How to choose the right legal structure for your franchise

Nellie Akalp

The franchise business model streamlines the entrepreneurial process. By acting as a franchisee, you can become a business owner without much of the initial groundwork involved in building the company’s infrastructure and systems from scratch.

But even if a franchised location is associated with a larger brand, its owners are responsible for setting up the business entity and managing all operations and administration at their location.

In this article, I will discuss some of the nuances of starting and running a franchise entity.

Franchisee vs Franchisor: What’s the Difference?

First, let’s clarify some of the terms I’m referring to in this post:

  • What is a franchisor? A franchisor is a business that sells the right to others to open stores or sell products or services using its brand, expertise, and intellectual property.
  • What is a franchisee? A franchisee is a natural person or business entity licensed to run its own business (franchise) under an agreement with the franchisor.

For example, McDonald’s is franchisor; the owner of a McDonald’s location in your city is a franchisee.

Franchising and setting up a business entity

Forming a legal entity provides liability protection for business owners and may provide some tax benefits. The primary purpose of establishing a franchisor entity is somewhat different from why it is important to create an entity for a franchise location.

Franchise entity

The franchisor creates an entity that sells franchisees the rights to open and operate a franchise location using the franchisor’s brand, intellectual property, and expertise. An independent legal and accounting entity, a franchise entity protects its owners and main business from the debts and legal obligations of franchisees.

Consider this hypothetical example: Subway is a franchisor. Suppose someone wants to sue a company after slipping and falling on a wet floor at a franchisee location. The individual would sue the local franchise company and the main franchise entity would be protected.

Frequently, franchisors choose the structure of a Limited Liability Company for their entity. Technically, a franchise entity can be formed in any state. However, it is wise for franchisors to discuss their options with an attorney and tax professional before making a decision.

Franchise entity

A franchise entity is an entity created by a franchisee when purchasing the rights to operate a local franchise. Many franchisors will require the franchisee to establish their entity before drafting a contract or franchise disclosure document (FDD) so that the documents can be placed in the entity’s name. Franchisees are usually LLCs. Many franchisors will not allow a corporation to buy a franchise because the stock issue would have serious legal and tax implications.

The franchisee should almost always register his entity in the country where he has a physical presence, regardless of where the owner resides. The physical location of a franchise will require permits, licenses, leases, etc., so the company must be registered in that jurisdiction to obtain them.

Franchise entity nomenclature

Many franchisors create an entity with a name that suggests its purpose of selling the franchise – for example, Your Company Franchising Inc. or Your Company Franchise Sales, Inc. This makes it easier to distinguish entities.

As for franchisees, they can use the franchise brand for marketing purposes by establishing a DBA (fictitious name). However, their legal entity name cannot contain the name of the franchise being acquired (because the franchisor has trademark rights to that entity name).

For example, franchisees would avoid registering their legal entities as Smith Subway, LLC or Smith’s Burger King, but could instead set up databases such as “Subway Store #1234” or “Burger King Woodland Hills”. Franchisors typically have a specific way franchisees should format their DBAs.

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What about multi-seat franchises?

A multi-site franchise is when one franchisee buys multiple locations. Typically, the franchisor will want each unit to be formed as a separate legal entity with separate database administrators and permissions.

In some cases, franchisees can set up a parent company that keeps all their entities under it to keep things simple. However, this only works if all franchises are owned by the same people.

Entity requirements for franchise companies

In addition to their contractual obligations to franchisors, franchisees must comply with federal, state, and local requirements when establishing their business entity:

  • Documentation on how to create state files to form an LLC or corporation.
  • Get an EIN (Employer Identification Number).
  • File a DBA (doing business as) to establish a fictitious franchise location name.
  • Create an LLC operating agreement (or corporate bylaw).
  • Register for payroll tax and other employment-related taxes.
  • Full sales tax registration (not usually applicable to service-based franchises).
  • Submission of any required business licenses and permits to operate legally in their location.

Become a franchisee

Are you curious about what it takes to start and run a franchise? Here are resources to help you assess feasibility and explore options:

Starting a franchise business allows you to enter the world of entrepreneurship with built-in brand awareness and established systems and processes. However, that doesn’t mean it’s completely “plug and play”! Make sure you get the legal and accounting guidance you need to make sure it’s right for you.

about the author

Nellie Akalp is a passionate entrepreneur, business expert, professional speaker, writer and mother of four. She is the founder and president of the company CorpNet.coma trusted provider of resources and services for company formation, LLC filing, and corporate compliance services in all 50 states.

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