As filed with the Securities and Exchange Commission on October 24, 1996 
                                                    Registration No. 333-11427 
===============================================================================

    

                      SECURITIES AND EXCHANGE COMMISSION 

WASHINGTON, D.C. 20549 
                                 -------------

   
                               AMENDMENT NO. 2 
                                      TO 
                                   FORM S-1 
    

                            REGISTRATION STATEMENT 
                                    UNDER 
                          THE SECURITIES ACT OF 1933 

                                 -------------

                          U.S. FRANCHISE SYSTEMS, INC. 

              (Exact name of registrant as specified in its charter) 

                                 -------------



                                                                     
               Delaware                              7011                        58-2190911 
    (State or other jurisdiction of      (Primary Standard Industrial         (I.R.S. Employer 
    incorporation or organization)       Classification Code Number)       Identification Number) 


                        13 Corporate Square, Suite 250 
                            Atlanta, Georgia 30329 
                                (404) 321-4045 

(Address, including zip code, and telephone number, including area code, of 
                  registrant's principal executive offices) 

                                 -------------

                               Michael A. Leven 
               Chairman, President and Chief Executive Officer 
                         U.S. Franchise Systems, Inc. 
                        13 Corporate Square, Suite 250 
                            Atlanta, Georgia 30329 
                                (404) 321-4045 

(Name, address, including zip code, and telephone number, including area 
code, of agent for service) 

                                 -------------

                                  Copies to: 



                                                     
        Judith R. Thoyer, Esq.                         Patricia A. Ceruzzi, Esq. 
Paul, Weiss, Rifkind, Wharton & Garrison                  Sullivan & Cromwell 
       1285 Avenue of the Americas                         125 Broad Street 
      New York, New York 10019-6064                    New York, New York 10004 
             (212) 373-3000                                 (212) 558-4000 


                                ------------- 

   
Approximate date of commencement of proposed sale to the public: As soon as 
practicable after the effective date of this Registration Statement. 
    

If any of the securities being registered on this form are to be offered on a 
delayed or continuous basis pursuant to Rule 415 under the Securities Act of 
1933, other than securities offered only in connection with dividend or 
interest reinvestment plans, check the following box. [ ] 

   
If this Form is filed to register additional securities for an offering 
pursuant to Rule 462(b) under the Securities Act, check the following box and 
list the Securities Act registration statement number of the earlier 
effective registration statement for the same offering. [ ] 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) 
under the Securities Act, check the following box and list the Securities Act 
registration statement number of the earlier effective registration statement 
for the same offering. [ ] 

If delivery of the prospectus is expected to be made pursuant to Rule 434, 
check the following box. [ ] 
    

                                ------------- 

                       CALCULATION OF REGISTRATION FEE 



                                                                                 
                                       Amount      Proposed Maximum    Proposed Maximum 
       Title of Each Class             to be        Offering Price        Aggregate             Amount of 
 of Securities to be Registered    Registered (1)      Per Share     Offering Price (1)(2)  Registration Fee (3)
 --------------------------------------------------------------------------------------------------------------
 Class A Common Stock              2,673,750 shares      $14.00           $37,432,500            $12,377.66 


 

   (1) Includes shares which may be purchased by the Underwriters solely to 
cover over-allotments, if any. 

   (2) Estimated solely for purposes of calculating the registration fee. 

   
   (3) Calculated in accordance with Rule 457(a). 
    

                                ------------- 

The Registrant hereby amends this Registration Statement on such date or 
dates as may be necessary to delay its effective date until the Registrant 
shall file a further amendment which specifically states that this 
Registration Statement shall thereafter become effective in accordance with 
Section 8(a) of the Securities Act of 1933, as amended, or until the 
Registration Statement shall become effective on such date as the Securities 
and Exchange Commission, acting pursuant to said Section 8(a), may determine. 

================================================================================

 

Information contained herein is subject to completion or amendment. A 
registration statement relating to these securities has been filed with the 
Securities and Exchange Commission. These securitiesmay not be sold nor may 
offers to buy be accepted prior to the time the registration statement 
becomes effective. This Prospectus shall not constitute an offer to sell or 
the solicitation of an offer to buy nor shall there be any sale of these 
securities in any State in which such offer, solicitation or sale would be 
unlawful prior to registration or qualification under the securities laws of 
any such State. 

