We’ve been discussing the different general types of cost that a franchisee has to incur and that he or she must look at before purchasing a franchise. We looked at initial fees or costs, the fixed fees, we’ve looked at ongoing royalty payments and we’ve looked at advertising fees. We really haven’t examined them but we’ve identified them. Another issue that franchisees need to look at in doing their due diligence has to do with the advertising, and that’s a broad umbrella for advertising local, co-op and national, as well as any other marketing activity. So, I’m looking at all as one big category. I’ve written down some of the issues that we’ve dealt with in the last year or so, with regard to examining advertising costs as well as litigation with respect to advertising, lack of support and fees as well. Many times, there is an advertising fund in a franchise agreement. There could be co-op fee requirements, there could be local advertising fees that we talked about, in a national advertising program or that the franchisor, him or herself, administers. These are very large cost programs, usually. And if you’ve got a national franchisor, they’re theoretically administered nationally, and you’ve got commercials and written advertising, marketing, going over a very wide geographic area.
And things the franchisee needs to look at. The first is whether certain of the funds given to the franchisor as fees, the advertising fees, are gonna be used to offset administrative expenses. The franchisor, many times, implicitly looks at those additional fees and they’re sometimes very substantial, very close to the actual royalty fees, whether those are gonna be permitted under the franchise agreement, to be used by the franchisor to pay for its personnel that it allegedly devotes towards only the advertising mission. And that’s something that many franchisees don’t see in the fine print and, later on, when they look at the advertising as being defective, they see that the franchisor is devoting, sometimes, a very good portion or proportion of the fees paid by franchisees towards staff of the franchisor. And there’s no check in that regard, with respect to efficiency of the franchisor people. It could be used to house a group of franchisor employees, so it could be the rent for that particular facility. It could be cars for those people. It’s the expenses, the salaries and the larger the franchisor gets, many times, there’s some franchisee comfort or franchisor comfort in getting larger at the expense of the franchise national advertising fund.
Now, with regard to that, the franchisee wants to find out what other types of expenses are deducted from the advertising fund. It could be those that aren’t covered under administrative cost moniker. There’s also the issue of whether the franchisee has any control over how those national advertising dollars are spent. There’s the local advertising, in contrast, that the franchisee has complete control over and is only required to sell or advertise a certain number, a certain percentage of gross revenues. And the franchisee controls where and how that takes place. There’s also the issue of the co-op, the cooperative advertising, where a group of franchisees who are, arguably, similarly situated in a geographic area with similar market characteristics, combine and they advertise a market based on their local circumstances. And then there’s the issue of the national advertising fund, and in that case, the franchisor usually has sole discretion as to how to spend, when to spend, why to spend, where to spend. And that, many times, results in some of the worst offenses to the franchise agreement with regard to franchisee rights, in that the franchisor is gonna advertise on the West Coast on 90% of the funds from the national advertising fund, and advertise only 10% on the East Coast. And that creates a great conflict for many franchisees, obviously, on the East Coast in that example.
The question also is whether local advertising is a beneficiary of that national advertising, such that the franchisor might say in his franchise agreement that although the franchisee has to pay 4% or 3% for national advertising, that the franchisee cannot expect, as a benefit of the franchise agreement, to receive anything tangible in terms of a return on that national advertising expense. And where you’re the beneficiary of a majority of that national advertising fund, there’s no complaints. But where a franchisee is receiving almost no return, and I have a client right now that can show it tangibly and explicitly, their receiving no return on the 4% they’re paying, that creates a problem. But the problem can’t be a legal one where the franchise agreement says that the franchisee is not entitled to, nor is the franchisor required to undertake marketing and advertisement that’s gonna benefit a specific franchisee in a specific location. And with regard to that, I’d say you’d wanna find out what percentage of the franchisor’s previous expenditures on advertising and marketing have been in that particular area that you’re gonna buy. And that’s some indication. It’s not an indication as, necessarily, to future events, but it is something that would give you some information.
Also, a franchisee who is gonna ask a lot of questions could ask the franchisor what plans they had to advertise in the future or market in the future, and take a look at the national advertising programs, take a look at the local advertising programs and see whether there’s any link between your potential market and what the franchisor actually intends to do. There’s also the question of whether you might be able to receive some type of benefit from advertising locally that you can offset against the national advertising thing. And I’ve seen cases, or we’ve negotiated for cases where the franchisee says, “How about if I spend X percent locally on local advertising, with your approval, and have it offset against those large national advertising fees?” In the co-op situation as well, that sometimes is permitted by the franchisor but, certainly, it’s not the rule that a franchisor would allow that type of offset.
Thanks for being with me today. And if anybody ask any questions, feel free to give me a ring. Thanks, again.