What is the Role of a Franchise Attorney When Buying a Franchise?

Transcription:

Leslie Kuban:
Great to see you in the studio.

Mike Rosenthal:
Thank you for having me.

Leslie Kuban:
Thanks for coming, Mike.

Mike Rosenthal:
I appreciate the opportunity.

Leslie Kuban:
So you’ve been in an attorney for a minute now.

Mike Rosenthal:
Doesn’t seem like that long, but yes.

Leslie Kuban:
So how did you decide on franchising as a practice area focus?

Mike Rosenthal:
Well, I’m going to answer that two ways. Partly, it decided on me. My first job experience as a lawyer was with the state attorney general’s office, and I was responsible for enforcing the state’s Business Opportunity Act, which was at the time a subset of franchising. And when I left the AG’s office and hung out a shingle, people started calling me and said, “Hey, you’re the guy that beat up on me about complying with the law. So you know what the law is, will you help me comply with the law instead of trouble.” And that kind of evolved over time into a more full-fledged franchise practice. So over the last 20-plus years, I’ve moved away from most everything else and just done franchise practice.

Leslie Kuban:
So you want to get in your own business too, just like franchisees and franchisors.

Mike Rosenthal:
In a way. And I will tell you that as I’ve gotten more and more involved in it, what I’ve come to love about it, besides helping entrepreneurs, which is great, the franchise law community is like a village. There just aren’t that many of us. And so I know a lot of the people all across the country and we treat each other really well. I never practiced law in a small town, but I kind of think it would be like this because you might see that person again soon, maybe at your children’s basketball game or at church on Sunday or whatever. You’re going to treat them differently, more respectfully and professionally. And I like that.

Leslie Kuban:
And it is surprising to people when they start investigating this and realize that they’re going to need some legal representation or legal help in this, that franchising is its own unique area of business law. And you serve in different roles with franchisees, with franchisors, perspective franchisees. Just say a bit more for our viewers about what your role is with these different parties.

Mike Rosenthal:
So, first of all, I think they really, doing both sides of the fence or playing both sides of the fence really helps me in representing either side. On the franchisee side, I help people initially by reviewing franchise disclosure documents and giving them feedback and information, kind of counseling, if necessary, through the buying process. And occasionally, deal with problems that come up that they may have and dealing with their franchisors. And that ranges from individuals who own one franchise unit to I’ve got a number of clients who own lots of franchise units in a particular system, or occasionally they might own three of franchise A and five of franchise B, that kind of thing.

Mike Rosenthal:
On the franchisor side, it’s really soup to nuts. So I love working with startup franchisors. So somebody’s got something and they want to see if they can franchise it. We’ll create the franchise disclosure documents, the contractual agreements that they need. Those have to be updated every year. So there’s a lot of work that needs to be done annually. In certain states, they’re required to file state registrations or notify state agencies that they’re selling franchises. So we help them do all of that. And we have systems set up for that. And then they just have a lot of ongoing needs that we work with. So like it or not, they have franchisees who may not comply with all the franchise system requirements. And we help the franchisors by sending out default notices, if necessary terminating those people from the system, but hopefully not, try to work with them.

Leslie Kuban:
So you’ve already mentioned something that is a new term to people as they are starting to investigate franchising, the FDD, the franchise disclosure document.

Mike Rosenthal:
Sorry to use acronyms.

Leslie Kuban:
But no, I wanted us to unpack that a bit. It’s a cornerstone of franchising that makes it unique from other forms of business opportunities. So please say what is it.

Mike Rosenthal:
Okay.

Leslie Kuban:
And why is it important?

Mike Rosenthal:
So what it is a very large document. It runs typically between 100 and several hundred pages long. It is something that is required by the Federal Trade Commission’s Franchise Rule. And the rule lays out all these different categories of information that franchisors have to give to prospective franchisees. The idea is you can make an informed decision if you have this information. It has to be updated every year. It also has to be updated if there’s a material change during the year. So let’s say you are going to buy a Wendy’s and you found out that Dave Thomas sold the company. That might be material to you because you like Dave and you wanted to be associated with him. So Wendy’s would have to update their FDD in order to reflect that right away.

Mike Rosenthal:
Also, attach to the FDD of all the contracts that the franchisor is using. So the franchise agreement. There are a lot of side or ancillary agreements, things like covenants not to compete, things that let the franchisor grab back your customer list, your internet listings, all those kinds of things that are dealt with contractually. So the idea is it’s all here and you can look at it and then talk with a professional, whether that’s a lawyer or an account.

Mike Rosenthal:
Why it’s important is it’s actually a great opportunity to learn more about that franchisor. And it’s a really good starting point for people, I think. And I’ll add this. I get contacted all the time by people who want me to review it and give them comments on it, which I’m happy to do. And I always say to them, “So from your reading of it, do you have questions?” And frequently they say, “Well, I’m not going to read it. It’s too long.” Right? And my response is, “Grab a pot of coffee or tea or whatever stimulant you need to stay awake and sit down on Saturday or Sunday morning and read this thing because it’s going to govern the relationship that you have with the franchisor. And you need to know what you’re getting into. If you don’t read it and I’m the only one that reads it, you’re relying on my judgment alone. And I’m looking at it from a legal perspective, not necessarily always from a practical perspective.”