   
                SUBJECT TO COMPLETION, DATED OCTOBER 24, 1996 
    

[U.S. FRANCHISE SYSTEMS, INC. LOGO]


                               2,325,000 Shares 

                         U.S. Franchise Systems, Inc. 

                             Class A Common Stock 
                              ($0.01 par value) 

   Of the 2,325,000 shares of Class A Common Stock offered hereby, 1,825,000 
shares are being sold by U.S. Franchise Systems, Inc. ("USFS" or the 
"Company") and 500,000 shares are being sold by the Selling Stockholders. The 
Company will not receive any of the proceeds from the sale of shares of Class 
A Common Stock by the Selling Stockholders. See "Selling Stockholders." 

   Prior to this offering, there has been no public market for the Class A 
Common Stock. It is currently estimated that the initial public offering 
price per share will be between $12.00 and $14.00. See "Underwriting" for 
information relating to the method of determining the initial public offering 
price. 

   
   The Company has two classes of authorized Common Stock: Class A Common 
Stock and Class B Common Stock. The holders of Class A Common Stock are 
entitled to one vote per share and the holders of Class B Common Stock are 
entitled to ten votes per share. Otherwise, the rights of the holders of 
Class A Common Stock and the holders of Class B Common Stock are 
substantially identical. Certain members of management own all of the 
outstanding shares of Class B Common Stock. Upon completion of the Offering, 
such members of management will control approximately 78% of the combined 
voting power of the Class A Common Stock and the Class B Common Stock. Shares 
of Class B Common Stock are convertible into shares of Class A Common Stock 
on a share-for-share basis. Both classes will generally vote together as one 
class on all matters submitted to a vote of stockholders, including the 
election of directors. See "Description of Capital Stock." 

   The Class A Common Stock has been approved for quotation and trading on 
the NASDAQ National Market System upon completion of the Offering under the 
symbol "USFS." 
    

   The Common Stock offered hereby involves a high degree of risk. See "Risk 
Factors" beginning on page 9. 

   
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND 
  EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE 
    SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION 
      PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY 
            REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. 
    



                                Underwriting                        Proceeds to 
                   Price to     Discounts and     Proceeds to         Selling 
                    Public     Commissions (1)    Company (2)       Stockholders
- --------------------------------------------------------------------------------
                                                        
Per Share              $                 $           $                  $ 
Total (3)           $               $              $                 $ 


(1)See "Underwriting" for indemnification arrangements. 
(2)Before deducting estimated expenses of $700,000 payable by the Company. 
(3)The Company and the Selling Stockholders have granted to the Underwriters 
   a 30-day option to purchase up to an additional 273,750 and 75,000 shares 
   of Class A Common Stock, respectively, solely to cover over- allotments. 
   If this option is exercised in full, total Price to Public, Underwriting 
   Discounts and Commissions, Proceeds to Company and Proceeds to Selling 
   Stockholders will be $     , $     , $      and $     , respectively. See 
   "Underwriting." 

   The shares of Class A Common Stock offered hereby are being offered by the
several Underwriters named herein, subject to prior sale and acceptance by the
Underwriters and subject to their right to reject any order in whole or in part.
It is expected that the Class A Common Stock will be available for delivery on
or about , 1996, at the offices of Schroder Wertheim & Co. Incorporated, New
York, New York.

Schroder Wertheim & Co.                                    Montgomery Securities

                                         , 1996. 

 

                                [PHOTO OF MAP] 

================================================================================

   IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVERALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE CLASS A COMMON
STOCK AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET.
SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET OR OTHERWISE.
SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.

