMPANY

Limited
,a Liability
Company
State in
Name of Limited Liability
which Business Address
Company
organized

OTHER TYPE
OF ENTITY

_____________
_
Name of Entity Type of Entity Business Address, State

NOTE: Regardless of the type of entity you form, you will be required to provide
applicable organizational documents to us prior to the execution of the franchise
agreement.

B-11
 SUPPLEMENTAL ENTITY WORKSHEET

ENTITY

Name Business Address, State

PARTNER,
SHAREHOLDER OR
MEMBER INFORMATION
Name Phone % Ownership
Address:

Name Phone % Ownership

Address:

Name Phone % Ownership

Address:

Name Phone % Ownership

Address:

FINANCIAL NOTE: If the candidate is an Entity, a separate Request must be completed

by all persons listed above. If the proposed franchisee is an Entity, please attach
signed copies of the Entity’s current financial statements (balance sheets and income
statements) and bank statements or other documentation supporting the liquidity
position of the Entity.

B-12
 FRANCHISOR DISCLOSURE

We do not disclose certain information (average sales volumes, average return on

investment, variable expense percentage, etc) to prospective Franchise applicants other
than information included in our Franchise Disclosure Document (FDD). If required in
your state or country and if you further qualify for a XYZ franchise, you will be provided
with a FDD before you sign a franchise agreement.

Applicant acknowledges that we do not warrant or guarantee the accuracy or validity of

information obtained from franchised contacts. Applicant further acknowledges that,
other than information published in the FDD, neither we nor our representatives have
stated or suggested (orally, in writing or visually) a specific level or range of potential or
actual sales, income, gross or net profits or variable expense data in connection with
the making of this application. Furthermore, this application or any other document or
verbal advice is not to be construed in any way as a franchise agreement or the
granting thereof.

REPRESENTATION WARRANTIES

Applicant acknowledges and agrees that all information contained in this Request is
complete, true and accurate. The information included in this Request is for use by us
in determining approval of a franchise. I authorize XYZ Franchise, Inc. to utilize other
investigative sources that it considers necessary in making this determination, including
credit and criminal reporting agencies. Further, I hereby authorize the banks listed in
this Request to release the information necessary to assist XYZ Franchise, Inc. in its
review.

Entity Name

A) B)
Signature Signature

Printed Name Printed Name

Date Date

B-13
 ATTACHMENTS

Must be submitted with this completed application.

Please attach:

_______Financial Statements

_______Résumé or Detailed Work History

B-14
 APPENDIX C

Due Diligence Questionnaire1

(For Entire Franchise Team)

IMPORTANT DISCLOSURE INFORMATION

Confirmation of corporate organization of ________________, the Franchisor entity

(“Franchisor”), for purposes of disclosure under federal and state franchise laws.

The general partners, members of the board of directors, managing members, and
trustees of Franchisor, according to the Franchisor’s records are as follows:

Name Title
_________________________________ _________________________________
_________________________________ _________________________________
_________________________________ _________________________________
_________________________________ _________________________________

The officers of the Franchisor, according to the Franchisor’s records are as follows:

Name Title
_________________________________ _________________________________
_________________________________ _________________________________
_________________________________ _________________________________
_________________________________ _________________________________

The persons (other than those listed above) who will have management responsibility
relating to the sale or operation of franchises are as follows:

Name Title
_________________________________ _________________________________
_________________________________ _________________________________
_________________________________ _________________________________
_________________________________ _________________________________

The “franchise sellers” of Franchisor (both internal and external) are as follows:

Name Title
_________________________________ _________________________________
_________________________________ _________________________________
_________________________________ _________________________________
_________________________________ _________________________________

1
Based on a document provided by Jim Meaney.

C-1
I confirm that the foregoing information is complete and correct according to the
Franchisor’s records and my knowledge.

___________________________
[NAME OF FRANCHISOR]

___________________________ __________________________
Signature Printed Name

____________________________
Title

____________________________
Date

[NOTE: THIS QUESTIONNAIRE SHOULD BE SIGNED BY AN EXECUTIVE OFFICER

OF FRANCHISOR, PREFERABLY THE CEO OR PRESIDENT.]

C-2
 APPENDIX D

Due Diligence Questionnaire1

(For Individual Franchise Team Members)

For Use By

(“Franchisor”)

THIS QUESTIONNAIRE IS TO BE COMPLETED BY ALL DIRECTORS, TRUSTEES, GENERAL

PARTNERS, AND OFFICERS OF THE FRANCHISOR, AND ANY OTHER INDIVIDUALS WHO
WILL HAVE MANAGEMENT RESPONSIBILITY RELATING TO THE SALE OR OPERATION OF
FRANCHISES.

