Californians need jobs. Franchising has historically provided those jobs in the hotel, restaurant and service industry. Without a change which rewards franchisees as owners, risk capital will not be attracted to California. California will lose out on job creation, and its budget woes will be worsened if the Level Playing Field for Small Business Act of 2012 is not passed, Bill AB 2305.
California, the spiritual home of franchising
California and San Bernadino are the spiritual home of franchising. In the late 50's, the McDonald brother's restaurant routinely recreated the secular miracle of feeding the hungry with a nutritious and delicious 15 cent Hamburger Meal -burger, fries and a milk-shake.
But, it took the owner of a franchised business, franchisee Ray Kroc from Chicago, to export California's golden miracle. Ray Kroc formalized the McDonald's brother's system. Ray Kroc created the scalable restaurant system - as a franchisee.
Before he bought out the McDonald's brothers, Ray was a master franchisee, a company that was granted a master license. Ray was a supply chain genius, and had an operator's understanding of what made a restaurant profitable. He was constantly challenging the supply system to scale and grow the franchise system.
In the 1950's, Ray broke every rule in his license or franchise agreement, and ended up paying a penalty of some $5 million to the McDonald brothers. He was brilliant, ungovernable, yet made many of his operators millionaires — enriching the middle class and contributing to many state's coffers.
Ray could attract a variety of operators in the 1950's and 1960's because he could legitimately offer them the prospect of real wealth.
Passing Bill 2305 will stimulate job growth
The current franchise legal model allows the franchisor to exercise so much control over the franchisee as to be an employer. This legal model creates employees where there should be owners. This is the fairness issue is being addressed by Bill AB 2305: the problem of too much control and not enough sharing. Such a model does not attract risk capital.
Today many franchisees are nothing more than employees who pay good cash money to obtain jobs. No serious minded entrepreneur is attracted to this business model. The growth of franchising is largely fueled by those who are seeking to buy a job.
Without AB 2305 being passed, franchising will stagnant because it will not and cannot attract the Ray Kroc's as franchisees - the operators with boots on the ground who have the experience and capital to implement systems that scale and deliver value to the consumer.
It is not merely a matter of downloading these payments to the franchisee/employees. It is a matter of making the franchisee nothing more than an employee who pays for the right to work.
The California example, United Parcel Service franchises
The widely and rightly praised United Parcel Service Company (UPS) has used the current franchise legal model in this manner.
Prior to acquiring the franchising firm Mailboxes Etc. in San Diego, Atlanta-based UPS had a series of depots and unmanned drop-off boxes to process returns. UPS makes money when more packages are shipped, and their business model is to increase this volume. Some packages must be returned from where they were shipped to: the part is defective, the address is wrong, or the customer has lost interest in the product.
United Parcel Service would need to recruit employees to man and manage the returns and could have done so by expanding their depots. They did not hire more employees. Instead, they acquired an existing franchise system, Mailboxes Etc. out of bankruptcy. They changed the franchise agreement, giving the franchisor more control. They put their signage in front and the public now believes that they are dealing with UPS employees.
UPS achieved their business goals: they effectively turned these franchisees into employees who will not be a payroll expense to the franchising firm. All of this is currently legal —as many court filings in California's courts show. It was also a very shrewd business decision.
But it is time to end this overreaching and return balance and fairness to franchising.
Franchisors avoid taxes due to California
Now, you will hear from franchisors about how important franchising is as an industry. But what you will not hear from the franchisor corporatist apologists is this secret: the current franchise legal model is detrimental to California's public interest.
The current legal model allows the franchisor, which is the company who grants a franchise license to a local business, to escape or evade paying state taxes compared to other firms trading in California.
This is how it is done. A franchisor incorporates a company in Delaware and that company owns the franchisor's trademarks and other intellectual property. Delaware does not tax royalty payments made to the holders of intellectual property. A franchisor funnels the royalty payments made by its California franchisees to Delaware - minimizing or sometimes eliminating the correct amount to remit to California for income tax.
This tax issue is not addressed by Bill AB 2305. But, you need to be aware of it when the franchisor apologist urges upon you the value of the great economic engine of franchising. Such industry does exist - what benefit is it to California if the surplus is untaxed and moved out of state?
Proper risk and reward between franchisor and franchisee will create wealth
California, in particular Silicon Valley, creates great immediate weatlh. For that wealth to become capital, it makes sense to woo those individuals into investing into a restaurant, hotel or service franchise — creating permanent jobs in the restaurant, hotel and service industries in California.
But the current franchise legal model is not hospitable to risk capital. Proper balance between control and reward must be restored.
Bill AB 2305 is aimed at correcting or restoring this imbalance. By returning the franchise legal model model to the correct balance, where the franchisor creates and mantains brand standards, while the franchisee executes those standards and everyone shares in the surplus value as owners, Bill AB 2305 creates a hospitable environment for operator and supply chain geniuses like Ray Kroc.
Jobs and growth will follow.
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