November 2014 Archives

Earlier this year, the California Department of Business Oversight (DBO) launched a new electronic filing portal that franchisors and other companies can use to file franchise, securities, and other business documents for California.

Having personally used it for a number of franchise-related filings, I can tell you that the portal was difficult to use and full of flaws. In fact, because of problems with uploading documents and managing filings for my franchisor clients, in some instances I was forced to send paper copies of documents to the DBO -- even though I had already e-filed them through the portal.

The good news is that the DBO has been listening to our complaints and making changes to the portal -- just in time for franchise renewal season.

The latest update now makes it possible for a single law firm to register and file documents for multiple franchise companies.

This is a vast improvement from the prior version, which required outside franchise counsel (like me) to register a different account for each franchisor I represent. Now, a franchise attorney will be able to manage multiple California franchise registrations through one account.

Here is the text of the DBO's press release (dated November 14, 2014) on the latest updates to DOCQNET:

DBO Self-Service Portal Users:

Based on feedback the Department of Business Oversight (DBO) received from DBO self-service portal users like you, the DBO will modify the portal to make the Franchise or Securities notice filing process more convenient and user-friendly. 

Beginning on Monday, November 17, 2014 firms that file multiple franchise or securities notices, such as the Limited Offering Exemption Filing under Corporations Code Section 25102(f), will have the option to submit multiple filings under a single registered account.  The notice filing history and payment history for 25102(f) filings will be available to you in the online portal.  

However, please note that the notice filing history and payment history for any other notice filing is not available.

When you register (sign up) on the portal, you'll be given the option to select from one of two registration links:

1) To register as a Financial Services Licensee, as a securities issuer or franchisor filing on your own behalf, or a firm submitting Franchise registration applications or securities permit applications, you will go through the same registration process that exists currently, where both contact information and information about the Issuer/Licensee are required for registration.

2) To register a law firm seeking to file franchise and securities notices for multiple issuers, you will be asked to provide only your law firm's information and desired username.  You will provide Issuer information with each individual filing.

More information on which registration form is appropriate for your user needs can be found on the self-service portal.  You can also contact [email protected] with any questions. 

If you have previously registered and filed multiple times (and therefore have multiple accounts), the Department will be combining your previous filings under a single account.  We will send you a follow up email by Monday, November 17 with the username of the account that has been retained.  If you choose not to continue to use that username, you can still create a new single user account to submit all future filings.

Other features and changes include:

•  The filing summary preview page for 25102(f) notices will now have a button to select a printer-friendly version of the page
•  Issuer Representative information will be auto-populated using the information you provided at the time of registration

We hope these changes further improve your experience using the DBO self-service portal.  For more information, please visit the Frequently Asked Questions page.

If you want to make a legal franchise sale, you must follow certain basic franchise sales steps.

Those steps are shown in the picture below.

We will move through each step, noting the potential compliance pitfall.

1. You must have a current Franchise Disclosure Document (FDD). It must be in the format specified under the FTC franchise rule and state laws.

a. The FDD may be paper or electronic.

In either case, it must be a "single document." In other words, for example, the franchise agreement and the franchisor's financials must be integrated into the FDD, and may not be free-standing.

If the FDD is electronic, it may contain scroll bars, search features, internal links and limited external links, but it must not contain multi-media features such as audio, video, animation, pop-up screens or other external links.

b. The FDD must be current.

This generally means that it must have been updated within 120 days after the franchisor's most recent fiscal year end, and, in addition, must have been updated promptly after the occurrence of any "material change" (anything such as a lawsuit, bankruptcy, fee increase, cost increase, financial reversal, or other change that might be significant to a prospect).

For example, if the franchisor has a fiscal year ending December 31, the FDD must be updated no later than April 30 (120 days after December 31). If it is not, you must not offer or sell the franchise.

You should check with the franchisor's lawyer or compliance manager before using any FDD that might be outdated because there are exceptions that may apply. For example, you can use an FDD that has not been updated after a "material change" has occurred when only the more lenient updating requirements in the FTC franchise rule apply.

