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When Can I Sell a Franchise Without Creating a Franchise Disclosure Document or Registering with the State

I have written repeatedly about the franchise laws requiring a detailed Franchise Disclosure Document or FDD, and state governmental registration requirements, before a company can "franchise" or "become a franchisor" , or "sell a franchise".

While this is true for the vast majority of businesses that seek to sell franchises, the fact is, there are a number of exemptions both in Federal and California franchise laws that allow a company to sell a franchise without either a Franchise Disclosure Document, or registering to sell franchises in a registration state. These exemptions focus primarily on minimum net worth requirements, and substantial business experience of the prospective franchisee.

The Franchisee exemptions most often utilized pursuant to California franchise exemption laws*, are the following:

1. "Experienced Franchisee Exemption" The Franchisee (or a 50% or more owner of Franchisee) must have at least 24 months experience operating a business substantial similar to the franchise being offered OR, must have been a recent officer, director managing agent or 20%+ owner of Franchisor for at least 24 months (and the Franchisee is NOT controlled by the Franchisor). OR

2. "Large Franchisee Exemption": Franchisee is an entity with Five Million Dollars net worth, or natural person with net worth of One Million Dollars (excluding residence, retirement plans and automobiles), or natural person with gross income of $300,000+ in past 2 years (or $500,000 with spouse), and reasonably expects same level of income in current year, or an entity in which all the owners meet the individual net worth or income conditions. Plus, the Franchisee must have significant financial and business experience or appropriate advisors, Plus the purchase will not exceed 10% of that Franchisee's net worth (excluding residence, retirement plans and automobile. And the purchase must not be for "re-sale" but for Franchisee's own account.

The "Large Franchisee Exemption" puts the requirement on the Franchisor to "reasonably believe" that the Franchisee (and all its' owners) has the capacity to evaluate the merits and risks of, and protect their own interests in, the franchise investment. Franchisors generally satisfy this requirement by having the Franchisee sign a very detailed Exemption Certification that acknowledges meeting all the conditions.

If the "Large Franchisee Exemption" applies, the Franchisor need not have a Franchise Disclosure Document, and need not register with the State of California to sell franchises, although the Franchisor must file the appropriate Exemption Notice and pay a state fee where the franchisee is to be located in California.

*FTC-"Large Investment Exemption"-Federal franchise laws allow an exemption for a Franchisee purchase that exceeds one million dollars (exclusive of financing and land purchase), but California does not have this independent option. There are other federal and other state specific exemptions for non-California located franchisees.

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