Multi-unit franchising is a good way to grow a franchise system quickly. We now have guidance on how franchisors should present multi-unit franchise offerings.
The North American Securities Administrators Association, Inc. (NASAA) adopted a Multi-Unit Commentary September 16, 2014. Its message was this: Starting in early 2015, registration states will not accept a combined franchise disclosure document (FDD) that includes both the single unit offering and the area representative offering. The area representative offering must be disclosed in a separate document from the unit offering, and the two must be registered separately. States that require franchise registration will no longer accept these combined offerings.
But area development offerings can indeed be combined with single unit offerings in the same franchise system. Why the difference in approach? Because NASAA wants to ensure that offerings are clear to prospective franchisees, and the area rep offering is very different from the single unit offering and the area development offering.
What is the difference between area development and the area representative offering?
An area development agreement is typically a framework agreement that includes a development schedule. The developer is obligated to open a specified number of units over a defined period of time within a defined geographic area. Each franchised unit becomes the subject of a separate unit franchise agreement under the umbrella obligation of the development schedule within the framework of the development agreement. The franchisee under each unit agreement is either the area developer entity or an affiliated company. Successful franchise systems that use this approach include Dunkin Donuts, Applebee’s, Hardee’s and others.
The area development approach allows the franchisor to deal with a smaller number of franchisees, each of whom will each open multiple units. Area developers are typically successful businesses with the means and the experience and staff that improve their likelihood of success. From the franchisee’s point of view, the area development agreement locks in a territory and gives the franchisee the opportunity to benefit from economies of scale with a proven brand.
By contrast, the area representative pays a fee for the right to recruit and manage the unit franchisees in a defined geographic area in exchange for a percentage of the franchise fees that the unit franchisees pay to the franchisor. The unit franchise agreements are signed by the unit franchisees and the franchisor, not by the area representative. The area representative might provide site assistance to unit franchisees as well as training and ongoing support services. For these services, the franchisor typically pays the area representative a portion of the initial fees and ongoing royalties that the franchisor receives from the franchisees in the representative’s territory. Cold Stone Creamery and Tasti D-Lite are examples of franchise systems that use the area representative approach.
NASAA’s Multi-Unit Commentary states that franchisors may combine in one FDD the offering for a single unit franchise and an area development franchise. “An area developer essentially is a unit franchisee with the right to operate more than one unit franchise.” For this reason, combining the two types of offerings is not confusing.
But the Commentary states that the FDD may not combine the single unit franchise offering with an area representative offering. According to NASAA, “the relationships and agreements for these offerings are very different, and it can be confusing” to combine disclosures for both in the same FDD.
The Commentary states that subfranchise offerings must also be disclosed in a separate document from the unit offering and registered separately in franchise registration states. I will cover the subfranchise offering in a separate post.
by Tom Pitegoff of LeClairRyan