Even if you are permitted to use the previous FDD, you may be required to re-disclose the prospect with the updated FDD before you sell a franchise.

Always check with the franchisor's lawyer or compliance manager before proceeding in this type of situation, giving an outdated FDD and then re-disclosing with the correctly updated FDD.

(This was the first post in a series of 11 posts on making compliant franchise sales.)

If you would like to know if you can franchise your business, connect with me on LinkedIn and give me a call.

If you would like all these tips in a bound book, for a handy desk reference, sign up for the Franchise Seller's Handbook.

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A very long time ago (about 15 years) I wrote about why new franchisors fail.

During that 15 year period we lawyers have "improved" upon the legal infrastructure of the franchisor quite substantially.

As you may know, the franchise legal infrastructure, a/k/a franchise agreements and FDDs, have moved significantly along the road to elimination of all legal risks for franchisors, except maybe for the more hard core thugs.

If you are not and do not intend to become a hard core thug, you might just want to read all of this.

There is still a lot of room for sound concepts to be developed into investment worthy business replication models. And the fact that in doing that your legal infrastructure has morphed into much better protection should be a positive influence for you.

After all, isn't risk reduction what this is all about after you demonstrate to yourself that you have a profitable model and that you can translate that into a profitable business for others even after loading onto it the costs of being in a franchise relationship?

The Current Franchise Landscape

Even in the old days there were dodgy franchisors:

• They sold tons of franchises and opened very few.
• They made profit representations that were total fiction and impossible to achieve.
• They said things about where the business was positioned and about the quality of the support they provided that were outright falsehoods.

In the 1960s some states began enacting franchise disclosure and relationship laws modeled somewhat upon the laws regulating securities selling.

But there were also a lot of really good, serious opportunity franchisors, and a reasonably careful person with some professional help could buy into such things as KFC, McDonalds, Little Caesars Pizza, Pizza Hut, Wendy's and Burger King, among others.

Today there are many more dodgy deals being put out for investment to less able investors.

The techniques for getting around the law one way or another have become more sophisticated. Analysis of potential franchise investments is more complicated. Most lawyers shrink from giving any business advice or analysis for fear of professional liability lawsuits. Asked about an opinion whether a particular franchise is a good investment, the lawyers say that it might be if they are telling you the truth, and stop there - utterly useless.

Franchise blog sites abound on the Internet, chock a block with broke and whining franchisees on their way to bankruptcy and unable to afford legal representation. Class action lawsuits against tough franchisors take years and are rarely certified by the courts. When they are, they drone on for a few years and settle out for paying the lawyers, with the franchisee class members getting little or nothing.

Where Does That Leave You?

If you really have long term intentions regarding the health and survivability of your franchisees, it helps to build a dynamic financial model of what the business is that your franchisees have to live in.

(None of the bozos do this. They don't really care anyway. All they want is as much fast revenue as they can squeeze out of the system)

For the serious long term franchisor, departure from the IFA norm can really help you measure the health of your system.

But you have to make the franchisees send in the tax returns their agreements require anyway, and from those, you can build the dynamic financial model, making the adjustments to derive an approximate EBITDA. It is not the impossible project that the IFA says it is. 

The reason it isn't thought to be a smart move is that then you would eventually find out which franchise system in any business segment is the most profitable, and once that got out no one would ever buy any of the others in that segment. Nobody wants to be known as tail end Charlie on producing positive cash flow.

The IFA also fears that such activity will one day lead to compulsory financial performance disclosure, which is a distinct possibility only if the IFA lobbying arm, Franpac, runs out of money.

So it is a bit of a dilemma. You really cannot count on the information not getting out. On the other hand, since the franchisees will soon be doing this for themselves, there is little justification for you to deprive yourself of the information. Dynamic financial modeling will enable you to see what the traffic can bear and continue to have positive, meaningful yield potential for your franchisees.

If your franchisees start a lawsuit or arbitration proceeding using dynamic financial modeling to show that you are tearing the financial heart out of the business they invested in, you would have to build your own model to dispute theirs, and yours might have to be rather contrived and convoluted in its attempt to show that theirs is not reliable.

