California is a franchise registration state that requires franchisors to register their FDD before selling a franchise in the state. However, there are a limited number of exceptions to California's FDD registration requirements. These registration exemptions are stated in Section 31100 of the California Franchise Investment Law and relate to a series of transactions where the state believes that the protections afforded by FDD registration may not be required. These exemptions are typically based on the financial capabilities or experience of the franchisor or franchisee.
California's FDD registration exemptions include:
- Sophisticated Franchisee Exemption
- Experienced Franchisee Exemption
- Large Franchisor Exemption
- Fractional Franchise Exemption
- Out of State Franchise Sales Exemption
Review all Facts with Your Franchise Lawyer. Application of FDD registration exemptions are fact specific and require a careful review of California law with your franchise lawyer. Each exemption requires a careful analysis and a more detailed analysis that goes beyond the scope of this guide. If an exemption applies, you are still required to disclose a properly issued FDD and you may be required to file an exemption notice with the state. Below we provide a general overview of each exemption.
To learn more about how we can assist with your FDD registrations and exemptions, contact us at (800) 976-4904 or fill out our contact form.
Sophisticated Franchisee Exemption
California's sophisticated franchisee exemption is stated in Section 31109 of the Franchise Investment Law. Under this exemption, if the franchise buyer satisfies specific net worth and generalized business experience and sophistication requirements, the franchise sales transaction may be exempt from FDD registration requirements.
To qualify for the sophisticated franchisee exemption, each condition must be satisfied:
- Net Worth and Income Requirements - If the franchisee is a corporate entity the corporate entity must posses assets exceeding $5.0M. If the franchisee is an individual the franchisee's net worth or joint net worth with a spouse must exceed $1.0M (excluding personal residence and retirement accounts) or the franchisee's individual gross income must exceed $300,000 per year ($500,000 per year if measured as joint income with a spouse) during the past three years. This net worth and income requirement is not necessary if the franchise buyers (all of them) are also are also partners, executive officers, or directors of the franchisor.
- General Business Experience - Each and every purchaser of the franchised business must possess business experience, either alone or with business advisors, such that the franchisor possesses a reasonable basis to believe that each purchaser possesses the ability to evaluate the merits and risks of the franchise investment.
- 10% Payment Limit - To make the franchise investment the immediate cash payment by each purchaser will not exceed 10% of that persons net worth or joint net worth with a spouse. Net worth excludes personal residence and retirement accounts.
- Notice of Exemption - Franchisor must file a Notice of Exemption and pay a $450 filing fee before offering or selling a franchise to a sophisticated franchisee.
Application of this exemption is fact specific and requires a careful analysis of the Franchise Investment Law which includes additional details that must be satisfied before relying on this exemption. For example when measuring a corporate franchisees net worth, the franchisee's financial statements must be not more than 90 days old and must be prepared in accordance with GAAP. There are many other nuances and requirements that must be evaluated as to this and all other exemptions referenced in this guide.
Experienced Franchisee Exemption
California's experienced franchisee exemption is stated in Section 31106 of the Franchise Investment Law and applies to franchise sales transactions that involve franchise purchasers that possess industry specific experience or experience as a franchisor insider or existing franchisee .
To qualify for the experienced franchisee exemption, one of the following experience requirements must be satisfied:
- Industry Specific Experience - At least one owner of the prospective franchisee, with at least a 50% interest in the franchisee, must possess not less than 24 months of experience "being responsible for the financial and operational aspects of a business offering products or services substantially similar to those offered by the franchised business." To qualify, the 24 months of experience must have occurred within seven years of the franchise sales transaction and the experienced franchisee cannot be owned or controlled by the franchisor.
- Franchisor Insider Experience - At least one owner of the prospective franchisee, with at least a 50% interest in the franchisee, must, within 60 days prior to the franchise sales transaction, have been an officer, director, managing agent, or a not less than 25% owner of franchisor, for not less than 24 months. This owner cannot be controlled by the franchisor.
