Franchise disclosure obligations and registration can carry significant costs of compliance and can be an administrative burden. Initially drafting a compliant Franchise Disclosure Document (“FDD”) is a time-intensive process. Then the franchisor must update the FDD annually for as long as it wishes to sell franchises. State registration of the franchisor and review of the FDD can further delay franchise sales. Additionally, an FDD contains confidential information that the franchisor may not wish to make public, especially if the business is a particularly sensitive to competition. Franchise laws restrict otherwise legal sales practices, such as making financial performance representations outside of Item 19, which can be another frustration for franchisors.
Exemptions to the franchise disclosure and registration laws provide both seasoned and start up franchisors the opportunity to reduce these burdens and costs by either (1) avoiding registration in a state or (2) avoiding drafting an FDD at all.
In this blog post series, we summarize the exemptions available under the Federal Trade Commission Franchise Rule (“Rule”), which allow a franchisor to sell a franchise without an FDD. Any analysis of what exemptions apply to your brand is incomplete if you do not also consider the application of state law. States may not recognize the federal exemptions and may offer different exemptions to their registration requirements.
The Rule contains eight exemptions, and the focus of this post is the Large Franchisee Exemption. The FTC created this exemption for sophisticated prospective franchisees who do not benefit from the disclosures in an FDD to the degree that unsophisticated franchisees do.
These sophisticated franchisees have business experience and significant net worth, which increases the likelihood that they will not be dependent on the success of the new franchise and will be able to negotiate protections to their interests. Franchisees who commonly qualify for this exemption are hospitals, universities, or airports.
Large Franchisee Exemption
To qualify for the exemption, the prospective franchisee must (1) have been in business for at least five years and (2) have a net worth of at least $6,165,500.
1. Business Experience
Unlike other Rule exemptions, the qualifying business experience of the large franchisee does not need to be in franchising or related to the industry of the franchisor. The prospective franchisee simply must have been in business for at least five years. Additionally, the business experience of the prospective franchisee’s parent, subsidiaries, and affiliates can also be considered. This is helpful because sophisticated businesses often create a subsidiary or affiliate to handle a specific transaction. For example, the new subsidiary of a hospital corporation that was created to own a restaurant franchise would have sufficient business experience to qualify for the exemption.
2. Net Worth
The qualifying large franchisee must have a net worth of at least $6,165,500. This amount is adjusted for inflation by the FTC every four years. The franchisor can determine net worth by examining the entity’s balance sheet or other financial information. The net worth of the prospective franchisee’s parent and affiliates can also be considered by aggregating commonly owned franchisee assets.
If the ideal franchisee for your system is a sophisticated business like an airport, hospital, or university, please reach out to Manning Fulton attorneys to understand the applicability of the Large Franchisee Exemption to your brand.