Franchises are everywhere. McDonald's, one of the most visible franchises in the US, has over 34,000 stores worldwide. Take a look at this extremely interesting spreadsheet on the number of McDonald's franchises by country over a five year period. Needless to say, McDonald's is a strong brand that isn't going anywhere anytime soon.
But how do businesses become franchises? Franchises are governed by Federal and State law, and the mix of the two have created the following best practices:
Determine if franchising is best for your business
The two primary options for a business to expand out of its area are to franchise or open branches. A branch is wholly owned and controlled by the business itself, and all of its profits flow to the business. However, opening and operating a branch are entirely at the expense of the business. Due to the expenses involved, branches are more suited for slow, calculated growth.
On the other hand, franchising can allow a business to grow quickly, as the expenses to open and operate a franchise are paid by the franchisee, or the person buying the franchise. The business will condition the operation of the franchise upon numerous terms to maintain uniformity as much as possible, and will receive royalties for use of the brand (usually in the form of a percentage of the franchise's profits). However, franchising requires a strong brand identity that potential investors (the franchisees) want to buy into, liquidity (both for costs and regulatory requirements), and standardization of practices to be effective.
If your business has yet to do so, register your brand as a trademark. Brand identity is extremely important when franchising, whether you are building a brand or franchising an established one. Hence, it may be best to register your trademark(s) as soon as possible to begin building your brand identity. Strong brand identities can drive the price of franchises higher, so its in the business' best interest to strengthen the brand as early, and as much, as possible.
Additionally, registering a trademark gives the trademark holder a multitude of rights under Federal law.
Create a subsidiary for the business
A business should create a subsidiary entity to serve as the franchisor, or the company that sells franchises. This practice is used for several reasons. First, it helps limit the liability of the original company such that if any liabilities arise from franchising, like lawsuits, the parent company is likely protected. Secondly, the subsidiary is created for ease of accounting. The primary disclosure document, which must be created and disclosed prior to engaging potential franchisees and will be discussed shortly, requires a financial audit for several years prior. However, by establishing a subsidiary, the financial history can only reach back as far as the creation of the subsidiary and would not include the finances of the parent company.
Drafting the necessary documents
Prior to engaging in any talks with potential franchisees, several documents must be drafted. Firstly, Federal and State Law require the creation of a document compiling specified information regarding the company including its financial history, its company officers, any litigation, trademarks, and more. Depending on which accepted format of this document your business uses, this is either called the Federal Disclosure Document or the Uniform Franchise Offering Circular ("UFOC").
Additionally, all contracts that the franchisee would have to sign must be drafted. Primarily, this includes the franchise agreement. This contract sets out the many rules that franchisee's must abide by, including royalties, training, required sellers, signage, marketing, duration etc. This contract is comprehensive, but can be amended.
Importantly, these documents must continually be updated as material changes to the information it contains is available. This means that if any information changes which could impact a potential franchisee's decision to purchase a franchise, then the document must also be changed.
Such documents are highly technical as they incorporate Federal and State law, and require a financial audit. For this reason, attorneys and accountants are generally retained to prepare these documents.
Compliance with State regulations
Although Federal law regulates franchises, State laws impart additional requirements that must be met in order for businesses to offer, or continue to offer, a franchise in that State. Some of these additional requirements include:
Of course, the above are only a small sampling of the variances in State laws pertaining to franchises. Due to the complexity of the regulations pertaining to franchises, compliance should be managed by the business' attorneys so they may update and alter any documents as necessary and inform business personnel of any changes they must make in communications.
It is especially important that all people who are involved in the selling of franchises at the business are aware of the applicable State regulations, and its changes, as some laws may take effect upon first contact with a potential franchisee. Communication between these individuals, and compliance counsel (or personnel) is extremely important.
Ready, set, go!
The legal aspects of franchising are a very technical process at the outset, but once established, compliance and any additional tweaking is all that is necessary. This is only a general overview of the process of franchising, and a business should have an attorney and an accountant guide them through the process of franchising their business.
