Episode 129: Legal Mistakes That Quietly Drain Franchise Profits

Before you sign a franchise agreement, make sure your assets are fully protected. Business attorney Matthew Fornaro joins us to expose the legal traps franchise buyers overlook.

Episode Overview: In this crucial episode of the Franchise QB Podcast, host Mike Halpern sits down with Matthew Fornaro, an elite business law attorney and startup legal expert. Matthew breaks down why buying a franchise is a completely different level of regulatory compliance compared to independent business ownership. Discover the legal and structural realities of hitching your wagon to a corporate brand, how improper intellectual property usage can lead to default notices from your own franchisor, and how to structure early business partner relationships to avoid financially draining partner disputes down the line. If you want to protect your capital and build your business on a rock-solid foundation, do not skip this comprehensive guide.

Highlights:
"The problem is that life happens, things happen... unless you have documents that control what happens when there's a dispute or how to resolve disputes or things like that, those are going to be issues that are going to adversely affect your business because if you don't have it in writing, it doesn't exist." — Matthew Fornaro, Business Attorney

Chapters
00:00 - Introducing Business Law Expert Matthew Fornaro
02:14 - From The People's Court Fan to Corporate Litigator
04:19 - Franchise Agreements: A Higher Tier of Legal Regulation
06:21 - Hidden Commercial Lease traps & Missing Governing Documents
07:49 - Hitching Your Wagon to a Brand: The "Big Brother" Effect
09:28 - Preventing Toxic Partnership & LLC Co-Owner Disputes
12:02 - Crucial Legal Mistakes That Silently Siphon Working Capital
13:51 - Franchise Intellectual Property & Trademark Infringement Pitfalls
15:51 - The True Story of the Filet-O-Fish & Unprotected Local Innovation
17:02 - Mediation vs. Mandatory Arbitration Clauses in Franchising
19:57 - Proactive Legal Planning: Build Your Local Cadre of Experts
21:08 - The First Three Corporate Formations Every Franchisee Needs

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Mike Halpern, CAFC
mike@franchiseqb.com

Transcript

0:42

Joining us in the huddle today is Matthew Fornaro, attorney and business owner. Welcome to the show, Matthew. Thank you, Mike, for having me here. Yeah, it's great to have you. So Matthew, tell us a little bit about your background and how you built your business law practice. Sure. So I started out when I graduated law school. I worked at a boutique firm, then I worked at two large Amlof 200 law firms. About 11 years ago, I decided I wanted to go out on my own and start my own law firm out here in the suburbs. And I wanted to focus on helping like small businesses, entrepreneurs and startups. So I went and did it. Had no business education. no formal business education, should say, other than watching my dad in his small business when I was growing up. So basically, he did medical equipment and medical supply distribution. So other than seeing that, was all kind of, I don't want to say on the job training and learning, but it was a lot of, you know, process of elimination trial by error. And, you know, 11 years later, think I'm doing pretty well, so I figured it out. But there's a lot of stepping stones and lot of learning to be done in the process. Yeah, well, I think you bring a lot of credibility to the space because you worked in quote unquote corporate America for the bigger firms and you took that risk as an entrepreneur yourself and kind of stepped into ownership. So I'm sure a lot of your clients can relate to that. So you primarily work with entrepreneurs, both startups and established business. So what, what kind of drew you to business law in the first place? Sure, you know, it's interesting because growing up I was a big People's Court fan. That's like what got me into wanting to be an attorney. But Judge Wapner, Judge Wapner, was actually, believe it or not, was interviewed by Doug Llewellyn, the actual dude who does the interviews on the People's Court. So was like the greatest moment of my life uh absent, like my kids and my wife and know, stuff like that. But... So I grew up watching and liking, advocating for people, adversarial stuff, but not family law, not criminal, whatever, helping people with real problems or whatever. So that's kind of my mindset of how I wanted to be an attorney. then through the evolution of going to law school, working where I did and doing what I did, I developed a pretty... good skill set I think regarding commercial litigation, helping people in business disputes or whatever. And then I've adapted that to focus on helping small businesses, entrepreneurs and startups with about now it's probably about 90 % of what I do is litigation and 10 % is transactional. So that's kind of how I got into that space. And I guess I mentioned my dad, I wanted to use my skill set to help people, like my dad who I thought were. underserved by professionals that I saw when I was growing up where, you know, he wasn't big enough to justify like, you know, having a huge law firm or like a big accounting firm or whatever. And like the people who are like in the smaller, you know, the smaller size