                                      2 
 

                              PROSPECTUS SUMMARY 

   The following summary is qualified in its entirety by the more detailed 
information and financial statements (including the notes thereto) appearing 
elsewhere in this Prospectus. As used in this Prospectus, unless the context 
otherwise requires, the terms "USFS" and "Company" include U.S. Franchise 
Systems, Inc. and its subsidiaries and their operations. The offering of 
shares of the Class A Common Stock, par value $0.01 per share (the "Class A 
Common Stock"), of U.S. Franchise Systems, Inc. is referred to herein as the 
"Offering". Unless otherwise indicated, all information included in this 
Prospectus (i) assumes that the Underwriters' over-allotment option will not 
be exercised and (ii) has been adjusted to give effect to the 
reclassification of the Company's Common Stock, par value $.10 per share (the 
"Old Common Stock"), pursuant to which each share of Old Common Stock will 
become 9.67 shares of Class A Common Stock, and to the exchange of 2,707,919 
shares of such Class A Common Stock held by certain members of management for 
the same number of shares of a newly created class of common stock to be 
designated Class B Common Stock, par value $0.01 per share (the "Class B 
Common Stock" and together with the Class A Common Stock, the "Common Stock", 
and the foregoing reclassification and exchange, the "Reclassification"). 

                                 THE COMPANY 

General 

   U.S. Franchise Systems, Inc. was formed in August 1995 to acquire, market 
and expand high-quality, well- positioned brands with potential for rapid 
unit growth through the sale of franchises to third-party operators. The 
Company's initial brands, both of which are in the lodging industry, are the 
Microtel budget brand ("Microtel") and the Hawthorn Suites upscale, 
extended-stay brand ("Hawthorn Suites"). The Company acquired the rights to 
these brands because of their potential for significant growth, which 
reflects, among other things, their profitability for franchisees at the 
property level and their positions in attractive segments of the lodging 
industry. 

   The Company has assembled an experienced management team and sales force 
led by its Chairman, President and Chief Executive Officer, Michael A. Leven, 
who has 35 years of experience in the lodging industry, and its Executive 
Vice President and Chief Financial Officer, Neal K. Aronson, a former 
principal of the New York investment firm Odyssey Partners, L.P. Mr. Leven 
most recently served as President and Chief Operating Officer of Holiday Inn 
Worldwide (1990-95) and President and Chief Operating Officer of Days Inn of 
America, Inc. (1985- 90), franchisors of the two largest lodging brands in 
the world. The Company has hired and trained a staff of 73 employees, 
including a 28-person sales force, which management believes is the third 
largest franchise sales organization in the lodging industry. Mr. Leven and 
the Company's sales force have collectively sold over 2,200 hotel franchises 
on behalf of other hotel chains. Since acquiring the Microtel brand in 
October 1995 and establishing a sales force by January 1996, the Company has 
executed 145 franchise agreements and accepted applications for an additional 
74 hotels as of September 30, 1996, expanding the number of states in which 
Microtels are or may be located from 10 to 44. Since acquiring the exclusive 
rights to franchise hotels under the Hawthorn Suites brand in March 1996 and 
establishing a sales force by July 1996, the Company has executed five 
franchise agreements and accepted applications for 16 additional hotel sites 
as of September 30, 1996. 

   As a franchisor, USFS licenses the use of its brand names to independent 
hotel owners and operators (i.e., franchisees). The Company provides its 
franchisees with a variety of benefits and services designed to (i) decrease 
development costs, (ii) shorten the time frame and reduce the complexity of 
the construction process and (iii) increase occupancy rates, revenues and 
profitability of the franchised properties. The Company offers prospective 
franchisees access to financing, a business format, design and construction 
assistance (including architectural plans), uniform quality standards, 
training programs, national reservations systems, national and local 
advertising and promotional campaigns and volume purchasing discounts. The 
Company does not currently build, own or manage properties. 

   The Company expects that its future revenues will consist primarily of (i) 
franchise royalty fees, (ii) franchise application fees, (iii) reservation 
and marketing fees, (iv) various fees and other revenues from third-party 
financing arranged by the Company for its franchisees and (v) payments made 
by vendors who supply the Company's franchisees with various products and 
services. Currently, the Company derives substantially all of its revenues 
from reservation and marketing fees collected from its franchisees. The 
Company also receives cash from its franchisees in the form of application 
fees, which are recognized as revenue only upon the opening of the 

                                      3 
 

underlying hotels. See the Consolidated Financial Statements and the related 
Notes included elsewhere in this Prospectus and "Management's Discussion and 
Analysis of Financial Condition and Results of Operations". 