Last week, I discussed why professional gaming teams should become businesses in order to secure sponsorships. With the staggering growth of eSports, online viewing of eSports competitions totaling 2.2 billion hours, and a dedicated gaming arena opening in Ohio, professional gaming is quickly becoming its own segment of the sports and entertainment industry. Although professional eSports teams may lack a traditional front office, there is room for a business adviser who secures sponsorships and other business opportunities for teams.
This business adviser would serve in a similar capacity to a sports agent for the team. Traditionally, sports agents represent individual professional athletes in negotiating their on-field contracts and securing endorsement agreements. However, as professional gaming is a tournament based league without individualized salaries, salary negotiation services and individual representation would be irrelevant.
Instead, a professional gaming sports agent would focus on sponsorships and other business opportunities for the team. An effective agent could leverage a team's substantial online presence (Twitter followers, YouTube subscribers, Twitch followers, etc.) to sponsors in return for sponsorships to provide products and financial support for the team. Such a tactic is not new for agents, as they have leveraged online followings for professional athletes and then-amateur athletes (see here) into sponsorships. Utilizing an agent would be in the best interest of eSports teams, as it leaves the players to focus on their sport while the agent secures much needed sponsorships to help get the team to additional tournaments.
The question then arises as to how agents would be paid. Normally, sports agents take a percentage of their players' salaries that they negotiated (generally 3-5%) and a higher percentage of any endorsements they secure (15-20%). However, that preexisting model does not fit professional gaming because players, or even teams, are not paid a salary. Additionally, many professional gaming sponsorships supply products, and not cash, which would be impossible to take a percentage of. Instead, agents would likely seek a percentage of tournament winnings in exchange for their services, as well as a percentage of any sponsorship money secured for the team.
Due to an agent's necessary reliance on tournament winnings and substantial online followings to be paid, teams that have yet to make a name for themselves in professional gaming may find it difficult to find an agent to represent them. It is important to remember, in both professional sports and e-sports, that agents do not establish a brand, but leverage an existing brand and shape it. An agent needs a foundation to leverage, and only the team itself can create that foundation.
Given the increase in popularity of eSports, and the money that is starting to flow through the industry, there is rising potential for a budding agent role for teams.
In the past few years, e-sports (playing video games competitively for profit) has seen staggering growth in the United States. This growth has largely been fueled by the development of a professional tournament association, the inclusion of e-sports in the X Games competitions, and at its core, technology which allows players to connect and compete in ways never previously possible.
Viewership of the e-sports tournaments is also extremely high. Last year, online viewers watched a total of 2.4 billion hours of competition footage. Live events have also sold well, prompting Major League Gaming (the preeminent e-sports tournament body) to establish an arena in Columbus, Ohio. As with the rapid rise of any industry segment, e-sports tournaments have received sponsorships from well-known brands such Coca Cola and American Express. Although the tournaments and their governing bodies have received substantial sponsorship income, teams have not had the same financial success.
Many teams are able to secure small sponsorships which supply products such as controllers and apparel. However, there is a lack of sponsorship dollars supplied to the teams, which may be what is needed most as the expenses of professional gaming can be high. One of the reasons that teams have difficulty securing sponsorships is due to their business organization, or rather the lack thereof.
For e-sports to develop into a true professional league, and for teams to see the sponsorship dollars they desire, teams will have to learn from the businesses of their MLB, NFL and NBA counterparts. Firstly, professional sports teams are business entities, not just a group of people who are acting together. This is extremely important because State law differs as to whether unincorporated associations can enter into contracts, and as to the rights of these associations as a whole. Further, choosing a business entity for the team simplifies the sponsorship process for the brand as it eliminates any question regarding whether the contract is enforceable.
The choice of what business entity to select is a trickier subject, and would have to be determined on a team by team basis. At this early stage of professional gaming, there is no "one size fits all" approach. Professional sports teams have Owners and front offices that handle the business end of the team while the players play. However, that wouldn't be the case at this stage of e-sports. Simply put, the players will also have to handle their team's business. That can become problematic in several situations, especially when team members are minors. Minors' business activities are restricted by State and Federal law, but State law may allow for some creative business-formation possibilities if there are team members over 18 who can start the business. For instance, some states allow minors to be shareholders in a business. Any team considering turning their team into a business should consult an attorney before doing so.