I. GENERAL INFORMATION

1. Name:

2. Business Address:

3. Business Telephone Number: ( )

4. You are completing this questionnaire as (check all that apply):

the Franchisor.
a director, trustee or general partner of the Franchisor (or a manager of the
Franchisor, if the Franchisor is an LLC).
an officer of the Franchisor.
an individual with management responsibility relating to the sale or operation of
franchises.
a salesperson employed by the Franchisor.
a franchise broker of the Franchisor.
a salesperson employed by the franchise broker.

5. Please provide the following information:

a. Current principal occupation or employment by title and description:

b. Current Employer:

c. Beginning date (by month and year) of your current position or employment:

d. Current Employer's address:

1
Based on a document provided by Max Schott, II and Gray Plant Mooty.

D-1
 e. Will you engage in franchise sales for the Franchisor? ............................. Yes ___ No ___

f. If the answer to 5(e) is "Yes," will you engage in franchise sales in all states?Yes ___ No ___

g. If the answer to 5(e) is "No," please list the states in which you will engage in franchise
sales for the Franchisor:

6. If a corporation or other entity will serve as a franchise broker, then each officer and director of
that corporation or other entity must complete this questionnaire. In addition, please provide the
following for the corporation or other entity:

a. State of incorporation/formation:

b. Date of incorporation/formation:

7. Please provide the following information for the employment or position which you held
immediately preceding your current principal occupation:

a. Employer:

(1) Principal occupation or employment by title or description:

(2) Beginning and ending dates by month and year) of this position or employment:

, ______ to , ______

(3) Previous employer’s address:

8. Please provide the following information for each principal occupation which you have held during
the preceding five full years, in chronological order:

a. Employer:

(1) Principal occupation or employment by title or description:

(2) Beginning and ending dates by month and year) of this position or employment:

, ______ to , ______

(3) Previous employer's address:

b. Employer:

(1) Principal occupation or employment by title or description:

D-2
 (2) Beginning and ending dates by month and year) of this position or employment:

, ______ to , ______

(3) Previous employer's address:

c. Employer:

(1) Principal occupation or employment by title or description:

(2) Beginning and ending dates by month and year) of this position or employment:

, ______ to , ______

(3) Previous employer's address:

d. Employer:

(1) Principal occupation or employment by title or description:

(2) Beginning and ending dates by month and year) of this position or employment:

, ______ to , ______

(3) Previous employer's address:

II. LITIGATION HISTORY

1. Pending Litigation

a. Are you, at the present time, a defendant in a pending criminal action? .... Yes ___ No ___

b. Are you, at the present time, a defendant, or defendant to a

counterclaim, in any pending civil matter? .................................................. Yes ___ No ___

c. Are you, at the present time, a party to a pending administrative action? .. Yes ___ No ___

2. Do any of the above (under Section II.1) allege a violation of:

a. Any franchise law? ...................................................................................... Yes ___ No ___

b. Any antitrust law? ........................................................................................ Yes ___ No ___

c. Any securities law? ..................................................................................... Yes ___ No ___

D-3
 d. Unfair or deceptive practices?..................................................................... Yes ___ No ___

e. Fraud? ......................................................................................................... Yes ___ No ___

f. Comparable allegations? ............................................................................ Yes ___ No ___

3. Concluded Litigation

a. Have you ever been convicted of a felony? ................................................ Yes ___ No ___

b. Have you ever pleaded nolo contendere to a felony? ................................ Yes ___ No ___

c. Within the preceding 10 years, have you:

(1) Been convicted of a misdemeanor?............................................... Yes ___ No ___

(2) Pleaded nolo contendere to a misdemeanor? ............................... Yes ___ No ___

(3) Been held liable in a civil action by a final judgment?.................... Yes ___ No ___

(4) Been the named party or the subject of a complaint? ................... Yes ___ No ___

(5) Been the subject of other legal proceedings?................................ Yes ___ No ___

d. Did any of the above (under Section II.3.) involve a violation of:

(1) Any franchise law? ......................................................................... Yes ___ No ___

(2) Any antitrust law?........................................................................... Yes ___ No ___

(3) Any securities law? ........................................................................ Yes ___ No ___

(4) Fraud? ............................................................................................ Yes ___ No ___

(5) Unfair or deceptive practices?........................................................ Yes ___ No ___

(6) Comparable allegations? ............................................................... Yes ___ No ___

If the answer to any of the questions in 1, 2, or 3 above is “Yes,” please provide the following
information:

a. Court or arbitration office in which action filed:

b. Date of filing:

c. Docket number:

d. General nature of claims asserted:

D-4
 e. Relationship to defendant or party bringing the action (e.g., former franchisee, supplier,
etc.):

f. For pending actions, describe current status:

g. For actions no longer pending, please provide the disposition of the case, including the
terms of settlement.

