Business Concepts
Capitalization rate (or "cap rate") is the ratio between the net operating income produced by an asset and its capital cost (the original price paid to buy the asset) or alternatively its current market value.[1] The rate is calculated in a simple fashion as follows:
For example, if a building is purchased for $1,000,000 sale price and it produces $100,000 in positive net operating income (the amount left over after fixed costs and variable costs are subtracted from gross lease income) during one year, then:
If the owner bought the building twenty years ago for $200,000, his cap rate is
As another example of why the current value should be used, consider the case of a building that is given away (as an inheritance or charitable gift). The new owner divides his annual net income by his initial cost, say,
From this, we see that as the value of an asset increases, the amount of income it produces should also increase (at the same rate), in order to maintain the cap rate.
Capitalization rates are an indirect measure of how fast an investment will pay for itself. In the example above, the purchased building will be fully capitalized (pay for itself) after ten years (100% divided by 10%). If the capitalization rate were 5%, the payback period would be twenty years. Note that a real estate appraisal in the U.S. uses net operating income. Cash flow equals net operating income minus debt service. Where sufficiently detailed information is not available, the capitalization rate will be derived or estimated from net operating income to determine cost, value or required annual income. An investor views his money as a "capital asset". As such, he expects his money to produce more money. Taking into account risk and how much interest is available on investments in other assets, an investor arrives at a personal rate of return he expects from his money. This is the cap rate he expects. If an apartment building is offered to him for $100,000, and he expects to make at least 8 percent on his real estate investments, then he would multiply the $100,000 investment by 8% and determine that if the apartments will generate $8000, or more, a year, after operating expenses, then the apartment building is a viable investment to pursue.
Use for valuation In real estate investment, real property is often valued according to projected capitalization rates used as investment criteria. This is done by algebraic manipulation of the formula below:
This is often referred to as direct capitalization, and is commonly used for valuing income generating property in a real estate appraisal.
One advantage of capitalization rate valuation is that it is separate from a "market-comparables" approach to an appraisal (which compares 3 valuations: what other similar properties have sold for based on a comparison of physical, location and economic characteristics, actual replacement cost to re-build the structure in addition to the cost of the land and capitalization rates). Given the inefficiency of real estate markets, multiple approaches are generally preferred when valuing a real estate asset. Capitalization rates for similar properties, and particularly for "pure" income properties, are usually compared to ensure that estimated revenue is being properly valued.
Cash flow defined The capitalization rate is calculated using a measure of cash flow called net operating income (NOI), not net income. Generally, NOI is defined as income (earnings) before depreciation and interest expenses:
Although cash flow is the generally-accepted figure used for calculating cap rates, this is often referred to under various terms, including simply income.
Use for comparison Capitalization rates, or cap rates, provide a tool for investors to use for roughly valuing a property based on its Net Operating Income. For example, if a real estate investment provides $160,000 a year in Net Operating Income and similar properties have sold based on 8% cap rates, the subject property can be roughly valued at $2,000,000 because $160,000 divided by 8% (0.08) equals $2,000,000. A comparatively lower cap rate for a property would indicate less risk associated with the investment (increasing demand for the product), and a comparatively higher cap rate for a property would indicate more risk (reducing demand for the product). Some factors considered in assessing risk include creditworthiness of a tenant, term of lease, quality and location of property and general volatility of the market.
Debt Coverage Ratio
The debt service coverage ratio (DSCR), is the ratio of cash available for debt servicing to interest, principal and lease payments. It is a popular benchmark used in the measurement of an entity's (person or corporation) ability to produce enough cash to cover its debt (including lease) payments. The higher this ratio is, the easier it is to obtain a loan. The phrase is also used in commercial banking and may be expressed as a minimum ratio that is acceptable to a lender; it may be a loan condition or covenant. Breaching a DSCR covenant can, in some circumstances, be an act of default.
Uses In corporate finance, DSCR refers to the amount of cash flow available to meet annual interest and principal payments on debt, including sinking fund payments.
In personal finance, DSCR refers to a ratio used by bank loan officers in determining debt servicing ability.
In commercial real estate finance, DSCR is the primary measure to determine if a property will be able to sustain its debt based on cash flow. In the late 1990s and early 2000s banks typically required a DSCR of at least 1.2, but more aggressive banks would accept lower ratios, a risky practice that contributed to the Financial crisis of 2007–2010. A DSCR over 1 means that (in theory, as calculated to bank standards and assumptions) the entity generates sufficient cash flow to pay its debt obligations. A DSCR below 1.0 indicates that there is not enough cash flow to cover loan payments
[Calculation In general, it is calculated by: DSCR = (Annual Net Income + Amortization/Depreciation + other non-cash and discretionary items (such as non-contractual management bonuses)) / (Principal Repayment + Interest payments + Lease payments )
To calculate an entity’s debt coverage ratio, you first need to determine the entity’s net operating income. To do this you must take the entity’s total income and deduct any vacancy amounts and all operating expenses. Then take the net operating income and divide it by the property’s annual debt service, which is the total amount of all interest and principal paid on all of the property’s loans throughout the year. If a property has a debt coverage ratio of less than one, the income that property generates is not enough to cover the mortgage payments and the property’s operating expenses. A property with a debt coverage ratio of .8 only generates enough income to pay for 80 percent of the yearly debt payments. However, if a property has a debt coverage ratio of more than 1, the property does generate enough revenue to cover annual debt payments. For example, a property with a debt coverage ratio of 1.5 generates enough income to pay all of the annual debt expenses, all of the operating expenses and actually generates fifty percent more income than is required to pay these bills.
A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1, say .95, would mean that there is only enough net operating income to cover 95% of annual debt payments. For example, in the context of personal finance, this would mean that the borrower would have to delve into his or her personal funds every month to keep the project afloat. Generally, lenders frown on a negative cash flow, but some allow it if the borrower has strong outside income.
Typically, most commercial banks require the ratio of 1.15 - 1.35 times (net operating income or NOI / annual debt service) to ensure cash flow sufficient to cover loan payments is available on an ongoing basis.
Example Let’s say Mr. Jones is looking at an investment property with a net operating income of $36,000 and an annual debt service of $30,000. The debt coverage ratio for this property would be 1.2 and Mr. Jones would know the property generates 20 percent more than is required to pay the annual mortgage payment.
The Debt Service Ratio is also typically used to evaluate the quality of a portfolio of mortgages. For example, on June 19, 2008, a popular US rating agency, Standard & Poors, reported that it lowered its credit rating on several classes of pooled commercial mortgage pass-through certificates originally issued by Bank of America. The rating agency stated in a press release that it had lowered the credit ratings of four certificates in the Bank of America Commercial Mortgage Inc. 2005-1 series, stating that the downgrades "reflect the credit deterioration of the pool". They further go on to state that this downgrade resulted from the fact that eight specific loans in the pool have a debt service coverage (DSC) below 1.0x, or below one times.
The Debt Service Ratio, or debt service coverage, provides a useful indicator of financial strength. Standard & Poors reported that the total pool consisted, as of June 10 2008, of 135 loans, with an aggregate trust balance of $2.052 billion. They indicate that there were, as of that date, eight loans with a DSC of lower than 1.0x. This means that the net funds coming in from rental of the commercial properties are not covering the mortgage costs. Now, since no one would make a loan like this initially, a financial analyst or informed investor will seek information on what the rate of deterioration of the DSC has been. You want to know not just what the DSC is at a particular point in time, but also how much it has changed from when the loan was last evaluated. The S&P press release tells us this. It indicates that of the eight loans which are "underwater", they have an average balance of $10.1 million, and an average decline in DSC of 38% since the loans were issued.
And there is still more. Since there are a total of 135 loans in the pool, and only eight of them are underwater, with a DSC of less than 1, the obvious question is: what is the total DSC of the entire pool of 135 loans? The Standard and Poors press release provides this number, indicating that the weighted average DSC for the entire pool is 1.76x, or 1.76 times. Again, this is just a snapshot now. The key question that DSC can help you answer, is this better or worse, from when all the loans in the pool were first made? The S&P press release provides this also, explaining that the original weighted average DSC for the entire pool of 135 loans was 1.66x, or 1.66 times.