Econometric modeling of markets has been used for decades in antitrust litigation, to positive effect. The government lost its first merger case under Section 7 of the Clayton Act because the target defendant used competent econometric modeling. The same thing soon after that happened when the FTC lost the breakfast cereal oligopoly case. I know because I brought econometric modeling into both those cases.

Financial Models for Franchise Systems

Financial modelling of franchise systems is not more complicated than that.

The universal solvent would be a cooperative project that produces a really high value dynamic financial model. That, as we say in Texas, ain't gonna happen.

Franchisors that operate numerous company stores, if they are going to consider this, should have a separate financial model for the company stores. While it may lack positive sales information potential, the ability to compare company owned versus franchisee owned financial results probably would yield marketing information. It would show what we have always believed to be true, that absent artificially imposed barriers to positive cash flow, franchisees really do better than the company does in producing cash flow.

But the really important value of dynamic financial modeling would be that it would tell you when you are approaching marginalization of the franchisees through add on extraneous periodic charges. If you went just one step further, you would also know your franchisees' debt structure profile and would be able to determine what they can afford in terms of remodeling the stores and even to prearrange the financing of large projects before you impose them.

Lenders pay commissions to those who bring them large deals like that.

In this interim before everyone is doing it, you can designate all information regarding financial modeling to be a highly secret body of information and treat it as such. If you designate it secret but everyone in the company has access to it, you are just kidding yourself. If more than five people have access to it you can forget confidentiality. The grunts who churn the basic data can be controlled if you don't fire them every now and again.

Attitude Issues

No franchisor is ever going to be loved by her franchisees. That is axiomatic. Within a year or two of becoming anyone's franchisee, the attitude becomes one of disbelief that there is anything special or unusual in being your franchisee.

They believe your support sucks and that they are getting little or no value from being affiliated with you. How virulent this attitude is will be the only variable. If you don't have a competent information management protocol in place your franchisees will rob you blind. There are just as many cheating franchisees as there ever were dodgy franchisors.

Back in the days when franchisees filled out monthly paper sales reports, the audit of their actual performance was their biggest fear. Of the literally hundreds of depositions I took in cases having to do with under reporting terminations, not one franchisee was ever under reporting unintentionally.

Some of the stories of whining franchisees and what they were charging to the business would make your eyes roll back. One franchisee in Florida was writing off a twin engine airplane against the revenue of a print shop with a three mile territory. His lawyer went ape when that part of the examination happened. Lawyers rarely make the effort to understand the finances of their clients before the horse leaves the barn, and clients never tell you where the bad stuff is hidden. If you don't find it yourself, you can usually bet that your opponent will.

Since you will never be loved in franchising, your contentment will come in providing a working positive cash flow franchise model from which you will become wealthy. If you need more than that, well, be prepared for large legal bills.

The Ultimate Franchise Solution

The ultimate franchise solution for anyone wanting to begin or expand a franchise system is to provide a concept that you have field tested and proven to be revenue credible in a franchise mode, and then to continue to measure its financial performance through dynamic modeling. To be sure, you will also have to improve its appeal to its customer base, but that is what you tell your franchisee prospects that you do best. It helps is that is true.

(I am publishing another article about the risks of becoming a franchisee. If you read that you might be offended. Franchisees who see that I drive both sides of the franchise road often criticize me for that, and some franchisors wouldn't touch me with a stick because I represent franchisees too from time to time. I never worry about that, but be aware that I see this business from both sides all the time, every year, year after year. My feelings about franchising are really love - hate, but that is because I wish I could make it better and that people could more safely invest in franchise opportunities.)

As always, you can call me, Richard Solomon,  at 281-584-0519.

The famous negotiator William Ury has a nice story about how to solve difficult negotiations.

"Well, the subject of difficult negotiation reminds me of one of my favorite stories from the Middle East, of a man who left to his three sons 17 camels. To the first son, he left half the camels.

