Franchising 101

Franchising is a very popular form of entrepreneurship in Canada.  After all, buying into a proven business concept makes sense to a lot of people.  The basic underlying principle in all franchises is that the franchisor retains control over the franchisee's business in return for the use of the name, and by virtue, obtaining the advantage of the franchisor's goodwill. Franchisors retain a significant level of control over the franchisee, which distinguishes this relationship from that of a licensing arrangement, where there is little or no control.  The franchise's advertising and purchasing power is also a benefit to a local franchisee, and the research, development and training provided by the franchisor are likely beyond the financial capacity of an individual franchisee.

However, before you buy into a franchise you should consider a couple things.  First, location, location, location.  A poor location can significantly curtail your profits.  Second, the high level of compensation paid to the franchisor could eliminate many of the advantages that a franchise offers.  Third, the degree of control to which you are subject, as franchisee, can be troublesome and restrictions on transfer can affect the franchisee's marketability.  Finally, a franchise model can lead to an element of uncertainty as the franchise agreements are generally for a specific term.  

In Alberta, every franchisor must give every prospective franchisor a copy of its disclosure document, and a franchisee has the right to rescind all franchise agreements with a franchisor if the franchisor fails to provide a disclosure document within the time restrictions set out in the Franchises Act.  Before you jump into a franchise, make sure it's in the right location and has the right business model, and make sure you do your due diligence and go through your franchise agreement in detail. 

Exceptions to the Principle of Limited Liability for Shareholders

An often cited advantage of incorporation is that it provides shareholders with a shield from personal liability arising out of the operation of the business.  However, in Alberta, there are certain exceptions to the principle of limited liability and personal liability to a shareholder could occur under certain instances, for example, when:

• A shareholder signs a personal guarantee for the corporation's debts
• A shareholder has contracted personally without giving adequate notice to a third party that he or she was acting as an agent for the corporation
• Loss occurs as a result of a shareholder's personal act or negligence of a shareholder
• A shareholder has not fully paid for his or her shares
• Money or property was paid or distributed to a shareholder as a consequence of a reduction of capital contrary to the Business Corporations Act (Alberta)
• A shareholder has assumed powers of a directed under a unanimous shareholders agreement
• A shareholder has received over-payments on liquidation
• A court has "lifted the corporate veil"

Unanimous Shareholder Agreements: Considerations for Venture Start-Ups

A common discussion that takes place among founders of a venture start-up is the question of whether a unanimous shareholders agreement (USA) should be established. Generally speaking, a USA is an effective means of controlling the terms on which shareholders may sell their shares in the start-up entity. Most USAs will provide certain pre-emptive rights to purchase shares sold by other shareholders and may also include rights of first refusal, shot-gun provisions and other useful contractual rights. However, for growth companies, that is, companies whose products or services are likely to take off quickly and therefore the need to raise capital at various stages will become increasingly relevant, a USA has it downfalls.

Under many jurisdications, a USA removes power over the company from the directors and confers it on the shareholders. The number of shareholders in a growth company could quickly increase. Under its terms, subsequent shareholders become party to the USA and therefore incur, as shareholders, power over decision making functions for the company. In most cases, a growth company will include a number of passive investors who generally don't wish to be included in the day to day operations. A multiplicity of parties to a USA can lead to a cumbersome decision making process which in turn could be a competitive disadvantage to the growth company.

The automatic inclusion of new shareholders as parties to the agreement can lead to other problems (sometimes significant) when considering the share transfer rights contained in the USA as they apply to a company that is growing quickly. New shareholders may include venture capital investors or other institutional investors with signficant financial resources. Shareholders without financial means run the risk of being bought out by these wealthier shareholders right as the business is on the cusp of really taking off.  Also, an offer to purchase shares, exercised under a traditional shot-gun clause, could lead to unexpected share shuffling.  For example, if one shareholder makes an offer to the other shareholders, some of the shareholders may agree to sell their shares to that shareholder, while concurrently, the other shareholders would opt to buy the offering shareholders shares.

All in all, each situation is different, and before entering into a USA you should take a look at your business and its prospects for growth, and with the help of your professional adviser set up an arrangement that is in the best interests of your business.

Welcome to Innovators Law

Welcome to Innovators Law, a weblog /educational resource for innovators, entrepreneurs for the legal, business and stragetic considerations they encounter. On this weblog, timely discussion topics will be posted that will help business owners and entrepreneurs to grow their business and understand the various legal issues that arise in the course of a start-up enterprise. This weblog will also feature relevant discussions for owners at all stages of business growth. A particular emphasis will be placed on venture and growth businesses and various issues that are encountered in the process of raising capital and moving their business from idea stage to revenue generation. Also, this weblog will survey and discuss new literature, writings and ideas in the areas of venture business and real estate development and investment, as well as management, leadership and strategic planning. Please feel free to contact me at rjc@petersonshields.com if you have any comments about any of the posts on this weblog.