professionals, whatever, weren't really like attuned to helping small businesses and were really like savvy on helping small businesses whenever there's kind of like, oh, know, small business, sure, I'll do whatever. So I thought that that was a good niche and that's kind of what my focus was and that's what I've been doing. Yeah, that's great. I appreciate you giving us that context. So for someone that's exploring franchise ownership, so here on the Franchise QB, we mostly focus on franchising. What are the biggest legal issues they should be thinking about before they sign a franchise agreement or really sign anything? Sure, know, mean franchise law and franchises as I don't need to tell you, are their own, you know, super regulated, highly regulated, highly contract driven, statutorily driven thing where, you know, it's not just a business, but it's a highly regulated business based on, you know, the initial offerings, the franchise offerings, all that stuff. So. It's a whole nother level of not just getting into business, but getting into a franchise, because it's getting into business, then it's the next level of getting into a franchise where you have to deal with all kinds of franchise-y franchise or issues where if it was just your business, you wouldn't have to worry about. So it's a whole different level of compliance, a whole different level of due diligence, a whole different level of, you know, things that you have to do. that in addition to being in business, being a franchisee is a whole different level of having to do compliance, do due diligence, jump through hoops, put the round pegs in the round holes kind of thing where if it was just your business, you wouldn't have to be doing that. So when I deal with franchisees and sometimes franchisors too, it's all about you know, compliance with the franchise agreement, making sure that, you know, it's a uniform product, it's objectively run the same kind of things that you would expect in a business, but just in a more regulated environment for the franchise piece of it. Yeah, I think that makes a lot of sense. um, you know, lot of prospective franchisees that I interact with and you interact with are real excited about all of the front end, exciting things like the shiny object. They look at the revenue, they talk to owners, they get real excited about joining the franchise system. They see the revenue potential. but they also have to pump the brakes a little bit and make sure that they're signing something that is going to be effective for them and protects them. So what legal and structural issues do most prospective franchisees tend to overlook when they're early on in their kind of diligence. You know, it's kind of like any kind of business. It's setting it up in the correct fashion, having all the underlying, you know, like a written business plan in place before you can get in business. Having, picking out the right kind of business organization. then if you're a franchise, sometimes the franchise or dictates what it's got to be having the correct governing documents in place when you do pick the business organization and then having all the right contracts in place in addition to the franchise contracts. like your commercial lease, if you have a lease, your employment agreements, if the franchisor doesn't control those, your vendor agreements, if the franchisor doesn't control those, and all your various documents and contracts in place. sometimes people are just so eager, like you pointed out earlier, to get into business, particularly if they're a franchisee, that they just kind of jump and start doing stuff as quickly as possible, and they don't do the due diligence or the legwork or the footwork. to make sure that all the contracts are in place, all the documents are in place, all the due diligence is in place before they start doing stuff. Yeah. And we'll get into kind of the dispute side of things here in a minute, because when you have partnerships and you have multiple people joining a business and joining a franchise business, you have to get those documents in order. In addition to the ones you're signing with the, the parent entity or the franchise or, but, um, you know, what should franchise buyers understand about these contracts generally beyond just the signing of the franchise agreement? Well, you know, in franchise contracts in particular, I mean, you're not just obligating yourself to business. You're obligating yourself to a system, a mantra, a whatever you want to call it that if you're just in business for yourself, you're not doing. So you're hitching your wagon to a franchise or you're hitching your wagon to a national or international corporation, LLC, whatever it is. And you got to figure out that you know, the ship's gonna rise and set is gonna rise and set based on not just what's happening at your local level, but also at a national or international level based on what the franchise or is doing. And, you know, the franchise or always wants their money always wants their percentage always wants their, you know, their revenue based on your franchise agreement and they don't care that you had a rough month or something like that. That's a bill that's always gonna be there. You're always gonna have to give your dividend or whatever it is you have to do. And