1. Start Writing Things Down

2. Get Started Early

3. Make Sure Your Trademarks Are Protected

4. Hire an Experienced Franchise Consultant and Franchise Lawyer

5. Get Your Financial House in Order

You can read the full article here: 5 Tips for Businesses Considering Franchising in 2012.

Jeff Fabian is the owner of Fabian, LLC, a boutique law firm that assists business owners in protecting their interests so that they can stay focused on running their businesses. Visit fabianlegal.com for more information, or follow Jeff on Twitter @jsfabian.

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Social Media Tips for Franchisors and Franchisees (from a Franchise Lawyer)

How to Perform Meaningful Due Diligence When Investigating a New Franchise Opportunity

Protect Your Brand: Trademark Monitoring for Franchisors

Don’t Forget: Compliance Beyond Federal and State Franchise Laws

Considerations for Developing a Franchise System

Understanding the Franchise Disclosure Document (8-Part Series)

It’s been a great year, and I look forward to helping more business owners begin franchising and buy franchised businesses in 2012.

Trademark monitoring is the task of examining the market for illegitimate, unauthorized, and otherwise negative references to a company’s trademarks. United States trademark laws actually require brand owners to monitor and police their trademarks in order to retain their exclusive rights, and thus failure to conduct appropriate monitoring and enforcement activities can result in the combination of both negative image and loss of exclusivity.

Fabian, LLC (owner of TheFranchiseCafe.com) provides both pre-packaged and customized trademark monitoring services for flat monthly and annual rates. You can read more at eTrademarkSolutions.com. Our trademark monitoring services cover roughly 100 federal, state, domain name, social media, search engines and other Internet resources, and we provide our monitoring analysis in a reader-friendly format along with a detailed trademark portfolio.

Consumer Confusion

One issue addressed by trademark monitoring is that of consumer confusion. Whether from counterfeiters or other infringers (such as start-up enterprises that do not properly clear their trademarks before adopting them), consumer confusion created by multiple similar (or identical) trademarks in the marketplace can be disastrous for a brand-based business. By monitoring their trademarks, brand owners can quickly spot and address instances of infringement before they cause significant damage.

Imagine this: One day a consumer comes to you complaining about a product they purchased recently, and demands a refund. You review your order history, and discover that you did not sell the product in the first place. However, the customer insists that they purchased the product from you, because they recognized your logo on the packaging. You do some research, and find out that a competitor has been using a trademark almost identical to yours for the past six months. When you contact the competitor, they refuse to change their logo, claiming that they adopted it innocently (although this is not a legitimate excuse), and anyway they purchased their domain name a long time ago, so they aren’t sure that you actually have prior rights. Plus, they have sunk a lot of money into marketing, and they aren’t going down without a fight.

Now imagine this: You receive notice that someone has purchased a domain name that is uncomfortably similar to your primary trademark. You contact the purchaser almost immediately informing them of your pre-existing trademark rights, and stating your intent to enforce them. The domain name lies dormant over time.

This is the value of trademark monitoring.

Negative Image

Another issue that can be proactively addressed through trademark monitoring is preventing and (when necessary) responding to negative references to your company’s trademarks on the Internet. Whether from consumer reviews, social media posts, or competitors’ advertisements, negative brand references can appear and spread in the blink of an eye. Active trademark monitoring allows brand owners to identify and react to negative references before they get out of control.

Improper Use by Franchisees

In addition, franchisors need to monitor their franchisees’ use of their trademarks to make sure that franchisees remain in compliance with the Franchise Agreement and Operations Manual. Among other things, franchisors need to make sure that franchisees make proper “trademark use” of their brand names, avoid making misleading claims about their products or services, and do not state or imply a partnership or other direct relationship with the franchisor entity. For these reasons, trademark monitoring is an especially important aspect of an intellectual property protection strategy for franchisors.

Loss of Exclusive Rights

Failure to actively monitor and enforce a company’s trademarks can ultimately result in loss of the exclusive rights that accompany a federal trademark registration. Federal law actually requires trademark owners to monitor and enforce their trademark rights, and brand owners who neglect to do so are likely to face claims from third parties that they have “abandoned” their trademarks by failing to diligently enforce them. If a brand owner seeks to enforce its trademark rights against an apparent infringer who claims abandonment, it will have to be able to show that it has consistently made reasonable efforts to monitor and enforce its trademark rights.