In this way, the DSC (debt service coverage) ratio provides a way to assess the financial quality, and the associated risk level, of this pool of loans, and shows the surprising result that despite some loans experiencing DSC below 1, the overall DSC of the entire pool has improved, from 1.66 times to 1.76 times. This is pretty much what a good loan portfolio should look like, with DSC improving over time, as the loans are paid down, and a small percentage, in this case 4%, experiencing DSC ratios below one times, suggesting that for these loans, there may be trouble ahead.
And of course, just because the DSC is less than 1 for some loans, this does not necessarily mean they will default. As of the date of the S&P press release, the trust which holds the 135 loans has not experienced any losses.
Cash on cash return
In investing, the cash-on-cash return is the ratio of annual before-tax cash flow to the total amount of cash invested, expressed as a percentage.
It is often used to evaluate the cash flow from income-producing assets. Generally considered a quick napkin test to determine if the asset qualifies for further review and analysis. Cash on Cash analyses are generally used by investors looking for properties where cash flow is king, however, some use it to determine if a property is underpriced, indicating instant equity in a property.
Example Suppose an investor purchases a $1,200,000 apartment complex with a $300,000 down payment. Each month, the cash flow from rentals, less expenses, is $5,000. Over the course of a year, the before-tax income would be $5,000 × 12 = $60,000, so the cash-on-cash return would be:
$ 60,000 / $ 300,000 = 0.20 or 20%
. Limitations
Franchising
Franchising is the practice of using another firm's successful business model. The word 'franchise' is of anglo-french derivation - from franc- meaning free, and is used both as a noun and as a (transitive) verb.
For the franchisor, the franchise is an alternative to building 'chain stores' to distribute goods and avoid investment and liability over a chain. The franchisor's success is the success of the franchisees. The franchisee is said to have a greater incentive than a direct employee because he or she has a direct stake in the business.
However, except in the US, and now in China (2007) where there are explicit Federal (and in the US, State) laws covering franchise, most of the world recognizes 'franchise' but rarely makes legal provisions for it. Only Australia, France and Brazil have significant Disclosure laws but Brazil regulates franchises more closely.
Where there is no specific law, franchise is considered a distribution system, whose laws apply, with the trademark (of the franchise system) covered by specific covenants.
Businesses for which franchising works best have the following characteristics:
Although there are franchises around products – Chanel and other cosmetics, to name the prominent – by and large, the franchises revolve around service firms. At the sub-$80,000 level, they are, by far, the largest number of franchises.These allow a business, combined with family time and a location not far from home. Some franchises are available for a few thousand dollars.
The following US-listing tabulates the early 2010 ranking of major franchises along with the number of sub-franchisees (or partners) from data available for 2004. It will also be seen from the names of the franchise that the US is a leader in franchising innovations, a position it has held since the 1930s when it took the major form of fast-food restaurants, food inns and, slightly later, the motels during the first depression. Franchising is a business model used in more than 70 industries that generates more than $1 trillion in U.S. sales annually (2001 study).Franchised businesses operated 767,483 establishments in the United States in 2001, counting both establishments establishment owned by franchisees and establishments owned by franchisors:
1. Subway (Sandwiches and Salads | Startup costs $84,300 – $258,300 (22000 partners worldwide in 2004). 2. McDonald's | Startup costs in 2010, $995,900 – $1,842,700 (30,300 partners in 2004) 3. 7-Eleven Inc. (Convenience Stores) |Startup Costs $40,500- 775,300 in 2010,(28,200 partners in 2004) 4. Hampton Inns & Suites (Midprice Hotels) |Startup costs $3,716,000 – $13,148,800 in 2010 5. Supercuts (Hair Salons) | Startup Costs $111,000 - $239,700 in 2010 6. H&R Block (Tax Preparation and e-Filing)| Startup Costs $26,427 - $84,094 (11,200 partners in 2004) 7. Dunkin Donuts | Startup Costs $537,750 - $1,765,300 in 2010 8. Jani-King (Commercial Cleaning | Startup Costs $11,400 - $35,050, (11,000 partners worldwide in 2004) 9. Servo-Pro (Insurance and Disaster Restoration and Cleaning) | Startup Costs $102,250 - $161,150 in 2010 10. MiniMarkets (Convenience Store and Gas Station) | Startup Costs $1,835,823 - $7,615,065 in 2010 The midi-franchises like restaurants, gasoline stations, trucking stations which involve substantial investment and require all the attention of a business.
There are also the large franchises - hotels, spas, hospitals, etc. - which are discussed further in Technological Alliances.
Two important payments are made to a franchisor: (a) a royalty for the trade-mark and (b) the training and advisory services given to the franchisee. The two fees may be combined in a single 'management' fee. The fee for the "Disclosure" is separate and is always a "front-end fee".
The franchise is usually for a fixed period (broken down into shorter periods, which need renewal) and are for a specific "territory" or miles from location. There may be several such locations. Agreements typically last from five to thirty years, with premature cancellations or terminations of most contracts bearing serious consequences for franchisees. A franchise is merely a temporary business investment, involving renting or leasing an opportunity, not buying a business for the purpose of ownership. It is classified as a wasting asset due to the finite term of the license.
The franchise can be an exclusive, non-exclusive or 'sole and exclusive'. Although franchisor revenues and profit may be provided in a franchise disclosure document, no laws require the estimate of franchisee profitability, which depends on how intensively the franchisee will 'work' the franchise. Therefore, franchisor fees are always based on 'gross revenue from sales' and not on profits realized.
Various tangibles and intangibles such as national or international advertising, training, and other support services are commonly made available by the franchisor.
There are franchise brokers to find an appropriate franchisor. There are also the main 'master franchisors' who obtain the rights to sub-franchise in a territory.
According to the International Franchise Association approximately 4% of all businesses in the United States franchisee-worked.
It should be recognized that franchising is one of the only means available to access venture investment capital without the need to give up control of the operation of the chain and build a distribution system for their services. After the brand and formula are carefully designed,and properly executed, franchisors are able to sell franchises and expand rapidly across countries and continents using the capital and resources of their 'franchisees' while reducing risk.
Franchisor rules imposed by the franchising authority are usually very strict and important in the US and most countries need to study them to help the small or start-up franchisee in their countries to protect them. Besides the trademark, there are proprietary service marks which may be copyright - and corresponding regulations.
Obligations of the Parties Each party to a franchise has several interests to protect. The franchisor is most involved in securing protection for his trademark, controlling the business concept and securing his know-how. This requires the franchisee to carry out the services for which the trademark has been made prominent or famous. There is a great deal of standardization proposed. The place of service have to carry the franchisor's signs, logos and trademark in a prominent place. The uniforms worn by the staff of the franchisee have to be of a particular shade and colour. The service has to be in accordance to the pattern followed by the franchisor in his successful operations. Thus, for the franchisee he is not in full control of the business as he would be in retailing.
But there are fault-lines here! A service can be successful by buying equipment and supplies from the franchisor or those recommended by the franchisor if they are not over-priced. A coffee brew, for example, can be readily identified by the trademark when its raw materials come from a particular supplier. If the franchisor requires purchase from his stores, it may come under Anti-trust legislation or equivalent laws of other countries. So too the purchase of uniforms of personnel, signs, etc. But it also applies to sites of franchise if they are owned or controlled by the franchisor.
The franchisee must carefully negotiate the license. They, along with the franchisor must develop a marketing plan or business plan. The fees must be fully disclosed and there should not be any hidden fees. The start-up and costs and working capital must be known before taking the license. There must be assurance that additional licensees not crowd the "territory" if the franchise is worked to plan. The franchisee must be seen as an independent merchant. He must be protected by the franchisor from any trademark infringement by third-parties. A franchise attorney is required to assist the franchisee during negotiations.
Most often the training period - the costs of which are in great part covered by the initial fee - is too short to operate complicated equipment and the franchisee has to learn on his own from Manuals. The training period must be adequate but in low-cost franchises it would be considered expensive. Many frachisors have set up corporate universities to train staff online. This is in addition to literature and sales documents and reach by email.
