Individual Entrepreneur or Limited Liability Company: Choosing How to Buy a Franchise in Russia

When choosing a franchise, entrepreneurs usually compare brands and start-up terms. Before signing any documents, however, it is worth deciding who will actually buy it: a registered individual entrepreneur (known in Russia as an IP) or a limited liability company (an OOO). For anyone entering the franchise market, this is more than a formality. The choice affects liability for debts, the ability to bring in a co-owner and the arrangements for securing rights to use the brand.

Who can enter into a franchise agreement?

In Russia, arrangements granting a package of exclusive rights, including the right to use a trade mark, are governed by Chapter 54 of the Russian Civil Code, which covers commercial concessions. Under Article 1027, the parties to such an agreement may be commercial organisations or individuals registered as individual entrepreneurs. An OOO is one possible form of commercial organisation, but not the only one.

An individual who is not registered as an IP cannot be the user of rights under a commercial concession agreement. Registering for Russia’s tax on professional income does not, in itself, confer IP status. An IP can also use this tax regime, provided their activities meet its restrictions. For example, the regime does not allow the hiring of employees under employment contracts or, as a general rule, the resale of goods. For many franchises, these are significant obstacles.

The title of the document is not decisive. If a seller offers an individual a ‘partnership agreement’, its substance needs to be checked: which rights are granted, who conducts the business and which legal rules apply. Changing the heading does not remove the statutory requirements.

A commercial concession agreement must be in writing. Under Article 1028 of the Russian Civil Code, the grant of the right to use the package of exclusive rights must also be registered with Rospatent, Russia’s intellectual property office. It is therefore best to decide who will receive those rights before making a payment, rather than afterwards.

How does liability for debts differ?

An IP is not a legal entity separate from the individual. The entrepreneur is liable for franchise-related obligations with their personal assets, except for assets that the law protects from enforcement. Giving up IP status does not, in itself, write off debts owed to the franchisor, landlord or suppliers.

An OOO is liable for its obligations with its own assets. As a general rule, its members are not liable for the company’s debts, and their risk of loss is limited to the value of their ownership interests. However, it would be wrong to regard an OOO as complete protection for personal assets. For example, a personal guarantee creates a separate obligation for the individual. In circumstances specified by law, people who control the company may also incur subsidiary liability for its debts, including in insolvency proceedings.

Before choosing a business structure, draw up a list of future obligations:

• payments to the franchisor, including the initial franchise fee;
• rent and the cost of reinstating the premises when handing them back;
• payments for equipment and stock;
• payments due to employees;
• loans and borrowings, and any security or guarantees supporting them.

For each item, identify who owes the money and whether any personal security or guarantee is involved. If almost all the OOO’s obligations are backed by the owner’s personal guarantee, the expected protection for personal assets will be considerably weaker.

Do not limit your assessment to the amount needed to open the business. You need to understand which obligations will remain if there is no revenue and the outlet has to close. This helps you compare business structures by their actual risks, rather than their registration costs.

How should you structure a purchase with a partner?

An IP has no ownership interests to allocate and cannot have co-owners. If two people invest in an outlet registered to one individual entrepreneur, the second person does not automatically become a part-owner of the business. Transferring money and verbally agreeing to ‘split the profits equally’ does not give them corporate rights.

An OOO allows ownership interests to be divided between members and rules for managing the company to be established. Before buying a franchise, partners should agree not only how much each will invest, but also:

• who will be the director and who will control payments;
• how decisions about additional investment will be made;
• what happens if one member stops working in the business;
• how a deadlock will be resolved if voting rights are split equally;
• how a member can sell their ownership interest.

The relevant provisions should be set out in the company’s articles of association, a members’ agreement and other appropriate documents, in accordance with the law. Funds provided by members must also be properly documented: a capital contribution and a loan have different legal consequences.

Check the agreement with the franchisor separately. It may require approval for changes in company membership or control. Selling an ownership interest in an OOO and transferring the franchise agreement itself are different transactions. Do not assume that permission for one automatically means permission for the other.

What should you agree before the first payment?

Decide whether the franchise will be bought by an existing business or a newly established company. An existing OOO brings not only a trading history and a business bank account to the project, but also its previous obligations. A new OOO allows the operation to be kept organisationally separate, but it does not remove liability arising from its own transactions or its director’s actions.

Next, check that the documents are consistent. Under your chosen structure, the appropriate person or entity must be identified as the recipient of the rights, the tenant, the employer and the seller to customers. If these roles are split between several people or entities, separate legal arrangements are needed: common ownership does not allow companies to transfer the right to use a brand freely between themselves.

Do not sign an agreement as an IP on the assumption that you can later ‘just change the details’ to those of an OOO. An OOO is a different legal person. Transferring the contractual relationship may require the other party’s consent, new documents and registration procedures.

Before paying, carry out a joint review with a lawyer and an accountant: is the chosen business structure permitted for the activity concerned, is the tax regime suitable, who receives the rights and who bears the obligations?

Practical takeaway: first decide who will buy the franchise, allocate responsibility and formalise your partners’ involvement. Only then should you sign the agreement and transfer money on behalf of the correctly identified party.