As a result of these issues, trademark monitoring can sort of be thought of like insurance—a necessary expense that you will sure be glad you have when you need it. Only by monitoring their trademarks on an ongoing basis can brand owners ensure that they—and they alone—are controlling the image of their brands in the marketplace.

Fabian, LLC provides both pre-packaged and customized trademark monitoring services for flat monthly and annual rates. Visit etrademarksolutions.com for more information.

Item 20 – Outlets and Franchisee Information

Item 20 consists primarily of 5 tables that provide information on the number of franchised and company-owned outlets operating under the franchisor’s brand and business system.

Item 20 Tables:

• System-wide Outlet Summary (summarizes openings and closings of franchised and company-owned outlets over the past 3 years)
• Transfers by Franchisees to New Owners
• State-by-State Summary of Opened and Closed Franchised Outlets
• State-by-State Summary of Company-Owned (non-franchised) Outlets
• Projected Openings for the Coming Year

Except for the projected openings table, all of the Item 20 tables must provide information for the most recent 3 years of the franchisor’s operations.

Item 20 must also include contact information for (i) all current franchisees, and (ii) all former franchisees who left the system during the past fiscal year. Franchisees may request for the franchisor to provide limited or alternate contact information (such as an email address instead of a phone number for home-based franchisees). For franchisors with significant numbers of franchisees, this disclosure will typically be made in a separate Exhibit to the FDD.

Depending on the status of the franchise system, Item 20 can be an important sales tool for franchisors. It can also be a significant resource for prospective franchisees, who will want to review geographic distribution and termination figures in particular, and use the contact information to obtain as much information as they can from both current and former franchisees.

Item 21 – Financial Statements

Franchisors must disclose their financial statements in Item 21 of the FDD. The disclosure requirements are uniform for established franchisors (audited balance sheet and income statement for the 3 previous fiscal years), but there is a “phase-in” for new franchisors which allows them to provide limited financial disclosures during their initial years of franchising.

Importantly, where the franchisor also operates a unit-level business (i.e. a company-owned outlet), its financial statements may effectively constitute a Financial Performance Representation, potentially triggering mandatory disclosures and representations in Item 19 of the FDD. This is because, in such circumstances, the franchisor’s financial data provides an indication of the revenue and expenses of an operating outlet. In this situation, the franchisor must be careful to state that the information disclosed is not a representation of prospective franchisees’ likelihood of success.

In certain circumstances, franchisors may also be required to disclose the financial statements of their parents, affiliates and subfranchisors. If this is the case, in performing their due diligence prospective franchisees should carefully evaluate all of the financial information disclosed. A shaky affiliate who provides key support or branded products could be a bad omen.

Item 23 – Receipts

Finally, Item 23 of the FDD contains two copies of a standardized receipt for the FDD. Prospective franchisees must sign both copies—keeping one for their records and returning the other to the franchisor. The receipts will identify all Exhibits that should be included with the FDD, and they contain important information regarding the timing for signing the franchise agreement (the federal rule provides for a 14-day “cooling off” period, but some states have different requirements).

The receipt pages must also state the Issuance Date of the FDD, and prospective franchisees should make sure that the date listed here is consistent with the date listed on the cover page of the FDD.

Franchisees should read the receipt pages carefully, and thoroughly review the FDD to make sure that it contains all of the necessary information prior to signing.

Originally posted on FranchiseHelp.com.

Item 17 – Key Provisions of the Franchise Agreement

In Item 17 of the FDD, franchisors are required to provide summaries and cross-references for 23 key provisions in the franchise agreement. A careful franchise prospect will have the entire franchise agreement reviewed in-depth by an experienced franchise attorney, but the Item 17 disclosures can provide a quick guide to use in a preliminary analysis of the franchise opportunity.

Some of the Key Franchise Agreement Provisions Summarized in Item 17 Include:

• Renewal and transfer rights
• Franchisor and franchisee rights of termination
• Non-competition obligations (in-term and post-term)
• Dispute resolution provisions

Item 18 – Public Figures

Item 18 requires disclosure of any public figure “whose name or physical appearance is generally known to the public in the geographic area where the franchise will be located.” Importantly for franchisors, Item 18 applies only if the public figure engaged for the purpose of selling franchises—using public figures to promote franchisees’ products and services does not trigger an Item 18 disclosure.