Also, franchise agreements carry no guarantees or warranties and the franchisee has little or no recource to legal intervention in the event of a dispute. Franchise contracts tend to be unilateral contracts in favor of the franchisor; they are generally protected from lawsuits from their franchisee because of the non-negotiable contracts that require franchisees to acknowledge, in effect, that they are buying the franchise knowing that there is risk, and that they have not been promised success or profits by the franchisor. Contracts are renewable at his sole option. Most franchisors make franchisees sign agreements waiving their rights under federal and state law, and in some cases allowing the franchisor to choose where and under what law any dispute would be litigated
Regulations: The U.S. Isaac Singer, in the 1850s, who made improvements to an existing model of a sewing machine, was among the first franchising efforts in the United States, followed later by Coca-Cola, Western Union, etc. and agreements between automobile manufacturers and dealers.
Modern franchising came to prominence with the rise of franchise-based food service establishments. In 1932, Howard Deering Johnson established the first modern restaurant franchise based on his successful Quincy, Massachusetts Howard Johnson restaurant founded in the late 1920s.The idea was to let independent operators use the same name, food, supplies, logo and even building design in exchange for a fee.
The growth in franchises picked up steam in the 1930s when such chains as Howard Johnson's started franchising motels.The 1950s saw a boom of franchise chains in conjunction with the development of the U.S. Interstate Highway System.
In the U.S. the FTC requires that the franchisee be furnished with a Disclosure Agreement by the Franchisor, at least ten days before money changes hands. The final agreement is always a negotiated document setting forth the fees and other terms. Whereas elements of the disclosure may be available from third parties only that provided by the franshisor can depended upon. The U.S. Disclosure Document (FDD) is very lengthy (300-700 pp +)and detailed (see UFOC for elements of disclosure), and provides audited financial statements of the franchisor in a particular format. It will include data on the names, addresses and telephone numbers of the franchisees in the licensed territory (who may be contacted and consulted before negotiations), estimate of total franchise revenues and franchisor profitability. The States may require the FDD to contain specific requirements but the requirements in the State disclosure documents must be in compliance with the Federal Rule that governs federal regulatory policy. There is no private right of action of action under the FTC Rule for franchisor violation of the rule but fifteen or more of the States have passed statutes that provide this right of action to franchisees when fraud can be proved under these special statutes. The majority of franchisors have inserted mandatory arbitration clauses into their agreements with their franchisees, in some of which the U.S. Supreme Court has dealt with.
There is no federal registry of franchises or any federal filing requirements for information. States are the primary collectors of data on franchising companies, and enforce laws and regulations regarding their presence and their spread in their jurisdictions.
Where the franchisor has many partners, the agreement may take the shape of a business format franchise - an agreement that is identical for all franchisees.
Government procurement in the United States
Government procurement in the United States is based on many of the same principles as commercial contracting, but is subject to special laws and regulation as described below.
Persons entering into commercial contracts are pretty much free to do anything that they can agree on. Each represents their own interests and can obligate themselves in any way they believe will benefit them. If one or both persons are represented by agents, usually employees, commercial contracting law allows the agent to form contracts based on generally accepted notions of commercial reasonableness. In essence, the law allows each side to rely on the other's authority to make a binding contract. Of course there are many nuances and cases covering this, but generally speaking the law favors the creation of commercial contracts in order to facilitate business.
The powers given to the Government are set forth in the Constitution. The government exercises its powers through legislation and regulations issued as prescribed in legislation.
Thus, the authority of a Contracting Officer (the Government's agent) to contract on behalf of the Government is set forth in public documents that a person dealing with the Contracting Officer can review. As a result, unlike in the commercial arena, where the parties have great freedom, a contract with the U.S. Government must comply with the laws and regulations that permit it, and be made by a Contracting Officer with actual authority to make the contract.
The Contracting Officer has no authority to deviate from the laws and regulations, and the contracting party is held to know the limitations of the Contracting Officer's authority, even if the Contracting Officer does not. This makes contracting with the United States a very structured and restricted process.
The Law Government contracting involves the expenditure of public funds and as such it requires a great deal of transparency and accountability. The authority to enter into contracts begins with the authority given to the federal government through the constitution. All three branches of the government have a role. Congress passes legislation that defines the process and additional legislation that provides the funds. The executive branch, through all of the various agencies, then enter into the contracts and expend the funds to achieve their congressionally-defined mission. When disputes arise there are administrative processes that can be used within the agencies to resolve them, or the contractor can appeal to the courts.
The procurement process for executive branch agencies (as distinguished from legislative or judicial bodies) is governed by two primary laws - The Armed Services Procurement Act and the Federal Property and Administrative Services Act. To address all of the various rules imposed by Congress (and occasionally the courts, a body of administrative law has been developed through the Federal Acquisition Regulation. This regulation, all 53 parts, defines the process, provides guidance, implements special preference programs, and includes the specific language for many of the clauses found in a government contract.[1] Most agencies also have supplemental regulatory coverage contained in what are known as FAR Supplements. These supplements appear within the Code of Federal Regulations (CFR) volumes of the respective agencies. For example, the Department of Defense (DOD) FAR Supplement can be found at 10 CFR.
Government contracts are governed by what is known as the federal common law. This body of law is completely separate and distinct from the body of law familiar to most businesses, namely the Uniform Commercial Code (UCC). The UCC is a body of law passed by the legislatures of the various states and is generally uniform among the states. Interestingly, most government contracts involve subcontractors. The prime contract (i.e. the contract between the government and its contractors) is governed by the federal common law while the contracts between the prime contractor and its subcontractors are governed by the UCC of the respective states. This can, on occasion, squeeze the prime contractor due to the differences in the laws.
The United States Constitution The Federal Government gets its ability to act from the powers given to it by the people of the United States through the Constitution. The Constitution gives the Government specific enumerated powers in Article 1 Section 8. While the power to purchase is not explicit in the enumerated powers, it is understood to be implied as part of the specific powers granted. For example, the powers to establish post offices and post roads;to raise and support armies; to provide and maintain a navy; and to provide for organizing, arming, and disciplining, the militia, all would be meaningless if the Government could not purchase goods and services to these ends. In addition, the Government is given the power to make all laws which shall be necessary and proper for carrying into execution the foregoing powers, and all other powers vested by this Constitution in the government of the United States, or in any department or officer thereof. This clause has been interpreted extremely broadly.
[edit] The Statutes The Government exercises its powers through legislation. We can view legislation in the acquisition arena to fall into two classes.
Federal Property and Administrative Services Act Federal Property and Administrative Services Act
Armed Services Procurement Act ASPA
Federal Acquisition Reform Act Federal Acquisition Reform Act of 1995 Pub. L. No. 104-106, 110 Stat. 186 (1995) Division D of the National Defense Authorization Act for Fiscal Year 1996.
Federal Acquisition Streamlining Act Federal Acquisition Streamlining Act of 1994 (FASA) Pub. L. No. 103-355, 108 Stat. 3243; see also 10 U.S.C. § 2323 which contains language similar to FASA for the Department of Defense (DoD), NASA and the Coast Guard.
In this legislation, Congress extended the affirmative action authority granted DoD by 10 U.S.C. § 2323 to all agencies of the federal government. See 15 U.S.C. § 644 note. Regulations to implement that authority were delayed because of the decision in Adarand Constructors v. Peña, 515 U.S. 200 (1995). See 60 Fed. Reg. 48,258 (September 18, 1995). See 61 Fed. Reg. 26,042 (May 23, 1996) (proposed reforms to affirmative action in federal procurement) for the basis for the regulations to implement this provision of FASA. See 62 Fed. Reg. 25,648 (May 9, 1997) for government response to comments on the proposal, and 62 Fed. Reg. 25,786 (May 9, 1997) (proposed rules), 63 Fed. Reg. 35,719 (June 30, 1998) (interim rules), and 63 Fed. Reg. 36,120 (July 1, 1998) (interim rules), Federal Acquisition Regulation, Reform of Affirmative Action in Federal Procurement addressing the General Services Administration (GSA), NASA, and DoD.
