FTC, Marijuana

Want To Be The McDonald's Of Marijuana? Fat Chance

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 a marijuana franchisee.

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Right up there with most cannabis colleges and almost all publicly traded marijuana companies, I am always cautioning my clients about marijuana franchising. Do not be wooed by glitzy pitches of your becoming the new owner of the next “McDonald’s of marijuana.”

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 sometimes to even 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, etc.) and pay its franchisor a percentage on 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 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 must include 23 areas of background on the franchisor, including a list of other franchisees in the licensed territory, 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 ensure the franchisee has sufficient information to make an informed decision on becoming a franchisee. Many states also have their own franchise laws as well.

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. I am not aware of any state policing cannabis franchising.

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  1. 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 anyone other than an in-stater from owning a franchise. Most states have or likely will have rules regarding financial investment caps into a given marijuana entity that would make franchising 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.
  1. 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 the marijuana industry. Not yet anyway.
  1. Profitability.Nearly all marijuana businesses are still in startup mode, struggling to make a steady profit. One of the main reasons to pay for a franchise 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? Very few, if any at all.
  1. 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 comes close to that?  How many of those have any sort of branding clout outside their own state? Virtually 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 a 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? If the franchisor cannot or will not answer these questions, be prepared to walk away.

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P.S. If you’re interested in starting a marijuana law practice — or if you’d like to learn about the steps it will take to open a dispensary legally in your state — please attend Above the Law’s Marijuana Law event this summer in Denver, Colorado, where I’ll be a panelist. I look forward to seeing you there and helping you learn the ins and outs of this complicated and rewarding practice area.

Hilary Bricken is an attorney at Harris Moure, PLLC in Seattle and she chairs the firm’s Canna Law Group. Her practice consists of representing marijuana businesses of all sizes in multiple states on matters relating to licensing, corporate formation and contracts, commercial litigation, and intellectual property. Named one of the 100 most influential people in the cannabis industry in 2014, Hilary is also lead editor of the Canna Law Blog. You can reach her by email at hilary@harrismoure.com.

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