Right up there with cannabis colleges and publicly traded marijuana companies, we caution our readers on marijuana franchising. Do not be wooed by glitzy pitches of you becoming the new owner of the next “McDonald’s of marijuana” in your area.
What is franchising? Based in securities law, franchising involves a supplier — the franchisor — who permits an independent operator/franchisee to use the supplier’s trademarks, distribute the supplier’s distinct goods, and even to use the supplier’s building design. In exchange for this, the franchisee pays the franchisor a fee, all of which is memorialized in a franchise agreement. For example, to open a McDonald’s franchise you typically must pay at least $45,000 to McDonald’s and to open a UPS Store franchise you typically must pay UPS at least $29,950. The franchisee is then usually required to buy all (or at least most) of its supplies from its franchisor (think cups, burgers, napkins, french fries) and to pay its franchisee a percentage of all sales. Franchisors usually maintain substantial control over the operations of its franchisees and, in return, they usually provide those franchisees with branding and marketing support. Franchising is not to be confused with licensing which is governed by contract law and typically only entails one company giving another company the right to use intellectual property (such as a trademark) pursuant to a licensing agreement
The Federal Trade Commission has oversight of franchising via the FTC Franchise Rule. Before execution of a franchise agreement and before any money can change hands between a franchisor and a franchisee, the FTC requires that franchisors furnish potential franchisees with a Franchise Disclosure Document (FDD). The FDD must be very detailed and usually must include audited financial statements from the franchisor. The FDDs also include 23 areas of background on the franchisor including a list of other franchisees in the licensed territory (including who the potential franchisee may contact and consult before negotiations with the franchisor), restrictions on sources of products and services, intellectual property and trademarks possessed by the franchisor, the business experience of the franchisor, any bankruptcies or litigation involving the franchisor, earnings claims, and the estimated total franchise revenues and franchisor profitability. Federal law requires this information be given to the franchisee to enable the franchisee to have sufficient information with which to make an educated decision regarding whether to become a franchisee in a given franchise program. Many states also have their own franchise laws and some of these require that the FDD contain state-specific requirements.
How does marijuana franchising fit into all this? It really doesn’t. At least, not yet, and not in a way in which a reasonable person would want to participate. Here’s why:
1. Federal conflict and lack of state oversight. Marijuana is still a federally illegal controlled substance. This means that a franchisee could be subject to arrest and prosecution for violating the federal controlled substances act — if this is not in your potential franchisor’s Franchise Disclosure Document, you should be worried. As far as we know, the states have not yet begun policing cannabis franchising.
2. State marijuana regulations. Certain states explicitly preclude cannabis franchising in their cannabis regulations. For example, in Washington state, cultivators are currently limited to one production license associated with one business entity, so franchising simply cannot work for cultivators. In addition to this, strict state residency rules may prohibit ownership of a franchise by anyone other than in-staters. Most states have or likely will have rules regarding financial investment caps into a given marijuana entity that would make franchising either difficult or impossible. Most states also have laws prohibiting revenue-sharing between certain interested parties or marijuana business licensees that too would render franchising illegal.
3. Predictability. Until marijuana is legal federally — and even then we do not know what shape legalization will take –marijuana businesses operate from federal enforcement memo to federal enforcement memo. State marijuana laws are also in a constant state of flux. A new president in 2016 could stymie the entire momentum of legalization as we know it. All of this makes marijuana business profits less predictable than that of a burger chain. Franchising is an investment by a franchisee into the franchisor’s business model, brand, and corporate livelihood. That sort of stability just is not and cannot be there in marijuana. At least not yet.
4. Profitability. Nearly all marijuana businesses are still in start-up mode, struggling to make a steady profit. One of the main reasons to pay to become and remain a franchisee is to benefit from the franchisor’s economic strength, which it can use to advertise and to market in a way that benefits all franchisees. How many marijuana businesses have that kind of financial firepower? Again, most do not yet.
5. Limited branding power. The value of franchising lies mostly in the franchisor’s intellectual property like trademarks, copyrights, patents, company ethos, policy manuals, business procedures, and trade secrets. Think of Starbucks and its world-renowned green and white colors, its baristas all clad in black, and its distinct coffeehouse feel. What marijuana business even comes close to that? Now, how many of those have that sort of branding clout outside their own state? Almost none.
Marijuana franchising is highly questionable from both a legal and an economic standpoint. So, before you pony up a robust franchise fee, at least make sure you know what you would really be getting as marijuana franchisee. Who is the alleged franchisor and what is their record of business? What are the risks of such an investment? What are the details of the franchise agreement? Is that agreement even enforceable? What are the state and local laws in play? Who other than the lawyers, the accountants, and the franchisor are really going to benefit?
For a feasible alternative to franchising, be sure to check out Marijuana Licensing Works Well When Done Well.