AntiDeficiency Act (ADA) It has been noted that fiscal law is not about getting the mission accomplished or getting a good deal for the government. Fiscal law is only about Congressional oversight of the Executive Branch. Thus, fiscal law frequently prevents government agencies from signing an agreement that a commercial entity would not hesitate to execute. Thus, fiscal law has an invisible and frequently negative impact on the ability of a federal agency to accomplish its mission, and this fact is frequently lost on the public and Congress. On the other hand, this is the Constitutionally mandated oversight of the use of public funds which is essential to the scheme of checks and balances in the Constitution. A good working relationship and robust communication between the Executive and Legislative branches is the key to avoiding problems in this area.
The teeth for fiscal law comes from the Anti-Deficiency Act. The Anti Deficiency Act provides that no one can obligate the Government to make payments for which money has not already been authorized. The ADA also prohibits the government from receiving gratuitous services without explicit statutory authority. In particular, an ADA violation occurs when a federal agency uses appropriated funds for a different purpose than is specified in the appropriations act which provided the funds to the Agency. The ADA is directly connected to several other fiscal laws, namely the Purpose Act and the Bona Fide Needs Rule.
The Purpose Act (31 U.S.C. § 1301) provides "Appropriations shall be applied only to the objects for which the appropriations were made except as otherwise provided by law." The annual DoD appropriations acts include approximately 100 different appropriations (otherwise known as "colors of money"). Money appropriated for one purpose cannot be used for a different purpose, for example, operations and maintenance (O&M) funds to be used for buying weapons. Even if an expenditure might fall within the scope of one appropriation, such as repair parts for the O&M appropriation, it still may not be permissible to use the funds if there is a more specific appropriation or the agency has made a previous funds election contrary to the proposed use of funds. An example could be O&M can be used for purchasing repair parts, but if the parts are required to effect a major service life extension that is no longer repair but replacement - procurement funds must be used if the total cost is more than $250,000 (otherwise known as the Other Procurement threshold, for example, Other Procurement Army (OPA) threshold) or another procurement appropriation is available such as the armored vehicle or weapons appropriation.
An ADA violation can also occur when a contract uses funds in a period that falls outside of the time period the funds are authorized for use under what is known as the Bona Fide Needs rule (31 USC 1502), which provides: "The balance of a fixed-term appropriation is available only for payment of expenses properly incurred during the period of availability or to complete contracts properly made within that period."
The Bona Fide Need Rule is a fundamental principle of appropriations law addressing the availability as to time of an agency's appropriation. 73 Comp. Gen. 77, 79 (1994); 64 Comp. Gen. 410, 414-15 (1985). The rule establishes that an appropriation is available for obligation only to fulfill a genuine or bona fide need of the period of availability for which it was made. 73 Comp. Gen. 77, 79 (1994). It applies to all federal government activities carried out with appropriated funds, including contract, grant, and cooperative agreement transactions. 73 Comp. Gen. 77, 78-79 (1994). An agency's compliance with the bona fide need rule is measured at the time the agency incurs an obligation, and depends on the purpose of the transaction and the nature of the obligation being entered into. 61 Comp. Gen. 184, 186 (1981) (bona fide need determination depends upon the facts and circumstances of the particular case). In the grant context, the obligation occurs at the time of award. 31 Comp. Gen. 608 (1952). See also 31 U.S.C. Sec. 1501(a)(5)(B). Simply put this rule states that the Executive Branch may only use current funds for current needs - they can't buy items which benefit future year appropriation periods (i.e., 1 October through 30 September) without a specific exemption. The net result of this rule is funds expire after the end date for which Congress has specified their availability. For example, a single year fund expires on 1 October of the year following their appropriation (i.e., FY07 appropriations. (for example, 1 October 2006 through 30 September 2007) expire on 1 October 2007).
For example, operations and maintenance funds generally cannot be used to purchase supplies after 30 September of the year they are appropriated within with several exceptions - 1) the severable services exemption under 10 USC 2410 and Office of Management and Budget (OMB) Circular A-34, Instructions on Budget Execution, 2) Authorized stockage level exceptions and 3) long lead time exception. (see https://www.safaq.hq.af.mil/contracting/affars/fiscal-law/bona-fide-need.doc ) The Government Accounting Office Principles of Federal Appropriations Law (otherwise known as the GAO Redbook at http://www.gao.gov/legal.htm ) has a detailed discussion of these fiscal law rules which directly impact on the ability of a federal agency to contract with the private sector.
The Regulations The acquisition process is governed by regulations issued pursuant to the statutory authority given by the acquisition statutes. These regulations are included in the Code of Federal Regulations ("CFR"), the omnibus listing of Government regulations, as Title 48. Chapter 1 of Title 48 is commonly called the Federal Acquisition Regulation ("FAR"). The remaining chapters of Title 48 are supplements to the FAR for specific agencies.
As with any other regulation, the FAR has been promulgated through the legal regulatory process. This includes publication of proposed rules in the Federal Register and receipt of comments from the public before issuing the regulation. The FAR is considered to have the force and effect of law, thus Contracting Officers have no authority on their own to deviate from the FAR. The supplements to the FAR have been issued following the same process and must also be followed without deviation.
This does not mean that preparation of a contract is a simple matter of cut and paste. The regulations attempt to provide for every possible situation and acquisition from the purchase of paperclips to the acquisition of battleships. As a result, the FAR and its supplements permit a substantial variation. The Contracting Officer and the contractor must seek to achieve their sometimes conflicting goals while following the specific requirements of the regulations. As with any complex document (in book form, Title 48 of the CFR requires several shelves), the FAR and its supplements can be interpreted differently by different people. The reader is cautioned that, as stated above, this is a non-intuitive, complex subject, and the advice of someone knowledgeable in the field will often be required.
FAR Federal Acquisition Regulation
The Contracting Officer Unless specifically prohibited by another provision of law, an agency's authority to contract is vested in the agency head, for example, the Secretary of the Air Force or the Administrator, National Aeronautics and Space Administration. Agency heads delegate their authority to Contracting Officers, who either hold their authority by virtue of their position or must be appointed in accordance with procedures set forth in the Federal Acquisition Regulation. Only Contracting Officers may sign Government contracts on behalf of the government. 48 CFR § 1.601. A Contracting Officer has only the authority delegated pursuant to law and agency procedures. This authority is set forth in the Contracting Officer's certificate of appointment (formerly called a "warrant"). Unlike in commercial contracting, there is no doctrine of apparent authority applicable to the Government. Any action taken by a Contracting Officer that exceeds the Contracting Officer's actual delegated authority is not binding on the Government, even if both the Contracting Officer and the contractor desire the action and the action benefits the Government. The contractor is presumed to know the scope of the Contracting Officer's authority and cannot rely on any action of Contracting Officers when it exceeds their authority. Contracting Officers are assisted in their duties by Contracting Officer Representatives (CORs) and Contracting Officer Technical Representatives (COTRs), who usually do not have the authority of a Contracting Officer.
Process of Federal Acquisition Generally, federal acquisitions begin with identification of a requirement by a specific federal activity. A basic idea of what is needed and the problem statement is prepared and the requiring activity meets with an acquisition command having a Contracting Officer with an appropriate warrant issued by a specific acquisition activity.
Not all Contracting Officers are created equal. Contracting officers have different contracting thresholds and varying degrees of experience and capabilities. Each one has a specific warrant that states the conditions under which they are permitted to engage in federal contracting. Depending on the contracting activity, some contracting officers may have no experience whatever with the product, service or requirements in question or knowledge of any of the potential vendor base, representing a weakness on the part of the Government procurement process.
For example, if a building is purchased for $1,000,000 sale price and it produces $100,000 in positive net operating income (the amount left over after fixed costs and variable costs are subtracted from gross lease income) during one year, then:
- $100,000 / $1,000,000 = 0.10 = 10%
If the owner bought the building twenty years ago for $200,000, his cap rate is
- $100,000 / $200,000 = 0.50 = 50%.