Leslie Kuban:
And having been corporate counsel for many brands, you’ve written many franchise disclosure documents and you reviewed many, many for prospective franchisees. So you’ve seen a lot of brands and their disclosure documents.

Mike Rosenthal:
Hundreds, I would say.

Leslie Kuban:
Hundreds. And you and I have talked about this, that they’re not all equal. So they’re not just cookie cutter from one, they follow a similar format, but there can be big differences in the quality of how these documents are written. I hope this is a fair question, are there some things that really make it a bad FDD?

Mike Rosenthal:
There can be, yes. So usually, if it’s not an FDD I’m reviewing because of a referral from somebody like yourself, it’s usually somebody that found me online, and it’s usually a very small system, maybe a startup. And as I’m reading the document, I realize it’s filled with typos. The grammar is poor. It’s omitted, of course, information that’s required by law. And that means they didn’t go to a capable lawyer or franchise lawyer to have it drafted. That’s a warning sign to you. If you’re thinking about buying it, that’s how they run their business. They haven’t taken the time and maybe spent the money to do things that they’re required to do by law. And if that’s their attention of detail, do you want to be relying on these folks and investing your money with them? So I think that’s a bad FDD.

Mike Rosenthal:
The other kind of bad FDD we occasionally see is ones that are truly overreaching. And you have to recognize the franchise agreement is a very strong contract. It’s there to protect both the franchisor and also other franchisees from your bad behavior. So if you go to a McDonald’s, whether you love the food or not, you kind of know what you’re going to get. And that’s what is attractive to people. And so the McDonald’s franchise agreement is going to protect the franchisees from other franchisees bad behavior, failing to cook the French fries at the right temperature, not keeping the restrooms sanitary.

Mike Rosenthal:
So it does serve a purpose. But you can overreach if you’re a franchisor. And so we sometimes see things that I look at and say, “Whoa, I’m not sure if I were a franchisee, I’d want that in the contract.” And it makes me very uncomfortable. So a couple of examples would be extremely unreasonable provisions for liquidated damages. If you breach the contract, you’re going to owe the franchisor some money, and that’s normal. But if the number is too high or the formula’s unreasonable, that’s a warning sign and it puts you at risk.

Mike Rosenthal:
Another is what I call a clawback right. Occasionally, franchisors will put language in there that says at some point in the future, maybe after the end of year five, they can buy your unit from you at a predetermined price or formula. Oftentimes, it is a multiple of earnings or EBITDA. And I always say to folks, “Well, what if you bought a franchise and in 2005 and in 2010 this clause comes into play and we’re in the middle of the worst recession our country’s had since the Great Depression and you survived but you only made $2 last year? And if the formula says that the franchisor can buy you at six times earnings, which sounds like a pretty fair number, that’s $12. Would you want to sell your business for $12. You’ve invested all this time and money in it.”

Mike Rosenthal:
And also, a lot of the clients that I deal with, and I’m sure people that you deal with, this is their second career or their third career, and they’re hoping to stay in this business until they’re ready to retire, whenever that is. So giving up the right to continue to own the business is a problem because you wouldn’t want to wake up when you’re 63 and you’re planning to work till your 68 and now all the sudden you don’t have a business.

Leslie Kuban:
You know, sometimes, and we both have worked with some pretty sophisticated investors and executives, but they’re looking at franchising for the first time. And these contracts read differently than other types of business contracts. Is there any advice that you have for it’s the first time someone’s starting to read these documents? Just what expectations should they have about it?

Mike Rosenthal:
Well, they are sometimes described as onerous. And again, I understand why they are that way and I can help people understand that. Again, it’s to protect both the franchisor and the system. But as you’re reading through it, I always ask people to be critical and make notes and ask questions. So why is this here? What’s the reason for this? And as with any business agreement, ask yourself what’s the worst that could happen, right? You know, sort of what the consequences of this?

Mike Rosenthal:
And then lastly, again, I always suggest have a lawyer look at it, have their accountant look at it, make sure they understand both tax implications of things and also just the basic business parts of it. So as an example, in item seven of the FDD, the franchisor has to give you a list of what I’ll call the startup expenses. It’s supposed to run through roughly the first 90 days after you open your business. Well, you should be sitting down and doing a pro forma and taking that information. And if you don’t know how to do that, then get with your accountant and have her or him help you do that. The information is there, and then you can back check it by talking to other existing franchisees.

Leslie Kuban:
So what do you say, Mike, to that guy or gal who is ready to proceed through these semi-final steps having a lawyer review, but they say, well, my brother’s a lawyer or my neighbor and good friend is a corporate attorney for XYZ Company. And they’re not understanding the value of why they should pay the fees to go to a franchising, a specialized attorney in your field. What do you say to that guy who pushes back?

