New franchisors often come to us with one of two directives; “write an airtight franchise agreement that I can terminate if my franchisees do not do what I want them to do,” or, at the other end of the spectrum, “we want an agreement that is short, fair and neutral.” The best agreements lie in the middle, and for good reason.

The nature of franchising is such that the best franchisors are essentially “benevolent dictators.” Or, as famous boxing referee Judge Mills Lane used to describe himself, “fair but firm.” You have a system you want to replicate at presumably hundreds of locations and you need franchisees to comply with that system. In a world where consumers can tell the entire world about a bad experience with the click of a mouse, when a single franchisee runs a substandard operation, every potential customer in every market can hear about it within minutes. As a result, all the outlets in your system can suffer.

Clear Standards

You therefore need clear standards for your brand and you need to be able to either enforce compliance with those standards or get non-compliant operators out of the system before they destroy your system. You cannot be in a position of waiting until some judge, jury or arbitrator decides whether your policies or standards are “reasonable.” That is not to say that you can enforce your standards at gunpoint, but it does mean that franchise agreements do, by their nature, need to be relatively extensive, and yes, even one-sided in favor of the franchisor in order to give the franchisor the ability to protect its system.

At the other extreme, we have seen agreements that are so one sided that any prospective franchisee foolish enough to sign the agreement would not be a person you want operating your brand. That is why we refrain from including in the agreements we prepare onerous provisions that are simply not necessary to protect the brand or that impose unnecessary costs and burdens on franchisees.

Balancing Act

Putting together an agreement that is fair but firm and extensive but not unnecessarily burdensome is not an easy task. It is often a balancing act, and it is why a “form franchise agreement,” or cookie-cutter approach to developing a franchise program, simply does not work. When you prepare your franchise agreement, or have it prepared for you, you should be working with someone who has seen how agreements work in practice and will meet with you in person to understand you and your concept so that you can mutually develop a franchise agreement that works for your system.

How much money can I make?

The first question on the mind of most prospective franchisees is “how much money can I make?” By law, financial performance information, or “FPRs,” can only be provided to prospective franchisees in a franchisor’s Franchise Disclosure Document. Many franchise attorneys have historically advised their clients against including FPRs in their disclosure documents out of fear that franchisees will not perform as well and the franchisor will be sued over its FPR. However, the rules have changed, and today, most new franchisors are, and should be, providing this information to prospective franchisees.

The financial information you provide will typically be actual historical results based on the existing operations of your company-owned outlets, with adjustments to show any additional costs your franchisees may have – such as royalties and advertising contributions.  For many years, franchise examiners in some of the franchise registration states refused to allow franchisors to provide information to prospective franchisees based on company-owned outlets. The rules changed last year to specifically allow an FPR to be based on company-owned outlets. The new rules essentially give franchisors a road map as to how to prepare an FPR from their company-owned outlets, including what they can and cannot include.

We have always advised our franchisor clients to include financial information on their existing outlets in their Franchise Disclosure Documents. How else can a prospect make an informed decision whether or not this is an appropriate investment for them? If you have even one operating outlet, you have financial information you can provide, though we have always suggested that a company have financial information from at least two outlets before including financial results in their Franchise Disclosure Document, just because one outlet could turn out to be an aberration.

As a result of the changes in the disclosure laws over the last 10 years, and especially the latest changes, most franchisors are now including FPRs in their Franchise Disclosure Document. If you are a would-be, or existing, franchise company, and you are not providing this information, you should think about doing so or you will be at a competitive disadvantage when seeking out prospective franchisees. If you have questions about how to do so, and what you are permitted to do, we can help you.

The possibility that a franchisor could be pulled into a claim or lawsuit originating from a franchisee’s location continues to grow and evolve. This vicarious liability exposure is an increasing risk that franchisors need to know about and manage.

From an insurance standpoint, we’re frequently asked for the best practices on how to mitigate and reduce this exposure. While there isn’t one magic elixir to eliminate a franchisor’s potential vicarious liability exposure, there are some steps every franchise system should take to reduce this risk.

  • Start with properly written insurance requirements in the franchise disclosure document (FDD).
  • Manage system-wide compliance on FDD requirements. Maintaining franchisee compliance with the correct insurance requirements is increasingly important in protecting the brand and reducing potential exposure.

The challenges for many franchisors are determining what insurance requirements they need and, once they are written, effectively enforcing them. Obviously there’s nothing to enforce until your franchisee insurance requirements are drafted.

Five tips for Developing Requirements

  1. Have your FDD insurance requirements reviewed by an insurance broker who knows and understands the franchise industry. Too often I see FDD language that is boilerplate, vague, incorrect, or all of the above. The boilerplate language does not address your specific risks.
  2. Tailor the insurance requirements around the products and services your franchisees deliver and sell, not what you do as the franchisor. Are your franchisees working in homes, driving cars, working in a restaurant or handling client data? The insurance requirements need to be specific to those products and services performed and delivered by your franchisees.
  3. General liability insurance does not cover everything. Contrary to its name, your general liability (GL) policy has limitations. GL primarily covers bodily injury and property damage and can include coverage for personal/advertising injury and products and completed operations. It does NOT cover harassment, discrimination, wrongful termination claims, data privacy issues, third-party crime against clients, professional liability for services performed and many other scenarios. Too many franchise owners miss this point and don’t understand until they have filed a claim that they are not adequately covered under a standard GL policy.
  4. Additional insured (AI) status is important and should be tracked. This is the first and best step franchisors can take to limit their vicarious liability exposure. AI status is often the first thing that gets overlooked as franchisees’ policies renew each year. To have coverage extended to the franchisor under the terms of a franchisee’s policy, the franchisor must be listed as an additional insured or you can end up paying out-of-pocket.
  5. Collect franchisees’ certificates of insurance (COI): It’s a thankless job but one that needs to be done. A system should be put in place to collect COIs today and each year upon renewal. You can’t manage this process without collecting certificates.

While not as exciting as a new advertising strategy or product roll-out, a well-designed and managed insurance program is extremely important in helping you reduce risks to you and your franchise system. Reducing potential vicarious liability exposure, providing proper guidance, and maintaining consistent brand standards will enable you and your franchisees to focus on growing your business. And that, after all, is exciting.

 

Doug Imholte is a Franchise Risk Management Practice Leader at Marsh & McLennan Agency in Minneapolis. Contact him to learn more about insurance for franchisors.

This is an age-old question for new franchise systems. Should I hire a full-time salesperson, should I hire a franchise broker or should I sell my franchises myself?

In our experience, in the first year of the life of a new franchisor, there is nobody better to sell the franchise than the founder of the company. There are lead-generation firms that can help you generate leads, but most start-up franchisors have a pipeline of people who have asked them about franchising. You know your business better than anyone else, and you are the best one to explain that business to prospective franchisees, and just as importantly, determine whether the prospect is likely to follow your system and be successful in the business.

It is critical to a startup franchisor that its first franchisees are successful as they serve as your references, good or bad, to future franchise prospects. You also have to work with the people to whom you sell your franchise on a regular basis, and you will likely be more selective than a commissioned salesperson. If selling franchises is not your forte, see if there are others among your existing staff who have the skills to either make the initial offering, bringing you in to close the sale, or to close the sale after you have explained the opportunity to prospective franchisees.

Selling franchises takes time. It involves sorting through leads who have no financial wherewithal to start a business and people who seem to be “professional shoppers” and not “buyers.” It will take you away from your existing business. It is not something the founder or entrepreneur should be doing forever, but, it is our experience in the early stages of the life of a franchise company, that the founders must be involved in the sale of franchises as they are the ones who have to live with the results of these efforts.