As another example of why the current value should be used, consider the case of a building that is given away (as an inheritance or charitable gift). The new owner divides his annual net income by his initial cost, say,
- $100,000 (income)/ 0 (cost) = UNDEFINED
From this, we see that as the value of an asset increases, the amount of income it produces should also increase (at the same rate), in order to maintain the cap rate.
Capitalization rates are an indirect measure of how fast an investment will pay for itself. In the example above, the purchased building will be fully capitalized (pay for itself) after ten years (100% divided by 10%). If the capitalization rate were 5%, the payback period would be twenty years. Note that a real estate appraisal in the U.S. uses net operating income. Cash flow equals net operating income minus debt service. Where sufficiently detailed information is not available, the capitalization rate will be derived or estimated from net operating income to determine cost, value or required annual income. An investor views his money as a "capital asset". As such, he expects his money to produce more money. Taking into account risk and how much interest is available on investments in other assets, an investor arrives at a personal rate of return he expects from his money. This is the cap rate he expects. If an apartment building is offered to him for $100,000, and he expects to make at least 8 percent on his real estate investments, then he would multiply the $100,000 investment by 8% and determine that if the apartments will generate $8000, or more, a year, after operating expenses, then the apartment building is a viable investment to pursue.
Use for valuation In real estate investment, real property is often valued according to projected capitalization rates used as investment criteria. This is done by algebraic manipulation of the formula below:
- Capital Cost (asset price) = Net Operating Income/ Capitalization Rate
This is often referred to as direct capitalization, and is commonly used for valuing income generating property in a real estate appraisal.
One advantage of capitalization rate valuation is that it is separate from a "market-comparables" approach to an appraisal (which compares 3 valuations: what other similar properties have sold for based on a comparison of physical, location and economic characteristics, actual replacement cost to re-build the structure in addition to the cost of the land and capitalization rates). Given the inefficiency of real estate markets, multiple approaches are generally preferred when valuing a real estate asset. Capitalization rates for similar properties, and particularly for "pure" income properties, are usually compared to ensure that estimated revenue is being properly valued.
Cash flow defined The capitalization rate is calculated using a measure of cash flow called net operating income (NOI), not net income. Generally, NOI is defined as income (earnings) before depreciation and interest expenses:
- Cash flow = Net income + depreciation + interest expenses.
Although cash flow is the generally-accepted figure used for calculating cap rates, this is often referred to under various terms, including simply income.
Use for comparison Capitalization rates, or cap rates, provide a tool for investors to use for roughly valuing a property based on its Net Operating Income. For example, if a real estate investment provides $160,000 a year in Net Operating Income and similar properties have sold based on 8% cap rates, the subject property can be roughly valued at $2,000,000 because $160,000 divided by 8% (0.08) equals $2,000,000. A comparatively lower cap rate for a property would indicate less risk associated with the investment (increasing demand for the product), and a comparatively higher cap rate for a property would indicate more risk (reducing demand for the product). Some factors considered in assessing risk include creditworthiness of a tenant, term of lease, quality and location of property and general volatility of the market.
Debt Coverage Ratio
The debt service coverage ratio (DSCR), is the ratio of cash available for debt servicing to interest, principal and lease payments. It is a popular benchmark used in the measurement of an entity's (person or corporation) ability to produce enough cash to cover its debt (including lease) payments. The higher this ratio is, the easier it is to obtain a loan. The phrase is also used in commercial banking and may be expressed as a minimum ratio that is acceptable to a lender; it may be a loan condition or covenant. Breaching a DSCR covenant can, in some circumstances, be an act of default.
Uses In corporate finance, DSCR refers to the amount of cash flow available to meet annual interest and principal payments on debt, including sinking fund payments.
In personal finance, DSCR refers to a ratio used by bank loan officers in determining debt servicing ability.
In commercial real estate finance, DSCR is the primary measure to determine if a property will be able to sustain its debt based on cash flow. In the late 1990s and early 2000s banks typically required a DSCR of at least 1.2, but more aggressive banks would accept lower ratios, a risky practice that contributed to the Financial crisis of 2007–2010. A DSCR over 1 means that (in theory, as calculated to bank standards and assumptions) the entity generates sufficient cash flow to pay its debt obligations. A DSCR below 1.0 indicates that there is not enough cash flow to cover loan payments
[Calculation In general, it is calculated by: DSCR = (Annual Net Income + Amortization/Depreciation + other non-cash and discretionary items (such as non-contractual management bonuses)) / (Principal Repayment + Interest payments + Lease payments )
To calculate an entity’s debt coverage ratio, you first need to determine the entity’s net operating income. To do this you must take the entity’s total income and deduct any vacancy amounts and all operating expenses. Then take the net operating income and divide it by the property’s annual debt service, which is the total amount of all interest and principal paid on all of the property’s loans throughout the year. If a property has a debt coverage ratio of less than one, the income that property generates is not enough to cover the mortgage payments and the property’s operating expenses. A property with a debt coverage ratio of .8 only generates enough income to pay for 80 percent of the yearly debt payments. However, if a property has a debt coverage ratio of more than 1, the property does generate enough revenue to cover annual debt payments. For example, a property with a debt coverage ratio of 1.5 generates enough income to pay all of the annual debt expenses, all of the operating expenses and actually generates fifty percent more income than is required to pay these bills.
A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1, say .95, would mean that there is only enough net operating income to cover 95% of annual debt payments. For example, in the context of personal finance, this would mean that the borrower would have to delve into his or her personal funds every month to keep the project afloat. Generally, lenders frown on a negative cash flow, but some allow it if the borrower has strong outside income.
Typically, most commercial banks require the ratio of 1.15 - 1.35 times (net operating income or NOI / annual debt service) to ensure cash flow sufficient to cover loan payments is available on an ongoing basis.
Example Let’s say Mr. Jones is looking at an investment property with a net operating income of $36,000 and an annual debt service of $30,000. The debt coverage ratio for this property would be 1.2 and Mr. Jones would know the property generates 20 percent more than is required to pay the annual mortgage payment.
The Debt Service Ratio is also typically used to evaluate the quality of a portfolio of mortgages. For example, on June 19, 2008, a popular US rating agency, Standard & Poors, reported that it lowered its credit rating on several classes of pooled commercial mortgage pass-through certificates originally issued by Bank of America. The rating agency stated in a press release that it had lowered the credit ratings of four certificates in the Bank of America Commercial Mortgage Inc. 2005-1 series, stating that the downgrades "reflect the credit deterioration of the pool". They further go on to state that this downgrade resulted from the fact that eight specific loans in the pool have a debt service coverage (DSC) below 1.0x, or below one times.
The Debt Service Ratio, or debt service coverage, provides a useful indicator of financial strength. Standard & Poors reported that the total pool consisted, as of June 10 2008, of 135 loans, with an aggregate trust balance of $2.052 billion. They indicate that there were, as of that date, eight loans with a DSC of lower than 1.0x. This means that the net funds coming in from rental of the commercial properties are not covering the mortgage costs. Now, since no one would make a loan like this initially, a financial analyst or informed investor will seek information on what the rate of deterioration of the DSC has been. You want to know not just what the DSC is at a particular point in time, but also how much it has changed from when the loan was last evaluated. The S&P press release tells us this. It indicates that of the eight loans which are "underwater", they have an average balance of $10.1 million, and an average decline in DSC of 38% since the loans were issued.
And there is still more. Since there are a total of 135 loans in the pool, and only eight of them are underwater, with a DSC of less than 1, the obvious question is: what is the total DSC of the entire pool of 135 loans? The Standard and Poors press release provides this number, indicating that the weighted average DSC for the entire pool is 1.76x, or 1.76 times. Again, this is just a snapshot now. The key question that DSC can help you answer, is this better or worse, from when all the loans in the pool were first made? The S&P press release provides this also, explaining that the original weighted average DSC for the entire pool of 135 loans was 1.66x, or 1.66 times.
In this way, the DSC (debt service coverage) ratio provides a way to assess the financial quality, and the associated risk level, of this pool of loans, and shows the surprising result that despite some loans experiencing DSC below 1, the overall DSC of the entire pool has improved, from 1.66 times to 1.76 times. This is pretty much what a good loan portfolio should look like, with DSC improving over time, as the loans are paid down, and a small percentage, in this case 4%, experiencing DSC ratios below one times, suggesting that for these loans, there may be trouble ahead.