that's something that you have to bake into your business plans as being a franchisee is that that's always an issue where there's always gonna be, for better or worse, Big Brother is always gonna be watching you. Yeah. And I think fundamentally that's a really good conversation that a good franchise attorney should have with their client, as well as a franchise consultant. You know, the space I'm in, that's one of the first conversations I have is, you know, this is what it looks like to be an independent business owner. Here are the pros and cons. Here's what it's like to be a franchise owner, pros and cons. And you have to make sure that there's a match. Right. uh So in your experience, going back to the disputes that I mentioned earlier, what, what kind of disputes tend to arise most in business relationships and how can the owners reduce the chances of ending up in one, right? It could be between someone else they went into business with as a partner that has equity in the business. could be with an employee. It could be with the franchise or there's a lot of things that can go sideways in ownership. And there's another level of that when you're in a franchise model. So what's kind of your take on that. Sure, so absent the franchise model, just general business stuff, it goes back to not having the contracts in place and not doing the planning and having the necessary tools in place when you get into business. So, know, nobody goes into business saying, want to fail. Nobody goes into business with their friend, their brother-in-law, you know, their cousin or whoever to lose money and to go out of business. So problem is, that life happens, things happen. you know, there's personality disputes, you know, I don't like you anymore. You don't like me. You don't like my spouse. I don't like your spouse. Things happen. Okay. So unless you have documents that control that say what happens when there's a dispute or how to resolve disputes or things like that, those are going to be issues that are going to adversely affect your business because If you don't have it in writing, it doesn't exist and you're to have to go to whatever the law or the statute say and you're not going to like it. So that's one of the main things is that when there's a dispute among, you know, LLC members, among shareholders in a corporation, among, you know, partners in a partnership, you know, you have to have the framework in place to be able to deal with those disputes. And if you don't, you're going to have major problems. So that's probably one of the biggest things right there. And then in the franchise space, there's that plus there's the, you always got to get along with the franchise or you always have to play nice. You always have to play by their rules. And if you don't do that, you're going to have problems. Yeah, I mean, that's just practical advice that I give to most, if not all of my clients that are entering a franchise relationship is that you can be a friend of the franchise or or you cannot be and the ones that tend to be a friend. treatment, like they'll come to you if there's a new vendor they want to test out and if you take that risk and do something for them and there's an extra territory that pops up you might hear about it first. So just some of those relationship things that become you know if you're a good validator for the franchise or they're going to look at you differently through the lens of someone who's bad-mouthing the concept and I'm sure there's legal ramifications in that as well. But what are some of the the legal mistakes that can quietly drain margins or create headaches for a franchise owner that's really just trying to grow. You know, not planning properly as far as running a franchise, making sure, you know, as far as business things go, make sure you always have capital at hand and your cashflow is good and your business systems are good. Some people are always cash poor. They didn't plan ahead. You know, they think it only requires, you know, X amount of dollars to run when really it's like X plus 10 or something. So they don't have access to credit. They don't have access to, you know, certain things that they need. They don't have going back to what I said before, they don't have the correct business systems in place. They don't have the correct legal documents in place. They don't have the correct professional team in place helping them. They don't have a business law attorney who helps them. They don't have an accountant who focuses on helping small businesses help them. They don't have like a commercial banker who focuses on small businesses or franchisees help them. So those are all people who you should have. in your cadre of people that you call upon to assist you who aren't necessarily in your business but should be in your sphere that you can call on for help. And a lot of people just think they can do it themselves or they just need to be reactive and do stuff when things are bad or whatever instead of proactive and build relationships that will facilitate their business in the good times and the bad times. Such great advice. mean, with the item seven and making sure you have enough working capital to get through those tough times, especially if it's not an acquisition that already has customers and has cashflow and revenue