The Fractional Franchise Exemption
Under the Federal Franchise Rule, the sale of "fractional franchises" are exempt from franchise regulation relating to the development and disclosure of a FDD to prospective franchisees. That is, if the franchise opportunity that you are selling qualifies as a fractional franchise then you may be exempt from franchise regulation.
A fractional franchise typically exists as a supplemental business that is added onto an existing business that is operated by an individual or group that already possesses significant industry experience. The most typical example of a potential fractional franchise would be the operator of a large box retail chain adding a small franchised location to their corporate owned retail store, i.e., a Walmart adding a kiosk vision center.
When evaluating the fractional franchise exemption it is important to know that this exemption is extremely limited, applies to very few franchise opportunities and is not recognized by every state. So, before proceeding with any claim that you are exempt from the federal franchise laws under a fractional franchise exemption, you need to proceed with caution.
Two Elements Required to Qualify as a Fractional Franchise
Under the FTC Franchise Rule, a fractional franchise exists where the following two elements are met:
- Existing Industry Experience. The prospective franchisee (i.e., your fractional franchisee) possesses more than two years of experience in the same type of business as the business that your franchise offers; and
- Limited Sales. You and your prospective fractional franchisee have a reasonable basis to believe that the anticipated sales that your fractional franchisee will generate from the operations of the fractional franchise will not exceed 20% of the overall revenues generated by the fractional franchisee's entire business operations.
When evaluating industry experience, you may consider and evaluate the experience of the prospective fractional franchisee's directors, officers, parent company and even affiliate company. The industry experience that these individuals or entities must possess must be in the "same line of business" as the business in which the fractional franchise will operate.
The purpose of the fractional franchise exemption is to allow large experienced players in retail and other industries to add supplemental franchise brands without the requirements of franchise regulation. A determination as to whether or not a fractional franchise exists is case and fact specific to the existing business operations and revenues of your prospective franchisee and must be approached with caution. The fractional franchise model must be adopted because it fits a very precise strategy and plan for your franchise system. The fractional franchise exemption is not and should not be viewed as an alternative to franchising your business.