There are a myriad of reasons teams don't receive the sponsorships they desire, including the lack of a formalized business structure. If your team wants to be treated as a legitimate business, make sure your team is actually a business first.
Last week, my blog post regarding equity for endorsements focused on the benefits and disadvantages of the athlete/celebrity endorser. This post will focus on the companies, and why they should or shouldn't offer equity for endorsements.
Startups have long sought celebrity endorsements under the misguided notion that the endorsement will equate to the company's success by harnessing the celebrity's star power. In fact, there are many articles on how to attract celebrity endorsers (See here and here) Not surprisingly, offering equity for endorsements is a common suggestion on these "How To" articles. But, companies should be mindful of how they distribute their equity, as a celebrity endorsement does not always work out well for the company (see here).
In sum, all of the benefits of getting endorsements for equity necessitate sales increases and discount the loss of equity.
Celebrity endorsements of products and companies have long been commonplace. However, where these celebrities were once paid with money, many are instead accepting equity. This is particularly true when it comes to celebrities endorsing start-ups and their products.
Last week, The New York Times ran an article which stated that equity for endorsement agreements are gaining in favor with celebrities due to the recent explosion of the start-up scene, especially in California, and the deal's ability to create substantial income should the company become successful. This is especially true for professional athletes.
Professional athletes have particularly taken to equity for endorsement agreements. This is likely due to the potential of receiving a windfall and the players' understanding that athletic careers can be lost at any time. In recent years, several athletes have made headlines by entering into equity agreements. One of the most notable equity for endorsement agreements was David Wright's acquisition of .5% of Glaceau, the creator of Vitamin Water. When Glaceau was bought in 2007 by Coca Cola for $4.1 Billion, Wright's .5% was worth an estimated $20 Million. In 2010, Tom Brady entered into an equity deal with Under Armour, a now ubiquitous athletic apparel company. Most recently, in June, 2014, Richard Sherman entered into an equity for endorsement agreement with BODYARMOR SuperDrink.
However, accepting equity for endorsements has significant benefits and disadvantages for the endorsing athlete.
Although athletes and celebrities may be agreeable to equity for endorsements due to the low risk/high reward potential, companies do not freely offer such opportunity. Many companies are protective of their equity, and within good reason. My next post will discuss the benefits and disadvantages of equity agreements to companies, who bear a much bigger risk when offering equity for endorsements.
Virtual currencies have exploded recently and have been used as investment devices and freely tradeable currency. There has been a growing trend of businesses accepting virtual currencies as payment, despite warnings from the U.S. Securities and Exchange Commission and the Consumer Financial Protection Bureau. However, virtual currencies, such as Bitcoin, have not been regulated by the federal government nor by any of the States. New York is seeking to be the first State to do so.
Last month, New York's Department of Financial Services released proposed legislation for businesses that provide virtual currency financial services. Notably, this legislation does not apply to merchants and consumers that utilize virtual currency solely for the purchase and sale of goods or services. Instead, the proposed legislation focuses on businesses that provide Virtual Currency Business Activities, which it defined as any one of the following activities involving New York or its residents:
Under the proposed legislation, businesses engaged in any of the above virtual currency financial services must obtain a Bitlicense from the Department of Financial Services to operate. The Bitlicense necessitates that the businesses also be subject to a multitude of rules governing:
One of the most notable aspects of the proposed legislation is the record keeping provision, which requires that information regarding all parties to a transaction (including names, addresses and account numbers) be kept for at least ten years. Such a requirement is instrumental for the regulation of virtual currency as anti-money laundering efforts and protection from theft or fraud require this information to hold people accountable for their actions. However, anonymity had been a highlight of utilizing virtual currency thus far.