And of course, just because the DSC is less than 1 for some loans, this does not necessarily mean they will default. As of the date of the S&P press release, the trust which holds the 135 loans has not experienced any losses.
Cash on cash return
In investing, the cash-on-cash return is the ratio of annual before-tax cash flow to the total amount of cash invested, expressed as a percentage.
It is often used to evaluate the cash flow from income-producing assets. Generally considered a quick napkin test to determine if the asset qualifies for further review and analysis. Cash on Cash analyses are generally used by investors looking for properties where cash flow is king, however, some use it to determine if a property is underpriced, indicating instant equity in a property.
Example Suppose an investor purchases a $1,200,000 apartment complex with a $300,000 down payment. Each month, the cash flow from rentals, less expenses, is $5,000. Over the course of a year, the before-tax income would be $5,000 × 12 = $60,000, so the cash-on-cash return would be:
$ 60,000 / $ 300,000 = 0.20 or 20%
. Limitations
- Because the calculation is based solely on before-tax cash flow relative to the amount of cash invested, it cannot take into account an individual investor's tax situation, the particulars of which may influence the desirability of the investment. However the investor can usually deduct enough Capital Cost Allowance to defer the taxes for a long time.
- The formula does not take into account any appreciation or depreciation. When some cash is a return of capital (ROC) it will falsely indicate a higher return, because ROC is not income.
- It does not account for other risks associated with the underlying property.
- It is essentially a simple interest calculation, and ignores the effect of compounding interest. The implication for investors is that an investment with a lower nominal rate of compound interest may be superior, in the long run, to an investment with a higher cash-on-cash return.
Franchising
Franchising is the practice of using another firm's successful business model. The word 'franchise' is of anglo-french derivation - from franc- meaning free, and is used both as a noun and as a (transitive) verb.
For the franchisor, the franchise is an alternative to building 'chain stores' to distribute goods and avoid investment and liability over a chain. The franchisor's success is the success of the franchisees. The franchisee is said to have a greater incentive than a direct employee because he or she has a direct stake in the business.
However, except in the US, and now in China (2007) where there are explicit Federal (and in the US, State) laws covering franchise, most of the world recognizes 'franchise' but rarely makes legal provisions for it. Only Australia, France and Brazil have significant Disclosure laws but Brazil regulates franchises more closely.
Where there is no specific law, franchise is considered a distribution system, whose laws apply, with the trademark (of the franchise system) covered by specific covenants.
Businesses for which franchising works best have the following characteristics:
- Businesses with a good track record of profitability.
- Businesses which are easily duplicated.
Although there are franchises around products – Chanel and other cosmetics, to name the prominent – by and large, the franchises revolve around service firms. At the sub-$80,000 level, they are, by far, the largest number of franchises.These allow a business, combined with family time and a location not far from home. Some franchises are available for a few thousand dollars.
The following US-listing tabulates the early 2010 ranking of major franchises along with the number of sub-franchisees (or partners) from data available for 2004. It will also be seen from the names of the franchise that the US is a leader in franchising innovations, a position it has held since the 1930s when it took the major form of fast-food restaurants, food inns and, slightly later, the motels during the first depression. Franchising is a business model used in more than 70 industries that generates more than $1 trillion in U.S. sales annually (2001 study).Franchised businesses operated 767,483 establishments in the United States in 2001, counting both establishments establishment owned by franchisees and establishments owned by franchisors:
1. Subway (Sandwiches and Salads | Startup costs $84,300 – $258,300 (22000 partners worldwide in 2004). 2. McDonald's | Startup costs in 2010, $995,900 – $1,842,700 (30,300 partners in 2004) 3. 7-Eleven Inc. (Convenience Stores) |Startup Costs $40,500- 775,300 in 2010,(28,200 partners in 2004) 4. Hampton Inns & Suites (Midprice Hotels) |Startup costs $3,716,000 – $13,148,800 in 2010 5. Supercuts (Hair Salons) | Startup Costs $111,000 - $239,700 in 2010 6. H&R Block (Tax Preparation and e-Filing)| Startup Costs $26,427 - $84,094 (11,200 partners in 2004) 7. Dunkin Donuts | Startup Costs $537,750 - $1,765,300 in 2010 8. Jani-King (Commercial Cleaning | Startup Costs $11,400 - $35,050, (11,000 partners worldwide in 2004) 9. Servo-Pro (Insurance and Disaster Restoration and Cleaning) | Startup Costs $102,250 - $161,150 in 2010 10. MiniMarkets (Convenience Store and Gas Station) | Startup Costs $1,835,823 - $7,615,065 in 2010 The midi-franchises like restaurants, gasoline stations, trucking stations which involve substantial investment and require all the attention of a business.
There are also the large franchises - hotels, spas, hospitals, etc. - which are discussed further in Technological Alliances.
Two important payments are made to a franchisor: (a) a royalty for the trade-mark and (b) the training and advisory services given to the franchisee. The two fees may be combined in a single 'management' fee. The fee for the "Disclosure" is separate and is always a "front-end fee".
The franchise is usually for a fixed period (broken down into shorter periods, which need renewal) and are for a specific "territory" or miles from location. There may be several such locations. Agreements typically last from five to thirty years, with premature cancellations or terminations of most contracts bearing serious consequences for franchisees. A franchise is merely a temporary business investment, involving renting or leasing an opportunity, not buying a business for the purpose of ownership. It is classified as a wasting asset due to the finite term of the license.
The franchise can be an exclusive, non-exclusive or 'sole and exclusive'. Although franchisor revenues and profit may be provided in a franchise disclosure document, no laws require the estimate of franchisee profitability, which depends on how intensively the franchisee will 'work' the franchise. Therefore, franchisor fees are always based on 'gross revenue from sales' and not on profits realized.
Various tangibles and intangibles such as national or international advertising, training, and other support services are commonly made available by the franchisor.
There are franchise brokers to find an appropriate franchisor. There are also the main 'master franchisors' who obtain the rights to sub-franchise in a territory.
According to the International Franchise Association approximately 4% of all businesses in the United States franchisee-worked.
It should be recognized that franchising is one of the only means available to access venture investment capital without the need to give up control of the operation of the chain and build a distribution system for their services. After the brand and formula are carefully designed,and properly executed, franchisors are able to sell franchises and expand rapidly across countries and continents using the capital and resources of their 'franchisees' while reducing risk.
Franchisor rules imposed by the franchising authority are usually very strict and important in the US and most countries need to study them to help the small or start-up franchisee in their countries to protect them. Besides the trademark, there are proprietary service marks which may be copyright - and corresponding regulations.
Obligations of the Parties Each party to a franchise has several interests to protect. The franchisor is most involved in securing protection for his trademark, controlling the business concept and securing his know-how. This requires the franchisee to carry out the services for which the trademark has been made prominent or famous. There is a great deal of standardization proposed. The place of service have to carry the franchisor's signs, logos and trademark in a prominent place. The uniforms worn by the staff of the franchisee have to be of a particular shade and colour. The service has to be in accordance to the pattern followed by the franchisor in his successful operations. Thus, for the franchisee he is not in full control of the business as he would be in retailing.
But there are fault-lines here! A service can be successful by buying equipment and supplies from the franchisor or those recommended by the franchisor if they are not over-priced. A coffee brew, for example, can be readily identified by the trademark when its raw materials come from a particular supplier. If the franchisor requires purchase from his stores, it may come under Anti-trust legislation or equivalent laws of other countries. So too the purchase of uniforms of personnel, signs, etc. But it also applies to sites of franchise if they are owned or controlled by the franchisor.
The franchisee must carefully negotiate the license. They, along with the franchisor must develop a marketing plan or business plan. The fees must be fully disclosed and there should not be any hidden fees. The start-up and costs and working capital must be known before taking the license. There must be assurance that additional licensees not crowd the "territory" if the franchise is worked to plan. The franchisee must be seen as an independent merchant. He must be protected by the franchisor from any trademark infringement by third-parties. A franchise attorney is required to assist the franchisee during negotiations.
