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.
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.
When starting a business, one of the most important choices that is frequently overlooked is the business entity selection. The choice between forming your business as a sole proprietorship, partnership, LLC, C Corporation or S Corporation is much more than a choice of letters. Each entity alters how the business must be structured, how taxes are reported and paid by the owners, and impacts the business' ability to raise capital. Further, it is difficult to change business entities once the business is running, and doing so may incur substantial costs. This post will be the third, and final, in a series of explanations of the different corporate entities as well the features that make them attractive or unattractive to new businesses.
The final two types of business entities to discuss are known as C corporations and S corporations. Although the corporate entities have important differences, the formation of the corporations is the same. Firstly, it is important to recognize that a business which wishes to incorporate should do so in Delaware, as the State has the most robust corporate governance law in the country. In order to create a corporation in Delaware, the business must first choose a name including some derivation of one of the following words: Incorporated; Institute; Society; Union; Syndicate; Company; Club; Foundation; Corporation; or Limited. This name must be unique. Next, the business must prepare to file the certificate of incorporation. On the certificate, the business must state its registered agent, the nature of the business, the amount of shares of stock of the incorporators, the directors, and addresses for all named parties. Once completed, the certificate of incorporation must be filed with the State. Delaware also requires that corporations maintain written bylaws, although they are not required to be filed with the state. The bylaws establish the rules and procedures of the corporation, such as the size of the board of directors, the board's responsibilities, who may call shareholder meetings and where the meetings are to occur. Next, the corporation must appoint its initial corporate directors, hold its first board of directors meeting, and issue stock. Lastly, corporations must comply with any other business, tax, state (if conducting business outside of Delaware) or industry specific regulations, such as obtaining the necessary licenses to do business and filing other required paperwork.
The sole additional step in forming an S corporation is that the business must designate "S" status with the IRS within 75 days of the incorporation date (the date the business filed the certificate of incorporation). The S corporation must also meet the additional requirements of not having more than 100 shareholders, the shareholders cannot be non-resident aliens or corporations, and S status must be approved by all shareholders. These requirements generally necessitate that S corporations are small businesses.
The key distinctions of S corporations and C corporations are in the benefits that each structure receives. Although the directors and shareholders of both corporate structures enjoy limited liability, S corporations are taxed as "pass-through" entities, like LLCs and sole proprietorships. This means that the profits are passed directly to the shareholders, who must report their share of the profits as income on their personal taxes. In contrast, C corporations' profits are taxed twice as the forming of a C corporation creates its own taxable entity. The C corporation is taxed when it turns a profit, and is also taxed when the corporation pays dividends. However, a distinctive advantage for the C corporation is its ability to attract investors due to its highly regulated structure. Simply put, the regulated nature of C corporations makes the structure predictable and easily understood by investors. Contrast that with LLCs which are similar but can be structured any way the members please. Additionally, C corporations are also attractive to investors as shareholders are not subject to taxes unless the corporation pays them through dividends, distributions, or salary. This relieves investors of the possibility of being taxed on money they may not have necessarily received, as could happen under "pass-through" companies such as LLCs or S corporations.
The disadvantages of S and C corporations are few. Firstly, the requirements of S corporations, particularly that its limited to 100 shareholders, limits S corporations to small businesses. It would be extremely difficult, if not impossible, for a large corporation (or a company planning on expanding very quickly) to limit itself to 100 shareholders. Additionally, S corporations are restricted to one class of stock. Multiple classes of stock are normally issued in C corporations to establish different levels of voting rights. Under a single class of stock, the voting rights are equal. The disadvantages of C corporations are predominantly administrative. C corporations are costly and time consuming to start and operate. Additionally, C corporations have increased paperwork and recordkeeping burdens as it is highly regulated by federal and state governments. The most notable disadvantage to C corporations is the double taxation at the corporate and individual level. However, corporate tax levels are favorable as compared to income tax.
As a result of its requirements, advantages and disadvantages, S corporations are best suited for small businesses who seek greater structure than LLCs have to offer, and intend to remain small businesses. The 100 shareholder requirement is limiting, and it is important to note that changing corporate structures can be costly. As for C corporations, they are best suited for businesses that plan to utilize investor funding and/or plan to expand rapidly into large corporations. The startup and operating costs are greater than its S corporation counterpart, but any need for investor financing logically requires a business to form a C corporation.
These are just some of the advantages and disadvantages of LLCs. It is important to remember that the best choice of entity varies business to business.
When starting a business, one of the most important choices that is frequently overlooked is the business entity selection. The choice between forming your business as a sole proprietorship, partnership, LLC, C Corporation or S Corporation is much more than a choice of letters. Each entity alters how the business must be structured, how taxes are reported and paid by the owners, and impacts the business' ability to raise capital. Further, it is difficult to change business entities once the business is running, and doing so may incur substantial costs. This post will be the second in a series of explanations of the different corporate entities as well the features that make them attractive or unattractive to new businesses.