Mike Rosenthal:
The practice of law is specialized these days. So I have a brother-in-law and close friend who’s a radiologist and I’m sure he’s a brilliant doctor, but I wouldn’t go to him to have him deliver my grandchild, nor would I go to him for open-heart surgery. Right? So it’s no different. There are things we learn by being practitioners, both from experience and I attend all kinds of courses every year to keep me updated on what’s going on in the industry. So there are things that you wouldn’t recognize if you were let’s say the old-timey country lawyer working in a small town.

Leslie Kuban:
Well, I can say from personal experience that people often they usually regret it in time wasted and money spent going to a lawyer that really is not well versed in these documents before. It’s actually less expensive and less time-consuming to work with you or one of your colleagues who’s read hundreds of these documents.

Mike Rosenthal:
I appreciate that. And I also find, because I see the other side when I’m representing the franchisor and they get a five-page, single-space memo from some lawyer that doesn’t normally practice franchise law suggesting dozens and dozens of changes to the franchise agreement. You’re paying somebody to do a lot of work isn’t going to help you. You know, if somebody isn’t experienced in the industry, they don’t understand which things might be negotiable, and a lot of them are not, and which things aren’t.

Mike Rosenthal:
So why spend time writing a long memo to address things that aren’t going to get resolved? And quite honestly, when I’m on the franchisor side and one of my clients sends me one of these things, my first reaction is often you sure you want to sell to this person? You know, their expectations have now been changed in a way by that lawyer that you’re probably not going to be able to fix and they’re probably unreasonable.

Leslie Kuban:
Yeah. So on the franchisor side, Mike, so an entrepreneur is looking to scale their business. They’re really looking at using a franchising strategy to do so. At what point do you come in? Are you the first phone call or where in the sequence of franchising’s one business does your expertise come in?

Mike Rosenthal:
I’m glad to be the first phone call and I’ve got a call like that scheduled tomorrow. I will sit down with someone in person or the phone or now Zoom and walk them through both the legal processes that apply and then the structure and kind of help them understand it.

Mike Rosenthal:
They need to have a business understanding as well of what it means to be a franchisor. So there’s a lot involved. It’s not just selling somebody the right to use your name, and it’s a restaurant your menu, for example. There are a lot of operational things that the franchisor needs to be able to provide if the franchisees are going to be successful.

Mike Rosenthal:
So again, using the restaurant business as an example, if you own three barbecue joints, you may be a pretty good operator. You know how to deal with your customers, your employees, your vendors. Now if you’re a franchisor, your business has changed. You’re no longer a restaurateur. You are somebody who supports restaurateurs and trains restaurateurs and makes sure that they do everything they’re supposed to do to protect your brand. And that’s a whole different business. Also, you have to be able to sell franchises, and that’s a very different business.

Mike Rosenthal:
So working with an outside consultant I think is really important. And they can help you set all those things up. Understand at what point in time as your business grows, like any other business, you have to scale certain things, you’re going to need staff and support to do stuff. It’s not about just collecting checks.

Leslie Kuban:
Yeah. Yeah. Being a franchisor is a big deal. And there’s multiple resources. You’re one of multiple resources that emerging brand needs to get started off on the right foot. That’s for sure.

Mike Rosenthal:
Correct. And I will tell you that I joke about this, but if 10 people come to see me and it’s more than 10 every year that do and they’re inquiring about franchising their business, eight of them leave my office and never think about franchising again. One of them, hopefully within a few months, pulls out their checkbook and says, “Let’s do this.” And one leaves with a checklist of stuff they’d really need to be working on first before they franchise. And I may hear from them a year later, three years later, something like that. They’re not ready to do it, but they now have a better understanding of what they need in order to accomplish it. Most people I talk out of it.

Leslie Kuban:
Yeah. And I hope our viewers hear that and understand that you’re doing a great service to the community of helping people avoid the big mistake of franchising their business when they really shouldn’t. That’s really valuable.

Mike Rosenthal:
I hope so. Thank you. You know, I’m not just helping them, I’m also helping the poor franchisees…

Leslie Kuban:
Yeah. Yeah.

Mike Rosenthal:
… that would be walking into a disaster if these folks weren’t ready to franchise.

Leslie Kuban:
Yeah. Mike, how would people get in touch with you? Perspective franchisees, perspective franchisors, what’s the best way to reach you?

Mike Rosenthal:
They can either phone me or email me. We’ve now all gotten to the point where we just use our cell phone for everything. My office line is forwarded to my cell phone, which is 678-592-5346. And my email is MRosenthal@TaylorEnglish.com. And I try really hard to be responsive to people and get back to them quickly. So they’re welcome to reach out to me at any time.

Leslie Kuban:
Well, I thank you for what you do and thank you for joining us in the studio, really learned a lot today.

Mike Rosenthal:
Well, thanks so much for having me.

Leslie Kuban:
And folks, thanks for joining us on another episode of Atlanta Franchise Today. And I look forward to seeing you next week.