Most often the training period - the costs of which are in great part covered by the initial fee - is too short to operate complicated equipment and the franchisee has to learn on his own from Manuals. The training period must be adequate but in low-cost franchises it would be considered expensive. Many frachisors have set up corporate universities to train staff online. This is in addition to literature and sales documents and reach by email.
Also, franchise agreements carry no guarantees or warranties and the franchisee has little or no recource to legal intervention in the event of a dispute. Franchise contracts tend to be unilateral contracts in favor of the franchisor; they are generally protected from lawsuits from their franchisee because of the non-negotiable contracts that require franchisees to acknowledge, in effect, that they are buying the franchise knowing that there is risk, and that they have not been promised success or profits by the franchisor. Contracts are renewable at his sole option. Most franchisors make franchisees sign agreements waiving their rights under federal and state law, and in some cases allowing the franchisor to choose where and under what law any dispute would be litigated
Regulations: The U.S. Isaac Singer, in the 1850s, who made improvements to an existing model of a sewing machine, was among the first franchising efforts in the United States, followed later by Coca-Cola, Western Union, etc. and agreements between automobile manufacturers and dealers.
Modern franchising came to prominence with the rise of franchise-based food service establishments. In 1932, Howard Deering Johnson established the first modern restaurant franchise based on his successful Quincy, Massachusetts Howard Johnson restaurant founded in the late 1920s.The idea was to let independent operators use the same name, food, supplies, logo and even building design in exchange for a fee.
The growth in franchises picked up steam in the 1930s when such chains as Howard Johnson's started franchising motels.The 1950s saw a boom of franchise chains in conjunction with the development of the U.S. Interstate Highway System.
In the U.S. the FTC requires that the franchisee be furnished with a Disclosure Agreement by the Franchisor, at least ten days before money changes hands. The final agreement is always a negotiated document setting forth the fees and other terms. Whereas elements of the disclosure may be available from third parties only that provided by the franshisor can depended upon. The U.S. Disclosure Document (FDD) is very lengthy (300-700 pp +)and detailed (see UFOC for elements of disclosure), and provides audited financial statements of the franchisor in a particular format. It will include data on the names, addresses and telephone numbers of the franchisees in the licensed territory (who may be contacted and consulted before negotiations), estimate of total franchise revenues and franchisor profitability. The States may require the FDD to contain specific requirements but the requirements in the State disclosure documents must be in compliance with the Federal Rule that governs federal regulatory policy. There is no private right of action of action under the FTC Rule for franchisor violation of the rule but fifteen or more of the States have passed statutes that provide this right of action to franchisees when fraud can be proved under these special statutes. The majority of franchisors have inserted mandatory arbitration clauses into their agreements with their franchisees, in some of which the U.S. Supreme Court has dealt with.
There is no federal registry of franchises or any federal filing requirements for information. States are the primary collectors of data on franchising companies, and enforce laws and regulations regarding their presence and their spread in their jurisdictions.
Where the franchisor has many partners, the agreement may take the shape of a business format franchise - an agreement that is identical for all franchisees.
Government procurement in the United States
Government procurement in the United States is based on many of the same principles as commercial contracting, but is subject to special laws and regulation as described below.
Persons entering into commercial contracts are pretty much free to do anything that they can agree on. Each represents their own interests and can obligate themselves in any way they believe will benefit them. If one or both persons are represented by agents, usually employees, commercial contracting law allows the agent to form contracts based on generally accepted notions of commercial reasonableness. In essence, the law allows each side to rely on the other's authority to make a binding contract. Of course there are many nuances and cases covering this, but generally speaking the law favors the creation of commercial contracts in order to facilitate business.
The powers given to the Government are set forth in the Constitution. The government exercises its powers through legislation and regulations issued as prescribed in legislation.
Thus, the authority of a Contracting Officer (the Government's agent) to contract on behalf of the Government is set forth in public documents that a person dealing with the Contracting Officer can review. As a result, unlike in the commercial arena, where the parties have great freedom, a contract with the U.S. Government must comply with the laws and regulations that permit it, and be made by a Contracting Officer with actual authority to make the contract.
The Contracting Officer has no authority to deviate from the laws and regulations, and the contracting party is held to know the limitations of the Contracting Officer's authority, even if the Contracting Officer does not. This makes contracting with the United States a very structured and restricted process.
The Law Government contracting involves the expenditure of public funds and as such it requires a great deal of transparency and accountability. The authority to enter into contracts begins with the authority given to the federal government through the constitution. All three branches of the government have a role. Congress passes legislation that defines the process and additional legislation that provides the funds. The executive branch, through all of the various agencies, then enter into the contracts and expend the funds to achieve their congressionally-defined mission. When disputes arise there are administrative processes that can be used within the agencies to resolve them, or the contractor can appeal to the courts.
The procurement process for executive branch agencies (as distinguished from legislative or judicial bodies) is governed by two primary laws - The Armed Services Procurement Act and the Federal Property and Administrative Services Act. To address all of the various rules imposed by Congress (and occasionally the courts, a body of administrative law has been developed through the Federal Acquisition Regulation. This regulation, all 53 parts, defines the process, provides guidance, implements special preference programs, and includes the specific language for many of the clauses found in a government contract.[1] Most agencies also have supplemental regulatory coverage contained in what are known as FAR Supplements. These supplements appear within the Code of Federal Regulations (CFR) volumes of the respective agencies. For example, the Department of Defense (DOD) FAR Supplement can be found at 10 CFR.
Government contracts are governed by what is known as the federal common law. This body of law is completely separate and distinct from the body of law familiar to most businesses, namely the Uniform Commercial Code (UCC). The UCC is a body of law passed by the legislatures of the various states and is generally uniform among the states. Interestingly, most government contracts involve subcontractors. The prime contract (i.e. the contract between the government and its contractors) is governed by the federal common law while the contracts between the prime contractor and its subcontractors are governed by the UCC of the respective states. This can, on occasion, squeeze the prime contractor due to the differences in the laws.
The United States Constitution The Federal Government gets its ability to act from the powers given to it by the people of the United States through the Constitution. The Constitution gives the Government specific enumerated powers in Article 1 Section 8. While the power to purchase is not explicit in the enumerated powers, it is understood to be implied as part of the specific powers granted. For example, the powers to establish post offices and post roads;to raise and support armies; to provide and maintain a navy; and to provide for organizing, arming, and disciplining, the militia, all would be meaningless if the Government could not purchase goods and services to these ends. In addition, the Government is given the power to make all laws which shall be necessary and proper for carrying into execution the foregoing powers, and all other powers vested by this Constitution in the government of the United States, or in any department or officer thereof. This clause has been interpreted extremely broadly.
[edit] The Statutes The Government exercises its powers through legislation. We can view legislation in the acquisition arena to fall into two classes.
- First, every acquisition can be traced to legislation that permits the acquisition and that provides money for it.
- Second, every acquisition must follow the rules for acquisition contained in the applicable laws.
Federal Property and Administrative Services Act Federal Property and Administrative Services Act
Armed Services Procurement Act ASPA
Federal Acquisition Reform Act Federal Acquisition Reform Act of 1995 Pub. L. No. 104-106, 110 Stat. 186 (1995) Division D of the National Defense Authorization Act for Fiscal Year 1996.
Federal Acquisition Streamlining Act Federal Acquisition Streamlining Act of 1994 (FASA) Pub. L. No. 103-355, 108 Stat. 3243; see also 10 U.S.C. § 2323 which contains language similar to FASA for the Department of Defense (DoD), NASA and the Coast Guard.