However, if the public figure promotes franchisees’ products and services and also invests in the franchisor, then the public figure’s investment must be disclosed in Item 18.

Item 19 – Financial Performance Representations

Entire scholarly articles can (and have been) written on the subject of Financial Performance Representations (“FPRs”). Franchisors who provide FPRs in their FDDs do so with careful guidance from their legal and financial advisors, and state franchise examiners often heavily scrutinize these disclosures. While certain disclaimers and limitations can (and should) be included, there are limits on the lengths to which franchisors can go to effectively nullify the legal consequences of providing an FPR in the FDD.

There are two main types of Financial Performance Representations:

• Historical financial data based on the performance of franchised or company-owned outlets
• Projections of potential future performance

If a franchisor provides historical data, it may provide information for all outlets or a certain defined subset. However, it may not simply disclose the financial results of its top-performing franchisees.

Limited historical disclosures must be based on categorizations such as:

• Geographic location
• Years in operation
• Nature of location (e.g., free-standing versus shopping center)

If a franchisor provides an FPR, it must carefully train its sales staff to limit their discussions with franchisees to stay within the scope of the FPR.  Federal and state franchise laws prohibit franchisors from making any financial performance representations other than those included in the FDD.

Franchisors also have the option not to provide any FPR in the Franchise Disclosure Document, and this option has been gaining popularity in recent years. If a franchisor provides this “negative” disclosure in the FDD, it may not provide any financial information to prospective franchisees.

Next week’s installment will be the final chapter in this series, and will cover the system size and growth data in Item 20, franchisor financial statements in Item 21, and the Receipt pages that comprise Item 23.

Originally posted on FranchiseHelp.com.

Items 15 and 16 are two of the shorter Items in the Franchise Disclosure Document. However, they – and Item 15 in particular – still contain critical information for prospective franchisees to consider evaluating potential franchise opportunities.

Item 15 – Obligation to Participate in the Actual Operation of the Franchised Business

The key disclosure in Item 15 states whether the franchise owner is obligated to participate in the direct operations of the franchised business. For prospective franchisees looking for a pure investment rather than a business opportunity, this disclosure might be the first (and only) provision they read in the FDD. Although, an experienced franchise investor may be able to negotiate an exception with the franchisor.

Other Item 15 disclosures include:

• If participation is not required, whether or not it is recommended
• Any mandatory limitations for franchisees’ on-premises managers and supervisors (such as training obligations, confidentiality agreements and non-competition covenants)
• Any requirement for the franchisee’s managers or supervisors to own an equity interest in the franchise

While often overlooked, this final issue can be an important one for both franchisors and franchisees. By requiring day-to-day managers to literally buy-in to the franchise, franchisors and franchisees can help make sure that these essential personnel have an incentive to help grow the business instead of merely showing up to collect a paycheck.

Item 16 – Restrictions on what the Franchisee may Sell

Item 16 contains fairly straight-forward disclosures, including:

• Whether franchisees may only sell franchisor-approved goods/services
• Whether franchisees must sell all franchisor-approved goods/services
• Whether the franchisor reserves the right to modify the list of approved goods/services (it should)

For service-based franchises, the franchisor will almost always limit the scope of services franchisees can offer, as the service offering will often be the underlying concept for the entire franchise system. For restaurants and other product-based franchises, depending on the franchisor’s concept (and depending on whether the franchisor itself sells products to franchisees), the franchisor may limit franchisees’ sourcing options, or it may grant some leeway—subject to inspection, standards compliance, etc.—to use substitute or local products and suppliers.

Next week’s installment will focus on Items 17, 18 and 19 of the FDD, which cover the franchise agreement, use of public figures to promote the franchise, and financial performance representations.

Trademarks, Copyrights, Patents and Proprietary Information

As a preliminary matter, it is important to understand the distinctions between trademarks, copyrights, patents and proprietary information.

Trademark law protects brands, logos, company names and other “indicia of origin” that distinguish one merchant’s goods or services from its competitors’ in the marketplace. Geographically limited trademark rights are automatic, but national “priority” can be obtained through registration with the USPTO. International registrations can be obtained as well.