As of July 23, the Department of Financial Services' proposed virtual currency legislation is in its 45 day public comment phase. After the phase ends, the Department will revise the proposed legislation and re-release it for further review. It is important to note that the final version of this proposed legislation may be very different than its initial proposal.
This proposed New York legislation, which can be accessed through a link above, is the first attempt in the United States to regulate virtual currencies such as Bitcoin. As New York moves forward with some form of this legislation (pending revisions and approval) other States will certainly take notice. Of course, the real wild card is that the federal government has not yet regulated virtual currencies. Regulation by the federal government has been much anticipated, as favorable regulations could help virtual currency prices soar or conversely, tight regulations could depress prices. Federal regulation also helps guide states, who may wish to enact stricter regulations as they see fit.
Whether businesses that provide virtual currency financial services like it or not, regulation is coming. If businesses disapprove of New York's proposed legislation, they should submit their commentary to the Department of Financial Services while the public comment period is still open.
Earlier this week, the New York Post reported that the Union Street Guest House, a hotel in Hudson, New York, had a unique method of controlling negative reviews online. According to the New York Post, the hotel's website stated that “If you have booked the inn for a wedding or other type of event . . . and given us a deposit of any kind . . . there will be a $500 fine that will be deducted from your deposit for every negative review . . . placed on any internet site by anyone in your party.” However, the money would be refunded if the negative review is removed.
Effectively, this policy means that if a wedding guest posted a negative review of the hotel on the internet, then the couple whose wedding took place at the hotel would be fined $500.
Although the hotel's owner stated that the company policy was a joke, a Yelp review from November 12, 2013 (notably several months before the New York Post article) states that the reviewer received an email threatening to enforce the policy.
Businesses are always seeking to protect their reputations, especially online. However, this hotel's policy is not legally sound.
Challenging the hotel's policy
Should the hotel have enforced this policy, it could have been successfully challenged in court as the policy is an unconscionable contract. New York courts have defined an unconscionable contract as being "so grossly unreasonable...in light of the mores and business practices of the time and place as to be unenforcible [sic] according to its general terms" (Gillman v. Chase Manhattan Bank, N.A., 73 N.Y.2d 1, 10, 537 N.Y.S.2d 787, 791 ).
In order to determine whether a contract is unconscionable, New York courts utilize the following two-part test:
Essentially this means there must be a showing of an absence of meaningful choice with contract terms that are unreasonably favorable to one party. The substantive element allows a court to analyze whether the contract unreasonably favors the Defendant.
Should the Union Street Guest House's policy be challenged in court, it would fail the above test. Procedurally, it does not appear as if a complaining party would have had any choice to enter into the contract if they wished to hold a wedding at the hotel. Nothing has been reported as to the negotiability of this policy, and placing the policy on the hotel's website creates the impression that it is a standard policy of the hotel.
However, analysis of the substantive element provides much stronger evidence for the policy to be found unconscionable. First and foremost, it is unclear whether any couple holding a wedding at the hotel was made aware of the policy. If the policy truly was a joke as the hotel owner stated, then it likely would not have been found on, or annexed to, any of the other contracts the couple would have signed. Additionally, should the policy have only been located on the website, it can be argued that the hotel was deliberately hiding the policy from couples seeking to hold their weddings at the hotel.
The terms of the policy, as written, are unreasonably favorable to the hotel. The policy has the effect of limiting the speech of third parties to the contract, which is odd, unexpected, and a violation of society's mores and business practices. On public policy grounds, the court would likely find the policy unenforceable because society wants to encourage speech about businesses to empower consumers.
Potential recourse for Union Street Guest House's negative viral publicity
Shortly after the New York Post article was published, news of the hotel's policy went viral on the internet. As a result of this negative viral publicity, internet users quickly took to websites such as Yelp to post one star reviews citing the hotel's policy for negative reviews as the reason.
Although approximately 5 pages of such reviews on Yelp have been removed in the past few hours, there are negative reviews that have been posted subsequent to the hotel's viral publicity that discuss previous stays at the hotel. Should these reviewers be lying in their negative posts, the hotel could potentially have recourse against them. As previously discussed here, businesses can sue reviewers for false, negative reviews on defamation grounds.