In this legislation, Congress extended the affirmative action authority granted DoD by 10 U.S.C. § 2323 to all agencies of the federal government. See 15 U.S.C. § 644 note. Regulations to implement that authority were delayed because of the decision in Adarand Constructors v. Peña, 515 U.S. 200 (1995). See 60 Fed. Reg. 48,258 (September 18, 1995). See 61 Fed. Reg. 26,042 (May 23, 1996) (proposed reforms to affirmative action in federal procurement) for the basis for the regulations to implement this provision of FASA. See 62 Fed. Reg. 25,648 (May 9, 1997) for government response to comments on the proposal, and 62 Fed. Reg. 25,786 (May 9, 1997) (proposed rules), 63 Fed. Reg. 35,719 (June 30, 1998) (interim rules), and 63 Fed. Reg. 36,120 (July 1, 1998) (interim rules), Federal Acquisition Regulation, Reform of Affirmative Action in Federal Procurement addressing the General Services Administration (GSA), NASA, and DoD.
AntiDeficiency Act (ADA) It has been noted that fiscal law is not about getting the mission accomplished or getting a good deal for the government. Fiscal law is only about Congressional oversight of the Executive Branch. Thus, fiscal law frequently prevents government agencies from signing an agreement that a commercial entity would not hesitate to execute. Thus, fiscal law has an invisible and frequently negative impact on the ability of a federal agency to accomplish its mission, and this fact is frequently lost on the public and Congress. On the other hand, this is the Constitutionally mandated oversight of the use of public funds which is essential to the scheme of checks and balances in the Constitution. A good working relationship and robust communication between the Executive and Legislative branches is the key to avoiding problems in this area.
The teeth for fiscal law comes from the Anti-Deficiency Act. The Anti Deficiency Act provides that no one can obligate the Government to make payments for which money has not already been authorized. The ADA also prohibits the government from receiving gratuitous services without explicit statutory authority. In particular, an ADA violation occurs when a federal agency uses appropriated funds for a different purpose than is specified in the appropriations act which provided the funds to the Agency. The ADA is directly connected to several other fiscal laws, namely the Purpose Act and the Bona Fide Needs Rule.
The Purpose Act (31 U.S.C. § 1301) provides "Appropriations shall be applied only to the objects for which the appropriations were made except as otherwise provided by law." The annual DoD appropriations acts include approximately 100 different appropriations (otherwise known as "colors of money"). Money appropriated for one purpose cannot be used for a different purpose, for example, operations and maintenance (O&M) funds to be used for buying weapons. Even if an expenditure might fall within the scope of one appropriation, such as repair parts for the O&M appropriation, it still may not be permissible to use the funds if there is a more specific appropriation or the agency has made a previous funds election contrary to the proposed use of funds. An example could be O&M can be used for purchasing repair parts, but if the parts are required to effect a major service life extension that is no longer repair but replacement - procurement funds must be used if the total cost is more than $250,000 (otherwise known as the Other Procurement threshold, for example, Other Procurement Army (OPA) threshold) or another procurement appropriation is available such as the armored vehicle or weapons appropriation.
An ADA violation can also occur when a contract uses funds in a period that falls outside of the time period the funds are authorized for use under what is known as the Bona Fide Needs rule (31 USC 1502), which provides: "The balance of a fixed-term appropriation is available only for payment of expenses properly incurred during the period of availability or to complete contracts properly made within that period."
The Bona Fide Need Rule is a fundamental principle of appropriations law addressing the availability as to time of an agency's appropriation. 73 Comp. Gen. 77, 79 (1994); 64 Comp. Gen. 410, 414-15 (1985). The rule establishes that an appropriation is available for obligation only to fulfill a genuine or bona fide need of the period of availability for which it was made. 73 Comp. Gen. 77, 79 (1994). It applies to all federal government activities carried out with appropriated funds, including contract, grant, and cooperative agreement transactions. 73 Comp. Gen. 77, 78-79 (1994). An agency's compliance with the bona fide need rule is measured at the time the agency incurs an obligation, and depends on the purpose of the transaction and the nature of the obligation being entered into. 61 Comp. Gen. 184, 186 (1981) (bona fide need determination depends upon the facts and circumstances of the particular case). In the grant context, the obligation occurs at the time of award. 31 Comp. Gen. 608 (1952). See also 31 U.S.C. Sec. 1501(a)(5)(B). Simply put this rule states that the Executive Branch may only use current funds for current needs - they can't buy items which benefit future year appropriation periods (i.e., 1 October through 30 September) without a specific exemption. The net result of this rule is funds expire after the end date for which Congress has specified their availability. For example, a single year fund expires on 1 October of the year following their appropriation (i.e., FY07 appropriations. (for example, 1 October 2006 through 30 September 2007) expire on 1 October 2007).
For example, operations and maintenance funds generally cannot be used to purchase supplies after 30 September of the year they are appropriated within with several exceptions - 1) the severable services exemption under 10 USC 2410 and Office of Management and Budget (OMB) Circular A-34, Instructions on Budget Execution, 2) Authorized stockage level exceptions and 3) long lead time exception. (see https://www.safaq.hq.af.mil/contracting/affars/fiscal-law/bona-fide-need.doc ) The Government Accounting Office Principles of Federal Appropriations Law (otherwise known as the GAO Redbook at http://www.gao.gov/legal.htm ) has a detailed discussion of these fiscal law rules which directly impact on the ability of a federal agency to contract with the private sector.
The Regulations The acquisition process is governed by regulations issued pursuant to the statutory authority given by the acquisition statutes. These regulations are included in the Code of Federal Regulations ("CFR"), the omnibus listing of Government regulations, as Title 48. Chapter 1 of Title 48 is commonly called the Federal Acquisition Regulation ("FAR"). The remaining chapters of Title 48 are supplements to the FAR for specific agencies.
As with any other regulation, the FAR has been promulgated through the legal regulatory process. This includes publication of proposed rules in the Federal Register and receipt of comments from the public before issuing the regulation. The FAR is considered to have the force and effect of law, thus Contracting Officers have no authority on their own to deviate from the FAR. The supplements to the FAR have been issued following the same process and must also be followed without deviation.
This does not mean that preparation of a contract is a simple matter of cut and paste. The regulations attempt to provide for every possible situation and acquisition from the purchase of paperclips to the acquisition of battleships. As a result, the FAR and its supplements permit a substantial variation. The Contracting Officer and the contractor must seek to achieve their sometimes conflicting goals while following the specific requirements of the regulations. As with any complex document (in book form, Title 48 of the CFR requires several shelves), the FAR and its supplements can be interpreted differently by different people. The reader is cautioned that, as stated above, this is a non-intuitive, complex subject, and the advice of someone knowledgeable in the field will often be required.
FAR Federal Acquisition Regulation
The Contracting Officer Unless specifically prohibited by another provision of law, an agency's authority to contract is vested in the agency head, for example, the Secretary of the Air Force or the Administrator, National Aeronautics and Space Administration. Agency heads delegate their authority to Contracting Officers, who either hold their authority by virtue of their position or must be appointed in accordance with procedures set forth in the Federal Acquisition Regulation. Only Contracting Officers may sign Government contracts on behalf of the government. 48 CFR § 1.601. A Contracting Officer has only the authority delegated pursuant to law and agency procedures. This authority is set forth in the Contracting Officer's certificate of appointment (formerly called a "warrant"). Unlike in commercial contracting, there is no doctrine of apparent authority applicable to the Government. Any action taken by a Contracting Officer that exceeds the Contracting Officer's actual delegated authority is not binding on the Government, even if both the Contracting Officer and the contractor desire the action and the action benefits the Government. The contractor is presumed to know the scope of the Contracting Officer's authority and cannot rely on any action of Contracting Officers when it exceeds their authority. Contracting Officers are assisted in their duties by Contracting Officer Representatives (CORs) and Contracting Officer Technical Representatives (COTRs), who usually do not have the authority of a Contracting Officer.
Process of Federal Acquisition Generally, federal acquisitions begin with identification of a requirement by a specific federal activity. A basic idea of what is needed and the problem statement is prepared and the requiring activity meets with an acquisition command having a Contracting Officer with an appropriate warrant issued by a specific acquisition activity.
Not all Contracting Officers are created equal. Contracting officers have different contracting thresholds and varying degrees of experience and capabilities. Each one has a specific warrant that states the conditions under which they are permitted to engage in federal contracting. Depending on the contracting activity, some contracting officers may have no experience whatever with the product, service or requirements in question or knowledge of any of the potential vendor base, representing a weakness on the part of the Government procurement process.