Incorporation—Is It For You?
It appears to me that many, if not most, franchisees are now entering into store agreements in a corporate capacity rather than as individuals. On the other hand, most franchisees who signed or renewed an agreement some years ago are still operating as individuals. That’s probably because SEI only began, a relatively short time ago, to enter into new agreements with corporations or to permit existing individual franchisees to transfer his or her agreement to a corporation. In fact, two or more unrelated individuals can be shareholders in such a corporation with the consent of SEI. Should those non-incorporated franchisees consider assigning the agreement to a corporation?
The answer is probably yes—but there are both accounting and legal issues to consider. Most accountants, in my experience, would favor incorporation for tax benefits. In fact, they would probably favor Limited Liability Companies (LLCs) even more, but at this time SEI will not enter into agreements with an LLC, although this policy may change in the near future. Attorneys, on the other hand, will invariably recommend conducting any business under the umbrella of a corporation—and most assuredly, a 7-Eleven store—for the following reasons.
Probably the biggest risk for any business is that of personal injury to a third person (not an employee for which Worker’s Compensation comes into play) by reason of the negligence of the owner. Even where there has been no negligence, practical considerations often dictate huge settlements to avoid the risk of a jury verdict many times the amount of the settlement.
In today’s real world, a slip and fall in your store or the sale of a tainted product that results in a serious injury or illness could mean liability in the millions of dollars. Does that happen on a frequent basis? No. Can it happen? Absolutely, and you should make every effort to protect your personal assets in the event of such an occurrence.
You do have some protection under the indemnity amendment of your store agreement (Exhibit C) for personal injury to third persons in the amount of $500,000 per occurrence, but that amount falls far short of the amount of protection needed. Moreover, there are certain exclusions from this indemnity, most notably with respect to the sale of fresh foods after notification to you of a vendor’s failure to either submit the product to a microbiological test, or the actual failure of the test. Any intentional act by you or your employee (assault, etc.) is also excluded.
Of course, additional private insurance is available, and I have continuously urged that franchisees obtain such insurance with coverage of at least $1 million, and perhaps $2 million. My experience however, is that most owners either neglect to buy insurance or simply can’t afford it.
Operating under the protection of a corporation would not—in the event of a catastrophic injury to a customer—shield you from the loss of your franchise business, but there is not much that the business owns since SEI owns or leases the premises and leases the equipment. The real danger is the loss of your other personal assets (home, savings, investments) if an injured party gets a judgment against you that exceeds the indemnified amount of $500,000.
Transferring your store agreement to a corporation in which the signatories on the agreement are the only stockholders is not a difficult or expensive process, but because of specific language required by SEI that must be incorporated into the Articles of Incorporation and By-Laws, and because of the multi-step approval process by the SEI legal department, the transfer should be handled by an attorney. The rules are not complex. For your purposes, the only shareholders of the corporation can be the original signatory(ies) to the store agreement; the only business of the corporation is the operation of one or more 7-Eleven stores; and no shares may be issued, encumbered, assigned or transferred without the prior written consent of SEI. In other words, you cannot sell all or any part of your interest in the franchise by simply issuing shares of stock to a person not a signatory to the store agreement or not subsequently approved by SEI.
Once the store agreement is transferred to a corporation, there will be the need to also transfer your liquor, lottery, health, and other licenses, but this is not a major problem and SEI will be of help to you.
It is absolutely essential, to get the benefit of corporate protection against personal liability, that you hold your business out as a corporate entity in an unmistakable manner. This means that all business documents such as checks, letterheads, business cards, etc., must have the corporate name imprinted making sure the “Inc.” or “Corp” is at the end of the name. It is also essential that your vendors invoice you under the corporate name and not your individual name or 7-Eleven Store Number, and that you sign all documents with your corporate title. For instance “John Doe, President” or “Jane Doe, Secretary.” Above all, avoid personally guaranteeing corporate debt if at all possible. However, SEI will require that the individuals guarantee any debt to SEI.
Also, keep in mind that you will become an employee of the corporation and therefore will be subject to withholding taxes, FICA, Medicare, and the like. You will also receive a W-2 at the end of the year.
This is a matter that should be given serious thought. Any questions? Give me