and you have to start it from scratch. Like you really need to double down on how much working capital you think you need. And you mentioned access to credit and access to a team of experts that are in your corner to help you when you get in a pinch. and be proactive instead of reactive. mean, great basic advice that a lot of first time business owners don't take into account and it can really hurt them. So that's good stuff. So let's kind of talk a little bit about IP. Like should business owners think about IP, trademarks, branding, goodwill? mean, a lot of these things in the franchise model are assumptions, right? You just assume that you know, in the appropriate item in the FTD, says, yeah, the franchisor owns all the marks and which isn't always the case. mean, I've seen emerging brands that don't have them and they're pending and that's an extra risk that the franchise owner is taking on if they don't achieve that trademark, for example. But what are your thoughts on IP and trademarks, branding, et cetera, as it relates to franchise ownership? Sure, so you gotta make sure, obviously, like you said, you would think and you have the mindset that the franchisor has the master IP. They have their own IP companies where it's only a holding company that just holds the IP. So you wanna make sure that as a franchisee, you thoroughly understand what your role is in using. trade dress, trademarks, using logos, using slogans, having your custom polo shirt, your signs, whatever, make sure you're in compliance with your franchise agreement and make sure that you're using it in line with what your franchise or wants. Like if they have a preferred vendor that prints shirts or whatever, you're using them or a required vendor. You're not. taking your logo out and sending it to the local print shop and then all of a sudden your franchisor finds out that you're unauthorized reproduction of their trademark or something like that. So you don't want to be infringing your own franchisor's intellectual property. That's probably the biggest shooting yourself in the foot thing you can do is improperly using the IP that you have access to as a franchisee because you're not using it the way that the franchisor wants. And then also as a franchisee, if you're creating, you know, subjective things that aren't necessarily the franchise or is property or whatever, and you're allowed to do that or whatever, want to make sure just like any other business, you're protecting your intellectual property, you're registering trademarks, you're registering copyrights, you're keeping trade secrets, you're, you know, uh, you know, keeping confidential information and all that stuff. So that's someone. doesn't exploit it or doesn't, you know, at the franchisor level, take your thing and appropriate it, you know, kind of thing. think the classic, you know, I think a classic example of that, and I don't know how acrimonious it was or whatever, but you know, like a kind of urban legend is like the filet-o-fish with McDonald's. I mean, that was invented by a franchisee. in I think Ohio or something because of Lent and he didn't know that he had the rights to you know the Filet-O-Fish or whatever and he just gave it to McDonald's and you know it's a you know yeah correctly there's value that was the franchisees and he gave it to the franchisor and you know like he could have licensed it he could have probably leveraged it for capital or whatever, but he just gave it to his franchisor. So that's the kind of thing where as a franchisee, if you're coming up with, know, indigenous things like that or whatever, you want to protect that even from your own franchisor. really good point. So when a dispute does arise, how do you think about the approach, negotiation, mediation, arbitration, litigation as a way forward? I know in most cases, if not all cases, it's going to be spelled out in the franchise agreement that you can negotiate or agree to depending on your position on it as to what the process looks like from the franchisors vantage point. And once you sign that, that's the way it goes. But kind of what are your thoughts on on I mean, you know, obviously you want to make nice, nice with the franchise or in the franchisee. And if there's ever a problem or an issue or a beef, whatever you want to call it, you know, you want to try to keep it as cordial as possible because you need to have a working business relationship. If you're a franchisee and you've alienated your franchise or you're going to have real problems. So you want to try to keep it as professional and as in front of you as possible. And you know, always have an open dialogue with, you know, your rep or whoever it is you deal with at the corporate office or whatever. If you're a franchisee and you have an issue with your franchisor, obviously, if you have to get an attorney involved, you know, make sure that they're a business savvy attorney. Don't get your, you know, cousin who does personal injury law, who's going to go call up your franchise or threaten them or something. And at the same time, you don't, you know, whatever. So you want to keep it, you know, as professional, whatever, keep an open dialogue. You know, sometimes things happen and you get involved in, know, if your franchise agreement, a lot of franchise agreements have