- Experienced Existing Franchisee - The franchise transaction either: (a) involves the sale of an additional franchise to an existing franchisee of the franchisor where, for 24 months or more, the existing franchisee has been engaged in a business offering products or services substantially similar to those offered by the franchised business; or (b) involves the sale of a franchise to an entity where one or more of the officers, directors, managing agents, or owner of franchisee that possesses a not less than 25% ownership interest in a franchisee of franchisor, where, for 24 months or more, such qualifying person has been engaged in a business offering products or services substantially similar to those offered by the franchised business.
For franchisors that rely on this experienced franchisee exemption, within 15 calendar days of the franchise sales transaction, a Notice of Exemption must be filed with the California Department of Financial Protection and Innovation. There is a $450 filing fee.
Large Franchisor Exemption
California's large franchisor exemption exemption is stated in Section 31101 of the Franchise Investment Law. Under this exemption, if the franchisor satisfies specific net worth, experience, disclosure, and notice filing requirements, franchise sales may be exempt from California's FDD registration requirements.
To qualify for the large franchisor exemption, each condition must be satisfied:
- Net Worth - The net worth requirement is satisfied where: (a) the franchisor has a net worth, on a consolidated basis, of not less than $5.0M; (b) the franchisor has a net worth of not less than $1.0M and, the franchisor's parent company has a net worth of not less than $5.0M, as reported in their respective audited financial statements; or (c) the franchisor has a net worth of not less than $1.0M as reported in the franchisor's unaudited financial statements and, and the franchisor's parent company has a net worth of not less than $5.0M, as reported in the parent company's audited financial statements and where the parent company absolutely and unconditionally agrees to assume the duties and obligations of the franchisor under the franchise agreement if the franchisor should become unable to perform its duties and obligations. To qualify as a parent company, the parent company must own and control not less than 80% of the franchisor. When measuring net worth, a franchisor and parent may rely on the preceding fiscal years financial statements for a period of 15 months commencing from the preceding fiscal year end date.
- Franchised Business Experience - The franchise experience requirement is satisfied where the Franchisor or a parent company that owns not less than 80% of franchisor has either: (a) had at least 25 franchisees conducting business that is the subject of the franchise; or (b) conducted business that is the subject of the franchise.
Franchisor's that rely on the large franchisor exemption, as with other FDD registration exemptions, must properly disclose franchisee candidates with their FDD. Prior to relying on the seasoned franchisor exemption, a Notice of Exemption must first be filed with the California Department of Financial Protection and Innovation. There is a $450 filing fee.
Fractional Franchise Exemption
California's fractional franchise exemption is stated in Section 31108 of the Franchise Investment Law and applies to franchise sales transactions where the franchise sale adds a new product or service line to the existing business of a prospective franchisee.
To qualify for the fractional franchise exemption, each condition must be satisfied:
- Addition to Existing Business - For not less than 24 months preceding the franchise sale, the prospective franchisee must of been engaged in a business offering products or services substantially similar or related to those to be offered by the franchised business. If the prospective franchisee is a corporate entity then an existing officer, director, or managing agent of the prospective franchisee must have been an officer, director, or managing agent during the preceding 24 month period.
- Substantially Similar - The new product or service of the franchised business must be substantially similar or related to the product or service offered by the prospective franchisee's existing business.
- Same Business Location - The franchised business is to be operated from the same business location as the prospective franchisee's existing business.
- Less than 20% of Gross Sales - Franchisor and Franchisee anticipate, in good faith and at the time of entering into the franchise agreement, that sales resulting from the franchised business will not constitute more than 20% of the franchisee's total annual sales.
Prior to relying on the fractional franchise exemption, a Notice of Exemption must first be filed with the California Department of Financial Protection and Innovation. There is a $450 filing fee.
Out of State Franchise Sales Exemption
If the franchise sale is to a franchisee that is not a resident of the State of California and relates to a franchised business that will be developed and operated outside the State of California, then California FDD registration is not required even if, as franchisor, you are operating your franchise company from California.
Specifically, Franchise Investment Law Section 31105 states that "Any offer, sale or other transfer of a franchise, or any interest in a franchise, to a resident of another state or any territory or foreign country, shall be exempted from the provisions of Chapter 2 (commencing with Section 31110) of this part, if all locations from which sales, leases or other transactions between the franchised business and its customers are made, or goods or services are distributed, are physically located outside this state."