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Is A Fractional Franchise A Good Idea?

A fractional franchises can be useful to a franchisor in expanding its brand into untapped markets.  The exemption permits franchisors to offer franchises into complementary markets without the rigors of disclosure. Under the fractional franchise exemption, a franchisor can offer a franchise as an add-on to the prospective franchisee’s already established business.  Common examples of a fractional franchise include a coffee shop franchise for a hotel or bookstore, a health screening franchise for health care providers and a fast food franchise in a convenience store. In these examples, the hotel owner, health care provider or convenience store owner purchases a fractional franchise to add to the product or service they are already providing to the public.

The basics of the federal exemption permits a franchisor to provide a franchise, without disclosure requirements, to a prospective franchisee who has at least two years of experience in the same type of business as the franchisor, and, whose sales from the fractional franchise will not exceed 20% of the prospective franchisee’s total gross sales.  The experience element may be met if the franchisee is in the same business selling competitive goods, or, in a business that would ordinarily be expected to sell the franchisor’s type of goods.

While the exemption may seem ideal in certain circumstances, the exemption is complex due to varying state regulations.  Companies desiring to proceed under this exemption should do so with extreme caution.  An exemption under the federal regulations does not mean an exemption under all state laws. States have varying definitions a fractional franchise. A few states do not have a fractional franchise exemption at all. Other states have the exemption, but require a form of filing to obtain the exemption status.  Even if a state exemption applies, the fractional franchise may not necessarily be exempt from a state’s business opportunity law.  These intersecting regulations make for a delicate dance to successfully use the fractional franchise exception.

While an enticing expansion method into new markets, if you plan on relying on the fractional franchise exemption, caution is required.  Prior to relying on the exemption, a state by state analysis should be completed; and, revisited annually.  Prior to each sale, an analysis should be performed to make sure the prospect qualifies for the exemption.  It is good practice to have the prospect complete a well-drafted acknowledgement of the prospect’s business experience and anticipated sale volume.  This practice will protect the franchisor from later claims of franchise disclosure violations.  Finally, franchisors who wish to expand in every state should consider preparing a Franchise Disclosure Document rather than relying on the fractional franchise exemption.

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Debra Hill Partner, Fisher Broyles
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