To the second son, he left a third of the camels, and to the youngest son, he left a ninth of the camels.

Well three sons got into a negotiation. Seventeen doesn't divide by two. It doesn't divide by three. It doesn't divide by nine. Brotherly tempers started to get strained.

Finally, in desperation, they went and they consulted a wise old woman.

The wise old woman thought about their problem for a long time, and finally she came back and said, "Well, I don't know if I can help you, but at least, if you want, you can have my camel.

So then they had 18 camels. The first son took his half -- half of 18 is nine. The second son took his third -- a third of 18 is six. The youngest son took his ninth -- a ninth of 18 is two. You get 17.

They had one camel left over. They gave it back to the wise old woman."

I love this story, but one thing just bothered me.

If the wise old woman is the paragon of wise mediation, how come she makes nothing off of solving this difficult negotiation?

She gives a camel, solves a hard problem and gets nothing back for solving the impossible. That doesn't seem like a great business model.

Although her reputation as a problem solver grew, she still couldn't make any money solving the variants of the problem: dividing candy at Valentine's, dividing tracts of land, corporate votes, etc. Although, she did get a lot of speaking gigs - which helped.

She tried everything. But, she couldn't make the solution scale. Two groups of 17 still returned no profit.

The wise old woman was getting frustrated. She declared that "it was impossible" to make a profit solving this type of fair division problem.

Her grand-daughter, however, saw through the riddle.

She was a camel broker, matching buyers with sellers of camels.

She immediately began the 18 Lot Camel market, selling lots of camels of 18, but at near cost.

Bewildered, the wise old woman wondered how the both of them were going to survive making next to nothing on each transaction. How was volume going to help?

The next group of claimants who needed the wise woman's assistance had 35 camels and not 17. And her daughter was excited. Why?

Well, the wise old woman did her negotiating trick again. She added her one camel to get 36, gave 18 or 1/2 to the first claimant, 12 or 1/3 to the second claimant, and 4 or 1/9 to the last claimant.

Lo and behold there were 2 camels left, which the wise woman took as her fee.

She made a one camel profit - all because her daughter created a competitive market for 18 lot camels! Even though groups of 17 or 18 claimants were not profitable for the wise women, putting both groups together to form a bigger group with 35 camels was.

Sometimes, 0 + 0 = 1.

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1. Who is a Franchise Seller?

If you are an officer, employee, representative or broker involved in the offer or sale of franchises, you are a "franchise seller."

Your involvement in the offer or sale of franchises may be obvious, such as if you are a salesperson actively pursuing franchisee prospects for a franchisor, are signing agreements with new franchisees, or are accepting payments from new franchisees.

Or, your involvement may be less obvious, such as if you are participating as a finder or consultant in discussions with prospects about their business interests, pre-screening prospects through questionnaires, recommending franchise options, or assisting prospects in completing franchise application forms.

In either case, you are involved in the offer and sale of franchises, making you a franchise seller - who has to comply with a number of regulations.

2. What are Your Obligations as a Franchise Seller?

As a franchise seller, you must comply with the FTC franchise rule and numerous state laws that regulate the offer and sale of franchises.

The FTC franchise rule requires a franchisor to prepare a Franchise Disclosure Document, known as an FDD; to keep the FDD updated as "material changes" occur, new audited financials are issued and new fiscal years phase in; to follow and have its franchise sellers follow basic franchise sales steps in dealings with prospects; and to modify the basic franchise sales steps in certain special situations.

In addition, the FTC franchise rule permits and prohibits specific activities during the franchise sales process. The FTC franchise rule does not require a franchisor's FDD to be filed with the FTC, but it does permit the FTC to investigate and punish franchisors and franchise sellers believed to have violated the rule.

3. What are the Penalties for Non Compliance?

If you do not meet your obligations under the FTC franchise rule and state franchise disclosure laws ("state laws"), you and the franchisor you represent could suffer significant penalties.

The most frequent penalty is a claim or lawsuit by a franchisee which is costly to defend, and which results in a settlement or judgment requiring the franchisor to rescind or void the franchise agreement, refund the franchisee's payments, or reimburse the franchisee's damages, attorney's fees and costs.