Note: You may be asked to provide copies of the pleadings.

h. Please provide the following information regarding arbitration proceedings which are
either pending or have been concluded within the past 10 years:

(1) The number of such pending and/or concluded arbitration proceedings:

(2) The number of arbitration proceedings initiated by the franchisor:

(3) The number of arbitration proceedings initiated by franchisees:

4. Currently Effective Administrative Orders

a. Are you, at the present time:

(1) Subject to any currently effective injunctive or restrictive

order or decree relating to franchises? .......................................... Yes ___ No ___

(2) Subject to any currently effective injunctive or restrictive

order or decree under any federal, state or Canadian
franchise, securities, antitrust, trade regulation or trade
practice law as a result of a concluded or pending action or
proceeding brought by a public agency? ....................................... Yes ___ No ___

(3) Subject to any currently effective order of any national

securities association or national securities exchange (as
defined in the Securities and Exchange Act of 1934)
suspending or expelling you from membership in such
association or exchange? .............................................................. Yes ___ No ___

b. If the answer to any question in Section II.4.a. is “Yes,” please provide us with the
following

(1) The public agency or court:

D-5
 (2) A summary of the allegations or facts found by the court or agency:

(3) The date of the order or decree:

(4) Nature, terms and conditions of the order or decree:

III. BANKRUPTCY HISTORY

1. Within the past 10 years, were you:

a. Adjudged bankrupt? .................................................................................... Yes ___ No ___

b. Reorganized due to insolvency? ................................................................. Yes ___ No ___

c. A principal officer of any company or a general partner in any

partnership which was adjudged bankrupt or reorganized due to
insolvency during or within one year before or after you held such
position? ...................................................................................................... Yes ___ No ___

2. Are you presently subject to any pending bankruptcy or

reorganization proceedings?.................................................................................... Yes ___ No ___

3. If the answer to III.1. or 2. is “Yes,” please provide the following information:

a. The name of the proceeding:

b. Date of filing (if pending):

c. Date of judgment (if discharged):

d. Court:

e. Docket or case number:

f. Any other material facts or circumstances:

D-6
 IV. SUPPLIER INTERESTS

1. If you are an officer of the Franchisor, do you own an interest in any of the
Franchisor’s approved suppliers? (See attached list of approved suppliers) ......... Yes ___ No ___

Type of Interest Held

If yes, please describe:

Name of Supplier

V. OTHER MATERIAL MATTERS

1. Are you aware of any other matters relating to you, the Franchisor or the franchise
system, which are not already included in the Franchisor’s Franchise Disclosure
Document (FDD), but may be material to a prospective franchisee? ...................... Yes ___ No ___

2. If the answer to question 1 above is “Yes,” please describe below the other material
matters:
______________________________________________________________________
______________________________________________________________________
______________________________________________________________________
______________________________________________________________________
______________________________________________________________________
______________________________________________________________________
______________________________________________________________________

I confirm that the information in this questionnaire is complete and correct to the best of my knowledge.

Signature

Title

Date

Upon completion, please return this questionnaire to: _____________________________

_____________________________
_____________________________
_____________________________

D-7
 JAMES A. MEANEY

James A. Meaney, a frequent presenter on franchise topics, is a franchise attorney who

has practiced in the area for nearly 25 years and is currently Of Counsel to the law firm
of Zaino & Humphrey in Dublin, Ohio. During his career, Mr. Meaney has held the
following positions: General Counsel and Vice President of Franchise Development for
Damon’s Grill®, General Counsel of the Ohio Petroleum Retailers and Repair
Association, Section Chief of the Ohio Attorney General’s Consumer Protection Section
(responsible for enforcement of Ohio’s Business Opportunity Law), Chairman of the
Columbus Bar Association’s Franchise and Distribution Law Committee, and a member
of the Board of Governors, Columbus Bar Association. He has also contributed
numerous articles and presentations to various franchising publications, and is the
author of How to Buy a Franchise. Mr. Meaney has been a member of The American
Bar Association’s Forum on Franchising since 1989 and has had the honor presenting at
a number of Annual Forums. Mr. Meaney is licensed to practice law in Ohio and the U.S.
Virgin Islands. In addition to the practice of law, he serves as a consultant to Train-Ease,
Inc., an e-learning company that develops online training for franchise systems and
other businesses.
 MAX J. SCHOTT, II

Max J. Schott, II, is a shareholder in the Minneapolis office of Gray Plant Mooty and
practices primarily in the area of franchise and distribution law, assisting and counseling
franchisors in structuring domestic and international franchise programs. Max also
advises clients on issues of disclosure and registration, relationship matters, supply
chain maintenance, advertising, licensing, and acquisitions. Max works with start-ups, as
well as with nationally-recognized franchisors with multiple brands.

Max frequently writes and speaks on franchise-related topics, both locally and nationally.
Max assumed the role of Editor-in-Chief of the ABA Forum on Franchising’s The
Franchise Lawyer in August 2010, after serving as an Associate Editor for that
publication during the previous two years. Max also was a member of the IFA Legal
Symposium Task Force during 2008 and 2009. Max was named by Franchise Times as
one of its “Legal Eagles” in each of the last four years. In addition, Max has been a long-
time volunteer with The Advocates For Human Rights and currently serves on its Board
of Directors.