mandatory pre suit mediation. A lot of them have mandatory arbitration instead of litigation. Some of them have mandatory litigation. So. You got to make sure before you enter into your franchise agreement, you understand what it is. If there's a fallout between your franchise or your vendors, your whatever, what your avenues of resolution are and make sure that you're comfortable with those avenues of resolution. Cause if not, then maybe that's not the right franchise for you. Maybe that's not the right agreement for you. And if it is, make sure that you utilize the structure that's put forth in those documents. to minimize the impact on interruption to your franchise and interruption to your business and restoration of your business and your relationship with your franchise or. Yeah, really, really good practical advice. It's always good to just use common sense before you go down the path with a dispute. So I think that's great. So what can an owner do? Like what what does proactive legal planning look like for an owner who wants to grow but doesn't want to just react to the problems that surface they want to get out in front of it? You know, it goes back to what I said, make sure you have all the documents in place, make sure you do as much due diligence and planning as possible before you get into business. And once you're in business, make sure, you know, just like you go see the dentist twice a year, talk to your attorney at least twice a year, maybe more talk to your accountant, you know, more than tax season, talk to your banker more than when you go need money, you know, always have their ear, you know, ask them. for help, ask them for advice, even when you don't need it whatever, just have a nice conversation with them. That way you're always in their mind. You're always front and center. You're always, you know, putting new ideas in the business or whatever. You're always proactively out there trying to make things better, trying to improve things, update your contracts, update your agreements of what you can do at the local level, at the franchisee level. Don't just do it in a reactionary way. And you know, that's going to minimize a lot of potential issues as you go on. Yeah, that's really good advice. So for someone listening, who's considering franchise ownership or even starting a business, an independent business on their own, what are the first two or three legal steps that they should take right away before they get started? Sure, mean, to start a business in general, like I said, you want to have a written business plan before you do anything. It's the who, what, when, where, why, how of what you're going to do. And then, you know, get with a business law attorney, get with an accountant, get with a banker before you do anything and figure out what's the best business organization for you from a legal standpoint, from a tax standpoint, from a financial standpoint and implement it. Make sure you have the documents in place before you do it. do it correctly, do it the right way. And then if you want to get into a franchise, you know, if you want to go through a franchise broker or, you know, go to trade shows or do whatever it is, make sure it's the right franchise for you. Make sure you understand what the time money commitments, what the, you know, the, uh, you know, outlay is before you get into it. Because if you're in the wrong franchise, no matter how eager you are, no matter how much money you are, no matter smart you are, you're going to have problems. Yeah, I think that validation piece is so critical, especially on the franchise side, where you already have this network of people doing this thing and you can ask them about it before you really commit to anything, know, financially or legally, you can say, how's it going? Are you happy? Are you making money? Would you do it again? And there's a lot of really good questions you can arm yourself with to make sure you know what you're getting into. And of course, business ownership is unpredictable and linear and there's going to be surprises, but To limit those things is going to be an advantage for an owner. So that's good stuff. So Matthew, anything else you want to add to the mix before we wrap up today? No, just like I said, you know, bring in your group of professionals, no matter what business you're in, make sure, you know, they're allied with you, not necessarily your franchisor. You can have your own accountant, your own attorney, your own banker. You don't have to use who they say. You can use who they say and have your own people as well, just as a second set of eyes, second opinion. And just, you know, go make sure you comply with all the documents, comply with all the law, do all the due diligence. do everything objectively, uniformly, and hopefully you'll either succeed or fail based on the merits instead of technicalities, and that's all you can ask for. That makes sense. Well, Matthew, thank you so much for your insights. And if anyone listening would like to connect with Matthew to learn more about his legal services, contact me at franchiseqb.com and I'll get you connected. also put your link here in the when I publish the article. And thanks so much for taking the time to get in the huddle with us today. Thanks for having me, Mike. Appreciate it. You got it.