Copyright law protects creative expressions of ideas “fixed in a tangible medium.” What this means is that copyright law does not protect ideas themselves, but rather protects written, drawn, designed, recorded, etc. materials embodying those ideas. For example, the concept of a software application to streamline order processing is not protected by copyright, but the software code and the graphic design of the application would be. Copyright protection is also automatic, although registration with the U.S. Copyright Office provides substantial additional benefits.

Patent law protects and provides exclusive rights in inventions for a limited period of time (copyright protection is also limited, but the duration of the limitation is, for all intents and purposes, essentially perpetual for most business operations). There is a limited window of time for claiming patent rights, and the patent process can be grueling.

Proprietary Information refers to trade secrets, customer data and other confidential information that is valuable to the franchisor simply by virtue of its secrecy or restricted access. Since proprietary information is not protectable as a copyright, it must be protected through disclosure controls and contractual limitations.

Item 13 – Trademarks

In Item 13 of the FDD, the franchisor must disclose: (i) its “principal” trademarks, (ii) whether those trademarks are registered or pending registration, and (iii) certain other technical information relating to the applications or registrations. If none of the franchisor’s principal trademarks (most franchisors will only have one) are registered, the FDD must include the following disclaimer:

We do not have a federal registration for our principal trademark. Therefore, our trademark does not have as many legal benefits and rights as a federally registered trademark. If our right to use the trademark is challenged, you may have to change to an alternative trademark, which may increase your expenses.

Not only can loss of trademark rights increase the franchisee’s expenses, it can have a substantial impact on the value of the franchise. Much of the value in purchasing a franchise resides in buying into a recognized brand in order to spur public recognition and acceptance. If the franchisor is forced to change its brand, from a marketing perspective its franchisees are—at least to a certain extent—back to square one.

Other Item 13 disclosures include:

• Whether there is any pending litigation relating to the trademarks
• Whether there are any pending Office Actions or other proceedings with the USPTO
• Whether the franchisor is aware of any “prior” rights in the trademarks held by third parties
• Control and cost provisions relating to enforcement of trademark rights and litigation instituted against franchisees arising out of their use of the franchisor’s trademarks

Trademark rights are fundamental to a marketable and successful franchise concept, and franchisors and franchisees alike need to pay careful attention to the Item 13 disclosures.

Item 14 – Patents, Copyrights and Proprietary Information

In Item 14 of the FDD, franchisors are required to disclose an array of information relating to their rights in non-trademark intellectual property.

Item 14 disclosures include:

• Advertising materials, manuals, software and other media subject to copyrights owned by the franchisor
• Any patents owned by the franchisor
• The remaining duration of the franchisor’s exclusive rights
• Whether any agreements or other restrictions limit the franchisor’s ability to use and license its copyrights and patents
• Whether there is any pending litigation relating to the franchisor’s copyrights or patents
• Any other intellectual property rights claimed by the franchisor—including proprietary methods, recipes, market data and customer lists.

While Item 14 is treated much as an afterthought by many franchisors, for franchisors and franchisees who recognize and understand the inherent value in a robust intellectual property portfolio, the Item 14 disclosures can be a significant component of the FDD.

Next week’s installment will focus on Items 15 and 16 of the FDD, which cover management and operation of franchised units.

Item 12 – Territory

Territory sizes will vary widely depending on the type of franchise involved. For example, brick-and-mortar franchises (such as restaurants) will often have smaller territories than mobile service businesses (such as in-home senior care). For mall-based franchises, the territory may be limited to the mall itself. The reason for this is simple: the franchisor wants to grant franchisees sufficient opportunity to develop and sustain their business, but not more. That way, there are more territories to grant (and franchises to sell).

One key aspect of Item 12 is establishing how franchisees’ territories will be defined. This may be by zip code, population, population with certain demographics, or geographic or political markers (i.e. streets or county lines). For franchises with population-based territories, a franchisee in a busy downtown urban area may have a territory of only a few blocks, while a rural franchisee’s territory could reach for miles.

The other core aspect of Item 12 is identifying whether franchisees are granted exclusive, protected, or un-protected territories.

Common territorial rights and restrictions include:

• Territorial exclusivity (i.e. no franchisee- or franchisor-owned outlets will receive overlapping territories or compete for customers within your territory);
• Territorial protection (i.e. no overlapping territories, but other franchisees can advertise in your territory, or the franchisor can sell competing product over the Internet); and
• Territorial restrictions (i.e. your franchise can market only within a defined territory, and other franchisees’ territories may overlap with yours).

