As discussed in a previous post, there are several types of franchise models including Single Unit, Multi-Unit Development (or Area Development), Conversion, and Master Franchise. Each has its advantages and disadvantages based on the franchisor’s expansion goals for its business. In a Master Franchise model, the franchisor sells the franchisee the right to offer and sell franchises to other franchisees generally within a delineated geographic area. The franchisor becomes a “master franchisor” and the franchisee assumes the role of a “master franchisee” or “subfranchisor.” The master franchisee does not own the franchise system but acts as a middleman in developing additional franchises. Those who buy franchises from the master franchisee are known as “subfranchisees.”
Benefits
A master franchise is often used when a franchisor is a foreign company or unfamiliar with a particular region or market and wants to grant someone local the ability to sell and oversee franchises in a designated territory on the franchisor’s behalf. The master franchisee not only recruits and contracts with subfranchisees but will also provide training and ongoing support. The franchisor benefits from having the subfranchisor assume the risks and obligations of supporting local franchisees.
Risks
Unlike with other franchise models, in a master franchise relationship, the franchisor and subfranchisor are both responsible for compliance with the FTC Rule which requires the parties to prepare, file and update their Franchise Disclosure Documents annually. Moreover, they are jointly and severally liable for any violations by the other party. However, assumption of some of the risks related to the timely and accurate updating and filing of disclosure documents may be negotiated between the parties, which is the subject of a future post.
From a business standpoint, there are some inefficiencies and extra costs associated with having two layers of control over subfranchisees by both the franchisor and subfranchisor.
Franchise Disclosure Document
Both the franchisor and subfranchisor must ensure that prospective subfranchisees receive the proper disclosure in a Franchise Disclosure Document (FDD) and that the disclosures are accurate. The required disclosures may need to be supplied by both parties, by the subfranchisor only, or by the franchisor only depending on the nature of the information. For example, generally, Items 1-4 of the FDD (information about the franchise system, prior business experience, litigation, and bankruptcy) call for both the franchisor and subfranchisor to supply information. However, while a subfranchisor must provide Item 20 information (subfranchisee and company-owned outlet data for the subfranchisor’s territory), the franchisor must supply Item 20 information for the entire system. Both the franchisor and any subfranchisor must also include their own financial statements in Item 21.
Area Representation and Brokers Arrangements
Master franchises are different from Area Representation and broker arrangements. The term “subfranchisor” is defined as “a person [including any individual, group, association, limited or general partnership, corporation or any other entity] who functions as a franchisor by engaging in both pre-sale activities and post-sale performance.”
Area Representatives, however, do not enter into franchise agreements with subfranchisees. Their rights are limited to recruiting franchisees and providing certain services (e.g., training, ongoing support, etc.). The subfranchisor, however, can actually contract directly with the franchisees and sell franchises.
Brokers do not fall under the definition of subfranchisors because they are independent sales agents who solicit prospective franchisees to purchase franchises from the franchisor and receive a fee or commission from the franchisor or subfranchisor on the sale of the franchise. They have no post-sale performance obligations, such as a duty to provide support services to franchisees.
Master franchises differ significantly from other franchise models. While they offer many unique benefits, it is important to understand the rules that apply to them so you can make a well-informed decision.
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If you are considering acquiring a master franchise, Lusthaus Law can help. Contact us for a consultation.
