Franchising Under Attack Part 1

According to the International Franchise Association (IFA) nearly 4 percent of all small businesses in the U.S. are franchises; Government might not understand the true impact

It is estimated that there are more than 900,000 franchise businesses across 300 business categories in the U.S. which provide nearly 18 million jobs and generate more than $2.1 trillion to the economy. Franchising is a huge industry, yet, quite often, policymakers don’t understand the fundamentals of franchising enough to be mindful of its impact and the impact of their ideas.

1851 interviewed its 2017 Franchise Legal Players, those charged with protecting the industry from a legal standpoint, about why they believe franchising is under attack:

Lane Fisher, Fisher Zucker: As long as people exploit the franchise model to organize large brands, the landscape will be under attack from politicians and regulatory bodies, driven by constituencies like labor unions or taxing authorities and plaintiff’s lawyers.

We are delighted at the present administration’s efforts to pull back on expanding the joint employment concept, such as by withdrawing the Obama era Department of Labor guidance on the topic, but the issue isn’t going to go away. The genie is out of the bottle so to speak and I expect to see joint employment style claims continue to be made at the state level and by plaintiff’s attorneys looking for perceived deep pockets.

Moreover, upcoming changes issued by the North American Securities Administrators Association (NASAA) and the Financial Accounting Standards Board (FASB) will impact how new and emerging franchisors in the U.S. structure and present their franchise offer.

First, NASAA has proposed a number of troubling restrictions that limit emerging franchisors’ ability to present relevant financial data to prospective franchisees. Among these changes is a prohibition on franchisors from presenting financial performance representations based on a subset of locations if they have fewer than ten operational locations, even if there is a reasonable and objective basis for doing so. This change penalizes new and emerging franchisors, who may have a very good reason for presenting a subset of data but will be prohibited from doing so due to the fact that they do not have the required ten operational locations.

Additionally, FASB has issued new standards concerning the recognition of initial franchise fees which will go into effect in 2018 for public companies and 2019 for private companies and will alter the way in which franchisors can recognize initial franchise fees in their audited financial statements. Under the proposal, auditors will require franchisors to recognize initial fees over the course of the initial term of the franchise agreement, as opposed to recognizing the full fee at the time of opening.

The consequence of the FASB change for emerging franchisors will be financial statements showing lower assets and greater liabilities, resulting in a lower net worth. Franchisors that show a negative net worth in their audited financials are likely to be subject to an impound condition in certain franchise registration states, requiring the emerging franchisor to defer payment of initial fees, establish an escrow account or obtain a surety bond as a condition of registration. This also has the potential to scare off potential franchisees concerned, perhaps wrongly, that the franchisor’s financial standing is on shaky ground.

Franchising has survived many challenges and will no doubt overcome these challenges as well. Our roles as attorneys is to assist our clients in meeting and getting ahead of the challenges so that they can grow and contribute to the economic well-being of the country and their communities as they have done for many years.

Andy Beilfuss, Quarles & Brady: I'm not sure that I would say that franchising has been attacked in the recent past. I think that some of the challenges that we are seeing (e.g. joint employer) are the result of a fundamental misunderstanding of franchising, or -- at minimum -- a misunderstanding of the full impact that certain regulations would have on the industry. I believe that this business model is such a huge part of both the U.S. and global economies that the issues currently present will be solved and the industry will continue to thrive.

Alexander Tuneski, DLA Piper: While there has certainly been more pressure placed on the franchise model in recent years from a variety of factors, I am confident that the franchise model will emerge relatively unscathed. Ultimately, the franchise model is a win-win-win-win for franchisors, franchisees, employees and consumers. It is an economic engine that makes a significant contribution to the U.S. and global economy. When the issues are depoliticized, which they can be, the protection of the franchise model becomes a no-brainer. The challenge is to continue to educate lawmakers and regulators about the franchise model and its contributions, making clear that the model helps small businesses in local communities achieve success. That’s a goal that everyone supports.

Andrew Bleiman, Marks & Klein: I believe in the entrepreneurial spirit of franchising and believe that franchisees, franchisors, vendors and suppliers with figure out a path forward and franchising will be better for it.

Philip Zeidman, DLA Piper: It’s heated up, and it’s coming from a number of different quarters -- but there have always been “Existential Crises.” If we don’t mess it up, the fundamental beneficial characteristics of franchising will lead it not only to survive, but to thrive.