These are just a few examples. Each form of territory definition can be appropriate under the right circumstances and in the right franchise system.

Other mandatory disclosures in Item 12 include:

• Franchisees’ rights to relocate (this can be more or less significant depending on the nature of the franchise);
• Which parties are permitted to advertise and make sales over the Internet;
• Whether the franchisor must compensate the franchisee for soliciting orders within the franchisee’s territory (in which case the territory would be non-exclusive);
• Whether franchisees can advertise outside of their territory; and
• What franchisees are permitted/required to do with orders received from outside of their territory.

The franchise territory is often a key negotiating point for both the franchisee and the franchisor (provided that the franchisor does not merely assign plain vanilla territories), and rightfully so. Franchisors need to make sure that they give their franchisees the opportunity to be successful without inhibiting their ability to saturate the potential market, while franchisees need to make sure that they get adequate value and opportunity out of their investment.

Next week’s installment will focus on Items 13 and 14 of the FDD, which cover trademarks, copyrights and patents.

Item 8 – Restrictions on Sources of Products and Services

In Item 8 of the FDD, franchisors are required to disclose designated and approved suppliers, franchisees’ mandatory purchases, and any rebates they receive from vendors as a result of franchisee purchases.

When a franchisor mandates purchases—whether from itself or a related or independent third-party—prospective franchisees need to perform the appropriate due diligence to ensure that the designated vendor’s prices are in line with industry standards. This is particularly important where the vendor is the franchisor itself, the franchisor’s affiliate, or a vendor who pays rebates to the franchisor as a result of franchisee purchases. Generally, the prospective franchisee will be looking to see that their required purchases are not a significant revenue source for the franchisor.

Important Item 8 disclosures include:

• Franchisees’ mandatory purchases
• Identification of designated suppliers
• Provisions for obtaining approval of alternate suppliers
• Franchisor ownership of, or affiliation with, designated suppliers
• Terms of rebates, commissions and other benefits paid to the franchisor by franchisee suppliers
• Financial disclosures regarding rebates and commissions
• Whether the franchisor negotiates purchase arrangements for the benefit of franchisees

Each of these disclosures, even if omitted (or, more accurately, made “negatively” [i.e. the franchisor does not negotiate purchase arrangements]), can provide important insight for prospective franchisees when evaluating proposed franchise opportunities.

Item 11 – Franchisor’s Assistance, Advertising, Computer Systems, and Training

Item 11 covers the franchisor’s pre-opening and ongoing support obligations to its franchisees. Item 11 disclosure obligations can be separated into 7 main categories.

Item 11 disclosures include:

• Pre-Opening Obligations
• Timeline for Opening for Business
• Ongoing Support Obligations
• System-wide and Local Advertising
• Computer Systems
• Initial and Ongoing Training
• Operations Manual

Pre-opening Obligations

The scope of a franchisor’s pre-opening obligations can vary widely depending on the nature of the franchise system. In addition, franchisors required by state regulators to defer or escrow initial franchise fees will often try to limit their pre-opening obligations in order to accelerate their ability to collect. Post-opening and ongoing support obligations will also vary widely from franchisor to franchisor.

System-wide Advertising

With regard to advertising programs, in performing their due diligence, prospective franchisees will want to investigate the efficacy and geographic scope of the franchisor’s advertising efforts. Prospective franchisees will also want to make sure that ad fund contributions are predominantly used for direct ad placement, as opposed to in-house R&D or “administrative” expenses.

The Initial Training Program and Operations Manual

Training and Operations Manual disclosures are similarly critical to the due diligence process. Prospective franchisees should seek to make sure that the initial training program is conducted by qualified individuals, and is sufficiently comprehensive to prepare them to get their franchised businesses off of the ground and running smoothly during the initial phase.

Likewise, whether the franchisor discloses its Operations Manual’s table of contents in the FDD or permits franchisees to review the Operations Manual at its headquarters, prospective franchisees will want to ensure that the Manual is sufficiently comprehensive to meaningfully assist them in successfully operating their business in accordance with the franchisor’s system standards.

Next week, Part 4 of Franchise Disclosure Documents for Dummies will discuss Item 12 of the FDD, which covers territory rights of franchisees.