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.

There are a lot of mistakes one can make when initially franchising a business, from trying to copy documents used by others (that may not work for you at all), to not being prepared to offer proper support to franchisees. However, the biggest mistake a start-up franchisor can make is in its initial selection of franchisees. Particularly when the franchisor is strapped for cash, it is too easy to use the “mirror test” in selecting franchisees – if they have the money, and can fog the mirror, you take them.

It is critical that your first franchisees reflect the type of franchisee you want in your system. Are they prepared to follow the system? Do they have the proper skill set to be successful in the business, whether that means a cheerful personality, a true passion for your brand, or technical skills required for the business? (The best answer is “all of these.”) Do they have the time and resources to devote to the business?

When you get beyond your first year in franchising, you will be listing your initial franchisees in your franchise disclosure document. If you want to show prospects the kind of money they can make in the business, you will also need to use results from your early franchisees. If these early franchisees are not successful, they will not validate your system and it will be very difficult to overcome these failures. Perhaps even worse, if they are litigious, you will spend the next few years with lawyers and in courtrooms, an expensive and time consuming proposition, rather than growing your business. For these reasons, it is critical that you do your due diligence on prospective franchisees and satisfy yourself not just that they have an interest in your brand, or can “fog the mirror,” but that they will be a “fit” for your system and likely be successful.

Running a franchise company is a completely different business than selling products or services directly to consumers.  As a franchisor, you sell the right to use your brand and system (i.e., the franchise) to franchisees who in turn sell products or services to consumers using your brand and system.  Many new franchisors are caught of guard by the change in business model once they take the leap to franchising.  As a successful franchisor, you have to balance the growth of the brand and the overall health of the franchise system with the needs and wants of franchisees—sometimes your objectives and franchisees’ objectives are aligned, and sometimes they are not.  The franchisors that survive and continue to expand are those that understand how to run a franchise system.

You will find a lot of guidance on running a franchise system as a franchisor on this blog and elsewhere on the Internet, as well as through industry associations, including the American Bar Association’s Forum on Franchising and the International Franchise Association.  We would also recommend that startup and emerging franchisors read a new book, Franchise Management For Dummies, co-authored by Michael H. Seid and Joyce Mazero.  Although the book focuses on both franchisors and franchisees, it discusses creating marketing plans and branding and the secrets to continued success and future expansion.

The co-authors answered some questions regarding Franchise Management For Dummies in a Q&A published in Franchising World, a publication of the International Franchise Association.  Mr. Seid made a key observation for any entrepreneur looking to franchise his or her business:

Most important for prospective franchisors is to understand that there are consultants and lawyers that we call franchise packagers. They offer cookie-cutter services — and that is a serious problem. Pick your advisors carefully and talk to their clients to understand their reputations.

Q&A with the Authors of Franchise Management For Dummies, June 05, 2017, Robert Cresanti, International Franchise Association.

In a previous blog post, I talked about picking between a franchise law firm and a consultant.  As noted in Franchise Management For Dummies and on this blog, the franchise relationship between a franchisor and a franchisee is both a business and a legal relationship.  Franchising is governed by complex state and federal laws regarding the offering and selling of franchises and the ongoing relationship with franchisees, including renewal and termination.  Franchise law firms such as Larkin Hoffman are subject to ethical rules which require us to advice clients based on their best interests.  Consultants, while they may be engaging in the unauthorized practice of law, are not subject to these same ethical rules.  The Larkin Hoffman Franchise Team will not recommend franchising a business if we feel that franchising is not the best growth strategy or that the business is not ripe for franchising.

Mr. Seid continues in his Q&A noting that even among franchise law firms, not all franchise law firms are created equal.  Franchising is a niche area of law.  When choosing a franchise law firm, review the credentials and experience of the franchise lawyers and do your research on the reputation and work product of the law firm.  You may want to talk to current clients of the law firm on their experience working with that law firm.

Picking the right partner in structuring your franchise system at the onset is important to ensure your franchise system starts on the right path.  Remember, you will be signing 5 to 20 year franchise agreements with franchisees, so the terms you set in the beginning will govern the franchise relationship between you and your franchisees for the duration of the franchise term.  Choose wisely.