If some of the recently posted negative reviews are based on lies, it would be difficult for the hotel to succeed. One of the elements of a defamation claim is proof of damages that resulted from the false statement. Given the fact that the hotel has experienced a great deal of negative publicity in the past few days, it would be extremely difficult to prove that any false reviews caused damage to its business. Nonetheless, the hotel should continue to monitor its reviews, especially as time distances the hotel from its viral notoriety.
It is difficult for businesses to protect their online reputations, but they should employ legally sound measures to do so. Instead of threatening $500 fines, the Union Street Guest House should have engaged its negative reviewers in a positive manner. If the hotel received negative reviews that contained lies, it could have then proceeded with a defamation suit against those reviewers. Hopefully, the Union Street Guest House's policy to limit negative reviews, and the viral notoriety it spawned, serves as a cautionary tale to other business owners.
Yesterday, an article appeared in the New York Times which discussed the declining use of Non-Disclosure Agreements ("NDAs") among startup companies. The article centered on two main points:
The second point is particularly troubling for business owners. If the startup needs funding from VCs who refuse to sign an NDA, whats to stop them from sharing one business' idea or concept with another company they invest in? Simply put, nothing.
I was speaking with the founder of a startup last night who shared with me his uneasiness about VCs refusing to sign NDAs. He echoed a sentiment that I'm sure many other start-up owners feel "What can we do? We need the money." The unfortunate reality is that VCs refusing to sign NDAs only benefits the VCs. However, that does not mean that businesses should not request that an NDA be entered into with anyone that will be privy to proprietary information/materials.
So what does a non-disclosure agreement do? An NDA protects confidential information, materials or knowledge that is to be shared with another business or person (including employees.) The agreement establishes not only how the receiving party may use the confidential information, but also the remedies should a breach of the agreement occur. Of course the disclosing party is entitled to damages for a breach of the agreement, but the agreement can spell out how the damages are to be calculated or whether injunctive relief is appropriate.
NDAs also help establish the protection of a business' confidential information, which is a necessary element to any litigation challenging whether or not the confidential information qualifies as a trade secret. Simply put, a business must take steps to protect its proprietary information to qualify as a trade secret, and routinely entering into NDAs helps establish that. Even if a VC doesn't sign an NDA, it is in a business' best interests that they require other parties to enter into NDAs to help ensure trade secret protection.
In my discussion with the founder last night, he asked me "Even if the VC doesn't sign an NDA, aren't my ideas protected some other way, like by copyright?" The short answer to that question was no. Although this was already the subject of a blog post, copyright protects the expression of an idea, not an idea itself.
Upon learning that without an NDA, his business has no control over the proprietary information shared with a third party, the founder was rightly uncomfortable, but repeated "What can we do? We need the money." I told him what I would tell any business owner, that an NDA should at least be offered. Some VCs may sign it, some may not, but the few that do will at least give some piece of mind that the business' proprietary information is protected.
Although a business may make the decision that VC funding without an NDA is acceptable, NDAs should still be extended to all others with whom proprietary information is shared. No matter who a business is sharing proprietary information with, an NDA should be proposed.
(Photo used under Creative Commons License from Flazingo.com)
There has been an interesting trend in recent years of technology being developed for athletes. From simple pedometers, shoes that track your speed and distance, to equipment that monitors how you strike a ball, tech for athletes is becoming increasingly popular and mainstream.
Perhaps you've seen the new Apple commercial below which has been airing frequently during the World Cup:
What would a tech trend be without Apple's involvement? This video shows off several examples of how tech is integrating with athletes to help them hone their abilities. More importantly, the ad doesn't use any professional athletes, which highlights the wide reach of this tech trend.
I admit, I love my Nike Fuelband. It loosely keeps track of my movement throughout the day to lets me know if I've been sitting at my desk for too long and need to hit the heavybag. And although I like to box, I'm not training to be heavyweight champion of the world. That's why this story caught my eye.
