In general, selling and offering a franchise is regulated by state and federal franchise laws. Registering a franchise often impacts the sale and offer of a franchise, so it is important to know when registration is required. In Illinois, franchisors are required to register before offering and selling franchises. Having to register before offering and selling a franchise can be frustrating for a franchisor because registration can take a long time and be expensive. As a result, franchisors are often stuck waiting for a registration to finalize, when they can be offering and selling their franchise.
Luckily, Illinois has several exemptions from registration. These exemptions can be based on the different types of transactions or can be based on the characteristics of franchisors and potential franchisees. If one of these exemptions apply, then franchisors can avoid the registration process and sell their franchise a lot sooner.
The seasoned or large franchisor exemption is available to franchisors if they meet certain net worth and experience standards. For example, McDonald’s does not have to register in most states because it meets the net worth and experience standards. In Illinois, the net worth standard is $5 million or $1 million if the parent company has a net worth of $5 million. Ill. Admin. Code tit. 14, § 200.202(e). The experience standard requires franchisors to have 5 years in the business with at least 25 franchisees in its franchise system. Ill. Admin. Code tit. 14, § 200.202(e). Up to 3 years can be satisfied by conducting “substantially the same” business as the offered franchise. Ill. Admin. Code tit. 14, § 200.202(e). There is also a “jumbo” option that requires a net worth of $15 million or $1 million if the parent company has a net worth of $15 million. 815 Ill. Comp. Stat. Ann. 705/8(a). However, experience is not required under the “jumbo” option.
The large franchisee exemption is like the large investment exemption in that the exemption is available to franchisors when potential franchisees have strong bargaining positions. The net worth standard is $5 million, and the potential franchisee must have at least 5 years of experience. 815 Ill. Comp. Stat. Ann. 705/8(a).
The large investment exemption is available to franchisors when the franchisor and potential franchisee have relatively equal bargaining power and business expertise. If the potential franchisee can afford a large investment, then it is more likely that the potential franchisee is experienced in business and has the resources to protect itself. In Illinois, the initial investment amount must be $1 million. Additionally, franchisors must submit certain information to the Attorney General to apply for the exemption.
The insider exemption is available to franchisors if potential franchisees are already associated with franchisors. The idea is that “insiders” are knowledgeable about the franchise business, so Illinois is less concerned about sophistication or experience issues. “Insiders” are generally officers, directors, general partners, managers, or franchise administrators of the franchisor. 815 Ill. Comp. Stat. Ann. 705/8(a). Potential franchisees must have at least 2 years of experience with the franchisor (within 60 days of the transaction). 815 Ill. Comp. Stat. Ann. 705/8(a). Further, potential franchisees having ownership (within 60 days of the transaction) must have at least a 25% interest in the franchisor. 815 Ill. Comp. Stat. Ann. 705/8(a).
The institutional franchisee exemption is available to franchisors when a sale or offer is made to an institution. For example, an offer or sale of a franchise to a bank is exempt. Ill. Admin. Code tit. 14, § 200.202(a). Other institutions include trust and insurance companies. 815 Ill. Comp. Stat. Ann. 705/8(b). Overall, Illinois is less concerned about protecting these types of purchasers.
The single sale franchise exemption is available to franchisors who wish to avoid registration requirements by limiting the number of franchises offered for sale. In Illinois, the number of franchise sales is limited to 2 sales in any 12-month period. Ill. Admin. Code tit. 14, § 200.202(b).
The out of state franchise exemption is available to franchisors when a state allows them to sell outside the state to non-residents. First, franchisors in Illinois must ensure that potential franchisees are not domiciled in Illinois. 815 Ill. Comp. Stat. Ann. 705/10. Second, the franchise offer must not be made or accepted in Illinois or the franchise business must not be located in Illinois. 815 Ill. Comp. Stat. Ann. 705/10.
The renewal of an existing franchise agreement exemption is available to franchisors that already have agreements with potential franchisees. Illinois only requires that there be no interruption in the operation of the franchise business by the potential franchisee. 815 Ill. Comp. Stat. Ann. 705/7.
The sale by existing franchisee exemption is available to franchisors when the franchisor is not involved in the sale. In other words, if the franchisee’s sale is for its own account and is not “effected by or through” the franchisor, then the franchisor may be exempt from registration. 815 Ill. Comp. Stat. Ann. 705/7.
The exemption by order depends on whether the franchise is within the purpose of its franchise rule and whether the franchise is in the public interest. For example, registration may not be necessary for the protection of potential franchisees, for the investment involved, or for the character of the offering. 815 Ill. Comp. Stat. Ann. 705/9.
Aside from these exemptions, certain transactions or interests are excluded from the definition of a franchise. These include fractional franchises, nominal fees, leased departments, and franchise relationships covered by the Petroleum Marketing Practices Act (PMPA).
The fractional franchise exclusion is available to franchisors when a franchise is only a small percentage of the potential franchisee’s business. A “fractional franchise” is meant to allow an existing business to add new, but similar products or services. Potential franchisees must have at least 2 years of experience in the same type of business. 815 Ill. Comp. Stat. Ann. 705/3(1). Also, franchisors and potential franchisees must anticipate that sales from the franchise will not be more than 20% of the total sales in the first year of business. 815 Ill. Comp. Stat. Ann. 705/3(1).
The nominal franchise fee exclusion is available to franchisors when annual franchise fees are only nominal. For example, in Illinois, the franchise fee cannot be more than $500. 815 Ill. Comp. Stat. Ann. 705/3(1).
The leased departments exclusion is available to franchisors when a business is operated on the franchisor’s premises and is incidental to the franchisor’s business. 815 Ill. Comp. Stat. Ann. 705/3(1).
Again, if an exemption applies, franchisors can skip the registration process. Keep in mind that these exemptions are specific to Illinois and can be very different than federal exemptions. Additionally, there are some Illinois exemptions that may impact disclosures, but not registration, and vice versa. Thus, it is important to consider how federal and state exemptions interact with each other when registering, selling, and offering a franchise.