This penalty can be financially debilitating or devastating.

Another common penalty is the loss of your job or relationship with a franchisor.

The states often seek penalties, including orders which must be disclosed to prospects for 10 years or longer, monetary payments to franchisees or the states, or restrictions on your future business activities.

In some instances, a penalty may be an FTC investigation that results in an order which you must disclose to future prospects, a freeze of your assets, civil penalties of up to $10,000 per violation, payments to franchisees, or an injunction.

In rare instances, a penalty may be a state criminal prosecution against you.

Hopefully, your desire to make legal franchise sales and this array of possible penalties will motivate you to make a serious effort to meet your legal obligations during the franchise sales process.

4. How to Effectively Comply.

Education which leads to permanent changes in business methods is the best way to effectively comply with the franchise sales laws.

To facilitate this process, we, at Akerman, have identified 11 distinct steps of franchise sales compliance which need to be understood.

Here are the 11 steps.

Step 1: Have a Current FDD

Step 2: State Registration or Notice

Step 3: Notice of FDD Formats Available

Step 4: Notice of "Franchise Sellers" Involved

Step 5: Disclosure Whenever Requested By Prospect

Step 6: Minimum Disclosure Timing

Step 7: Receipts

Step 8: Providing Final Agreements to Prospect

Step 9: Re-Disclosure If "Material Change" Occurs

Step 10: Execution of Agreements

Step 11: Post-Sale Obligations

If you would like all these tips in a bound book, for a handy desk reference, click here for the Franchise Seller's Handbook.

Many years ago I was pulled away from my usual assignments to do a major product production tolling agreement between two of America's larger food companies.

It was a stroke of luck for me because it provided something new for my interest in multivariate risks management. Since then I have prepared many multivariate high risk agreements, and it is always an enjoyable as well as remunerative adventure.

When you think of every brand as a franchise in itself, it fits perfectly into my customary practice of managing franchise relationship disconnect issues.

Recently, I have been able to mix some of my more basic interests, consuming olive oil, with my interest in being able to negotiate and prepare the enabling agreements that bring together great marketing companies in America. More specifically, working with the best producers of great Extra Virgin Olive Oil and managing risks inherent in horticulture to delivery.

This is a wonderful exercise in multivariate risk management.

Olive Oil - Fraud and Standards

The notoriety of product purity fraud in the extra virgin olive oil business has stimulated my interest intensely. I love good olive oil to a degree that borders upon religion, I think that I probably consume good olive oil at the level of a Greek.

I am now eating the world's most incredible and unquestionably pure olive oil, and every meal is almost a religious ritual.

Olive oil is something with soul. You consume it with such incredible gratitude. I long ago gave up on European wines, with occasional ventures back there only when the auguries compel it.

California and the American Pacific Northwest is to me the world's most fantastic wine producing area, but has yet to arrive when it comes to top quality and taste olive oil.

Inasmuch as good wine also enjoys the presumptuousness of highly specific imprimatur, especially in France and, to a somewhat similar degree elsewhere in Europe, one might well expect that the snooty who insist upon their nomenclature prerogatives would, when put to it, lie cheat and steal to keep the black ink flowing on their financial statements.

Tom Mueller's book and blog, Extra Virginity, depicts the degree of hardship that olive oil producers are facing in the current economic difficulties and the "blending" that has become rampant to enable what is labeled Extra Virgin Olive Oil, "EVOO", to be sold profitability.

What is blended into it is often not even olive oil.

What most Americans buy as EVOO isn't, to make a long story short.

Whole Foods Market and Standards

However, there is some hope.

I was browsing in a new Whole Foods Market in Houston last Sunday, sitting at their new wine bar placed next to the olive oil shelves.

A rather nice looking woman was looking rather lost as she tried to determine which bottle of olive oil to select.