An LLC is an unincorporated business organization established by a single member, or group of people, who have limited liability for the debts and liabilities of the business. State law determines the formation and operation of an LLC. To form an LLC in New York, the organizing members must file the business' Articles of Organization with the state and pay the requisite fee. Subsequently, a notice that the LLC was formed must be published in two newspapers (that are designated by the county clerk of the county where the LLC is located) consecutively for six weeks. A Certificate of Publication, affidavits of publication in the newspapers, and the requisite fee must then be filed with the Department of State within 120 days of the initial filing of the Articles of Organization. The timing of the submission is important, as failure to provide this documentation would result in the suspension of the LLC's ability to conduct business. Additionally, the members of the LLC are required by New York law to adopt a written Operating Agreement. Under New York law, this agreement must be entered into no later than 90 days after the filing of the Articles of Organization. This document does not get filed with the State but is maintained internally by the LLC. Lastly, depending on the industry the LLC does business in, the members may have to comply with other tax and regulatory requirements. Although there are fees and several steps required to form an LLC, the benefits to its members are substantial.
The LLC is a flexible business structure that avoids some of the pitfalls of sole proprietorship. This entity allows the business to add members as it sees fit, unless otherwise provided for in the Operating Agreement. The necessity of an Operating Agreement also allows businesses to create its own organizational structure. One of the greatest advantages to the LLC is that members enjoy limited liability. This means that the members do not share in the liability of the business' debts or judgments like sole proprietors do. Essentially, the business insulates its members from liability by absorbing any debt or judgment. Limited liability is extremely beneficial to the members as their personal lives are not on the line with every debt or lawsuit. Additionally, LLCs are usually taxed like sole proprietorships, as they are considered "pass-through" entities. This means that the LLC's members report their share of the business' profits on their personal tax return. LLCs can also elect to be taxed as a C or S corporation instead of "pass-through" taxation (which will be discussed in a future blog post).
The disadvantages of LLCs are few, but could be impactful to a business. Firstly, it may be difficult for LLCs to raise money from investors. Generally, investors are hesitant to invest in LLCs due to the lack of a mandatory corporate structure and "pass-through" taxation structure. Simply put, investors may not be amenable to investing in LLCs because they would be taxed on a share of profits from the LLC, despite potentially not receiving any money to pay the taxes, and/or have tax-exempt partners who do not want to receive business income. The need for investor funding should be heavily weighed during business formation. If investor funding is, or will be, necessary for the business to thrive, it may be more advantageous to form a C corporation. Additionally, it is a disadvantage that there are no structural requirements to an LLC because it necessitates an all encompassing, tightly drafted, Operating Agreement. Such an agreement can be difficult to draft, review, negotiate and agree upon between the members.
These are just some of the advantages and disadvantages of LLCs. It is important to remember that the best choice of entity varies business to business.
When starting a business, one of the most important choices that is frequently overlooked is the business entity selection. The choice between forming your business as a sole proprietorship, partnership, LLC, C Corporation or S Corporation is much more than a choice of letters. Each entity alters how the business must be structured, how taxes are reported and paid by the owners, and the impacts the business' ability to raise capital. Further, it is difficult to change business entities once the business is running, and may incur substantial costs. This post will be the first in a series of explanations of the different corporate entities as well the features that make them attractive or unattractive to new businesses.
Sole proprietorships are a common business structure for single owner small businesses. Forming this type of business entity is very simple. Several states, including New York, only require you to register with the state if you will be doing business under a name other than your own. For instance, if Bob Jones opened up Happy Time Graphic Design in New York, he would have to register his sole proprietorship with the state. On the other hand, if Bob Jones were to do business under his own name, he could operate his graphic design business without having to register with New York. This ease of formation is what attracts single owner small businesses to this structure. Additionally, under the sole proprietorship, income is directly imputed to the owner. That means the business income is reported on the owner's taxes directly.
Sole proprietorships have two main disadvantages. Firstly, the business owner and his/her line of credit is all that is available to the business should it need additional capital. This could become particularly problematic if the business owner's credit score is low. In contrast, other business entities have the multiple methods to raise capital for their businesses. Secondly, and most importantly, sole proprietors face unlimited liability. This means that the owner can be personally sued for any debts obtained in the process of running the business or any accidents at the business. For most, the risks should outweigh any advantage. Hypothetically speaking, a sole proprietorship structure is not worth losing your family's home because someone slipped at your business and broke their arm. Yes, an owner should have insurance which would help mitigate the liability faced by the owner, but the coverage may not be sufficient.
So what types of businesses are best suited for a sole proprietorship? Home businesses are best suited for sole proprietorships. Assuming that the home business does not meet with clients in the home, the liability risk for accidents on the business premises is eliminated. The business would still be liable to creditors, but at home businesses generally operate with little overhead as compared to their storefront counterparts, so the need for a line of credit may also decrease.
These are just some of the advantages and disadvantages of sole proprietorships. It is important to remember that the best choice of entity varies business to business.
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., 2018. All rights reserved.