The difference between a franchise and a business opportunity is quite often confused and cause serious issues for the business if not handled properly. Both a franchise and business opportunity have federal and state regulations that govern them. Failure to properly comply with these regulations can cause serious penalties to result to the company.
Franchises are regulated by the Federal Trade Commission (FTC) and by various states that have franchise laws. The FTC defines a franchise as when an opportunity is offered by a business (“franchisor”), to another business or an individual investor (“franchisee”), and a 3-part test is met: (i) the franchisee is required to operate under the franchisor’s trademark; (ii) a fee of $500 or greater is paid by the franchisee to the franchisor for products, services or training and is paid during the first six months of the arrangement; and (iii) the franchisor exercises substantial control over the franchisee. It is typically pretty easy to determine if the first two tests are met, but the third prong, control, is not always clearly defined. If this three prong test is satisfied, the franchisor must provide a franchise disclosure document (FDD) to the prospective franchisee at least 14 calendar days prior to that investor paying any money to the franchisor or signing any franchise agreement with the franchisor. Certain states require that the FDD be registered with the state prior to the franchisor offering franchises for sale in that state.
Business opportunities are less uniformly defined. Historically, business opportunity laws were promulgated to protect investors in “pyramid schemes” – seller assisted marketing schemes, and work-at-home “businesses” that were not really beneficial to the investor. A business opportunity is defined as an arrangement in which a person (i) offers, sells or distributes goods, commodities or services to another; and (ii) the goods, services or commodities are provided by the seller of the opportunity or by someone affiliated with the seller or required by the seller; and (iii) the seller secures business for the purchaser or retail outlets or accounts for the purchaser; and (iv) the purchaser is required to pay or commit to pay to the seller or its affiliates at least $500 within six months after commencing operations. The purpose of these laws is to protect the purchaser from fraudulent or questionable schemes. The federal and state definitions of a business opportunity are intentionally broad and vague so as to capture the myriad of types of opportunities being offered to unsuspecting investors that may not be above board or legitimate opportunities for an investor to make money.
Franchises are typically excluded from federal and many state business opportunity laws. Most states, and the FTC require that a fairly simple disclosure document be provided to a prospective investor prior to that investor signing any documents or paying any fees. This disclosure document is much less detailed than the FDD and provides less information to the investor.
The laws on business opportunities are evolving. Any business that intends to offer opportunities of investment to another business or individual, whether as a joint venture, license or franchise, should be cautious before making that offer. Both the franchise and business opportunity laws can result in steep penalties for violations, including possible criminal and monetary penalties. Consultation with experienced franchise and business opportunity attorneys, such as those at Lanard and Associates, should be consulted prior to moving forward with any offers.