Some of the best-known franchises are restaurants. McDonald’s, Subway, Domino’s, Wendy’s, Buffalo Wild Wings, and others have thousands of locations. If you have a popular restaurant, you may be thinking of expanding to multiple locations. While you can choose to take on the work yourself, open more restaurants, and hire managers to run them, you may want to instead franchise. The decision whether to franchise your restaurant is complex. There are many factors to consider which apply regardless of the type of franchise as discussed in previous posts. However, some issues are unique to restaurants.
Royalties. Franchise agreements provide for payment of royalties in exchange for the franchisee licensing the rights to use the franchisor’s trademarks and systems of operation. The amount of royalties is typically based on a percentage of gross sales, a specified minimum amount, or the greater of the two. However, gross sales are generally defined very broadly in the franchise agreement which can lead to misunderstanding between parties. Often, gross sales are defined to include all revenue derived from the operation of the franchise. In a restaurant franchise, this would include not only payments for menu items, but also tips given directly to employees and amounts charged to customers to cover the costs of third-party delivery services. Franchisors include these revenues in the calculation of gross sales, contending that these payments to employees and third-party delivery providers are simply expenses associated with the operation of the business, no different from rent or inventory expenses. Franchisees, however, often want to treat amounts collected for tips or delivery fees as pass-through items and exclude them from the definition of gross sales. Ultimately, the franchisor will determine the royalty amount and if applicable, the definition of gross sales when drafting the franchise agreement. However, franchisors should be mindful that franchisees must be able to earn enough profit after paying expenses to be successful.
Liquor licenses. If your restaurant serves alcohol, franchisees will need to obtain liquor licenses. This can be a time-consuming process as applicants often must submit considerable amounts of information to local regulatory authorities and wait long periods of time for a determination. Furthermore, some localities have different classes of liquor licenses or may have quota systems that limit the number of licenses which will be granted. Franchisors should carefully consider where to focus their expansion efforts if certain localities will pose too many challenges for potential franchisees.
Wage and hour laws. In addition to labor and employment laws that apply to every business, restaurants have additional concerns because they typically employ staff who receive tips. These workers are subject to different minimum wage rules which may vary under federal, state and local laws. While this is generally an issue for the franchisee, the franchisor should be careful not to exert so much control over the working conditions of their franchisees’ employees that they become subject to a claim of joint employer. Restaurants can be very successful franchises, but it is essential to understand the relevant issues. If you are considering franchising your restaurant, speak to an experienced franchise attorney to help guide you through the process. For more information, contact Lusthaus Law for a consultation about your franchise.