One of the toughest challenges an aspiring franchisor may face is selling its first franchise. Who would take the risk of buying a franchise from a franchise company that has no franchisees?

For a few successful business owners, the idea of franchising may come from one or more customers who love the business concept and initiate the idea of buying a franchise even before the owner has taken the first step to prepare a franchise offering. But this rarely happens.

Here’s another suggestion: If the aspiring franchisor has a successful business unit (a store or a restaurant, for example) that is operated well by a trusted manager, that manager might be a good candidate to buy the business at that location and become the company’s first franchisee. The manager already will know the business inside out, having successfully managed the business as an employee. The transaction would entail the sale of the existing business at a single location in which the buyer undertakes to continue operating as a franchisee of the seller. The buyer’s newly-formed company would sign a franchise agreement as part of the purchase of the business.

To enhance the appeal of the transaction, the franchisor may extend credit for a portion of the purchase price or may waive the payment of any initial fee and give a grace period on the payment of any ongoing royalty or marketing fee. The idea is to maximize the fledgling franchisee’s chances of success. The franchisee’s success is crucial. This franchisee will be the first validator of the system for subsequent franchise buyers. With only one franchisee, the franchisor is unlikely to include financial performance representations in Item 19 of its franchise disclosure document (FDD). Without providing numbers in Item 19, the franchisor may not discuss numbers orally. Only an existing franchisee can do that.

But what about the legal requirements of franchise registration and disclosure, which may include the requirement to prepare and disclose audited financial statements and much more? Is there a way that the aspiring franchisor can avoid the cost, the time, and effort of preparing a detailed FDD and possibly registering it with the state? This answer is yes. There are ways to start small and test the concept before the franchisor is ready to prepare a disclosure document and to register the offering.

First Franchise Exemptions

The Federal Trade Commission’s trade regulation rule on franchising (the FTC Rule) excludes from the definition of a franchise the grant of the right to use a trademark where the license is the only one of its general nature and type to be granted by the licensor. So, a single license should not trigger the federal requirement to prepare a disclosure document. State laws usually will not be a concern if the outlet is located in a nonregistration state, although the business opportunity laws may pose an issue and should be reviewed.

What if the outlet is located in a state that requires franchise registration? A few states (Indiana, Minnesota, and New York) exempt the isolated sale of a franchise. The state of Washington exempts isolated sales from registration but not from the disclosure requirement.

New York’s single sale exemption calls for some explanation. The exemption applies when (i) the franchisor makes an offer to no more than two persons, (ii) the franchisor does not grant the franchisee the right to offer subfranchises, (iii) no commission or other remuneration is paid for soliciting the prospective franchisee, and (iv) the franchisor is domiciled in the state or has filed with the NY Department of Law its consent to service of process. [N.Y. Gen. Bus. Law §684(3)(c).]

Source: The Licensing Journal, April 2017