I walked the few steps over to her and pointed to the Lapas olive oil. She asked why I suggested that and I explained to her that it was from a reliable producer and told her that it was a house brand for Whole Foods Company, one of the very few trustworthy house brands in the world olive oil trade and completely organic.

She smiled and took the Lapas bottle as her selection.

Risk Management of Sole Source Producers

Whole Foods Company had to have carefully researched this project. Contracting for a single source agricultural product in a distant and troubled economy is high risk to say the least.

I know what terms the agreement has to include, but I wondered how each of the contract risks in the Whole Foods - Blauel Group agreement was dealt with.

Fritz Blauel is an Austrian who went to Greece in the 1970s and became interested in olive oil production and cultivation in the Peloponnesus and Kalamata in particular.

The Greeks of that area were still using rather ancient methods, and he sought to influence the producers of the area in totally organic methods.

To make a long story short, he succeeded, and Whole Foods Company's house brand of really top grade olive oil (not their 360 brand), Lapas, comes entirely from Blauel's operation. He produces about 650 tons of organic top grade olive oil each year within his group of farmers, and it may be found also under the brands Mani Organic and Kalamata Gold.

The Challenge and Rewards of Risk Management

What does one think of when contemplating the establishment of such a relationship, beyond the market research and the position of the brand as a "fit" within one's business?

For the lawyer crafting the seminal protocol it is a wonderful challenge. It requires input from several specialists who will probably be found within the client company or be on retainer for the client company.

In the matter of food and agricultural products, those would include not just the market research folks but also the agronomists, food chemists, manufacturing technique specialists, those in transportation and delivery as well as the financial staff.

The issues, especially in the instance of purchasing foreign agricultural output from a single producer or single group of producers include the management of numerous risks.

When you have accounted for absolutely everything you and the group can think of you have to start playing "what if..." games. The what if games should continue throughout the process of building the relationship and the agreement, right up to the moment of signatures.

Even then you can be assured that there are contingencies you missed. When that jumps up and stares you in the face you have to rely for relief upon the credibility and trust you were able to build up during the relationship right up to the moment when the event arises, and your approach to dealing with it must be obviously fair for it to be successful.

By way of illustration, a client lost total supply from a sole source vendor for a whole product line because someone served a subpoena on the vendor without handling the diplomacy properly.

The vendor was in Iceland and it required a several day long "social event" with its Vikingesque CEO just to get talks started on the real problem. It took a few weeks to recover from the "social event". You simply cannot think of everything.

Particularly in the instance of olive oil being produced at an exceptionally high level of quality within one of the most troubled economies on the planet where no one feels secure, just the notion that minute controls can be expressed in a single writing seems farfetched.

The cultural and economic divides standing alone would be insurmountable without bringing into acute focus many talents and skills in common easy to read and effective ways.

The resulting economic engine microcosmically and with mutual compassion and grace generates profitable product integrity without sacrificing the art or the nuances of timeless beauty encapsulated within a sacred tree fruit. We are speaking of olive oil, sacred, healthful and delicious.

Commercial lawyers rarely get to work on a symphony of nuances that embrace a fundamental expression of an entire culture. Smoothing the contrapuntal rhythms into a composed useful protocol calls upon artistry of expression as it seems to seek a trivializing of the ephemeral, a capturing of spirituality.

This is an example of the grace notes of law practice. It comes to very few.

What must be produced is a reliable encapsulation of many inherently indefinite forces that are answerable in the normal course to the uncertainties of agricultural crops and worked on by farmers and associated trades as well as social and political upheaval.
At many points along the lines potential leakage can occur if care and sensitivity are not brought to bear. Investing in great things is not to be approached without the willingness to support a work of very fine art as well as a mundane agricultural food product.

Doing that with an eye upon effective economics is rather breathtaking. If you are already in this business as you read this you understand the nuances and risks.

I really enjoy this kind of work because I find myself working with extremely competent committed people who take an almost worshipful approach to the products.

Whenever I get such an assignment it is a call to celebration and wall to wall happy in addition to remunerative. Professional life doesn't get much better than that.

As always, you can call me, RIchard Solomon,  at 281-584-0519.