A tennis racket has now been developed by Babolat which transfers to an app the strength of the racket's impact on the ball, the spin, and also counts the number of forehands, backhands, serves and overhands. More importantly, this racket was recently used by Julia Gorges during the French Open.
The tennis player, currently ranked 107th in the world, stated in the article that she is using the new racket because "sometimes you are in the emotions...and you sometimes lose the vision [to see] things." She is hopeful that her new tech will allow her to analyze and improve her game, and ultimately, her ranking.
This kind of tech is exciting, as its entire purpose is to develop its users' abilities. It is easy to see that widespread accessibility to this 'athletic development' tech can potentially increase the level of competition in a sport. Athletes are continuously looking for an edge over their competition, and similar tech can help them achieve that. On the developer side, tech for athletes can be utilized by a large market, and opens up the possibility of high-profile endorsement with multiple methods of activation. Athlete tech is here to stay, and some of the companies involved in its development could find the area particularly lucrative.
Companies developing tech for athletes could engage professional athletes for endorsement opportunities, as Babolat has with Gorges. Such endorsement frequently occurs with products manufactured for athletes' use. For example, Major League Baseball players generally have endorsement agreements with their bat manufacturers. These professional athlete endorsements can have a marketing trickle-down effect to the athletes' fans.
Athlete tech can allow professional athletes to engage with consumers in new ways. For instance, Babolat's app that works in conjunction with the smart-racket could have a leaderboard for hardest swing or most revolutions on a ball. Or, even a way for people to send challenges or encouragement to one another, utilizing the racket's measurables.
However, the more professional athlete involvement with the tech desired, the tighter the contract must be. Some things to consider include:
Of course, any time a company utilizes athlete endorsements, the contract should also have a broad morals clause for all the reasons outlined here.
There have been many exciting developments in tech for athletes, and I expect the trend to continue. Businesses in this niche industry could find professional athlete endorsements lucrative, but they must be specific in drafting such agreements.
As the internet has grown, businesses have had to contend with a multitude of websites that allow users to post reviews of their experience with a business. One of the most popular consumer-review websites is Yelp. Its understandable that every business will have a few dissatisfied customers, but what if a dissatisfied customer posts a negative review that is full of lies?
It is difficult enough for a business to deal with negative reviews that are truthful, but there are only two options for dealing with a negative review that is a lie: If the lie is not particularly scathing, the business could respond to the review; or, if the lie if is so harmful to your reputation that you believe it will harm your business, you can sue the reviewer for defamation (or at least threaten to do so.)
In order to prove defamation in this scenario, it must be shown that:
Earlier this year, in Virginia, a jury found that a homeowner defamed her contractor when she posted two reviews stating that the contractor botched her home renovation and stole from her. The sole reason the contractor was not awarded the $750,000 he should have won was because the jury found that the contractor also defamed the homeowner in responding to her negative reviews with accusations. This case opened the eyes of many business owners across the country.
Yelp has correctly stated that "litigation is not a good substitute for customer service," and business should only sue for defamation as a last resort. In this scenario, filing suit should only be reserved for blatant and serious lies.
Further, the idea of being sued for defamation may be enough to encourage the posting-user to take down their false damaging comment. As long as the business could have a conceivable defamation suit against the user, it may be more cost-effective for a business to have an attorney send a letter to the user demanding the removal of the comment, or otherwise be sued for defamation. However, this strategy should not be abused to suppress truthful free speech.
Businesses have a difficult enough time finding ways to manage and appropriately respond to truthful negative reviews online. They should not be subject to harmful lies as well, without recourse.
Quiles Law is an esports and sports law firm based in New York City.
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Attorney Advertising. The information presented in this site should not be construed to be formal legal advice nor is it intended to form any attorney/client relationship. Our attorneys, collectively, are licensed to practice law in the States of New York, New Jersey, and Pennsylvania. Copyright Roger R. Quiles, Esq., 2017. All rights reserved.