Microtel 

   The Microtel system currently includes 27 hotels operating under the 
Microtel Inn and Microtel Inn & Suites brand names. In addition, the Company 
has executed one franchise agreement for a hotel to be operated under the 
Microtel Suites brand name. Microtel properties operate in the budget segment 
of the lodging industry, which is the lowest priced segment in the industry 
(with an average daily room rate in 1995 of approximately $36) and which has 
experienced favorable growth in room demand relative to growth in room 
supply. For the six months ended June 1996, the rate of growth in room demand 
exceeded the rate of growth in room supply in the budget segment by 3.4 
times, significantly higher than comparable ratios for any other segment in 
the lodging industry during this period. According to an industry study, the 
rate of growth in room demand relative to the rate of growth in room supply 
was 2.0x in the luxury segment, 1.1x in the upscale segment, 1.3x in the 
mid-price segment and 1.5x in the economy segment over the same period. 

   Microtels are distinctively styled hotels with a residential look that 
offer travelers an attractive and consistent appearance, clean, comfortable 
rooms and the safety of interior corridor access, all for a competitive room 
rate. Management believes that Microtel is one of the only brands in the 
budget segment that franchises only newly constructed, interior corridor 
properties. In contrast, many other budget hotels are older properties with 
rooms that are accessible only through outside entrances and that may have 
been converted from independent hotels or other brands. Management believes 
that Microtels' strict new construction and interior corridor requirements 
provide travelers with a brand that is among the safest, most consistent and 
highest quality in the budget segment. Evidence of the appeal of Microtels to 
hotel guests is found in its "intent-to-return" rating, which measures 
guests' overall satisfaction and willingness to return to a Microtel in the 
future. In surveys of approximately 5,000 Microtel guests conducted by 
franchisees from 1989 to 1994, more than 95% of Microtel guests expressed an 
intent to return to a Microtel in the future. 

   The Company believes that Microtels offer franchisees significant 
financial advantages. Microtels are designed to minimize construction costs 
and maintenance expenses by incorporating smaller room sizes, limited common 
areas, relatively smaller land requirements and built-in standardized 
furniture, all of which enable franchisees to build and operate a Microtel at 
a lower cost. These lower costs may reduce a franchisee's equity investment 
and may broaden its debt financing alternatives, thereby expanding the appeal 
of the Microtel brand to prospective franchisees. See "Business--Microtel". 

Hawthorn Suites 

   The Hawthorn Suites system, which currently includes 18 open Hawthorn 
Suites hotels, targets the upscale segment of the rapidly growing 
extended-stay lodging market, which is defined as guests that stay five or 
more consecutive nights. Hotels in this segment offer guests the amenities of 
an apartment with the convenience and flexibility of a hotel. According to an 
industry study, extended-stay rooms accounted for over 30% of all hotel room 
nights sold in the United States in 1995. Another industry study indicates 
that the supply of dedicated extended- stay rooms accounted for only 1.3% of 
the total number of hotel rooms. Extended-stay properties offer attractive 
economics to franchisees because of the relatively high occupancy rates in 
this segment and the lower operating costs relative to similarly priced, 
full-service hotel properties. Extended-stay hotels experienced occupancy 
rates of approximately 80% in 1995 compared to approximately 65% for the 
lodging industry as a whole during the same period. 

   Hawthorn Suites hotels offer large suites equipped with full kitchens and 
work spaces, laundry facilities and exercise rooms, daily housekeeping, 
24-hour front-desk service, complimentary hot breakfast and hospitality 
hours. Hawthorn Suites hotels include both newly constructed properties and 
conversions of pre-existing hotels and apartment buildings. The Company has 
also recently developed prototypes for a mid-price, all-suite hotel brand, 
called Hawthorn Suites LTD, which is designed to meet the needs of both 
extended-stay and short-term guests. See "Business--Hawthorn Suites". 

   The agreement pursuant to which the Company acquired the exclusive 
worldwide rights to franchise the Hawthorn Suites brand of hotels (the 
"Hawthorn Acquisition Agreement") limits the Company's ability to franchise 

                                      4 
 

certain types of all-suite and full-service lodging brands prior to June 26, 
1998 and any non-lodging brands prior to June 26, 1997. For a more complete 
discussion of the terms and conditions of the Hawthorn Acquisition Agreement, 
see "Risk Factors--Risks Relating to Hawthorn Acquisition Agreement", 
"--Limitations on New Brands" and "Business--Acquisition of the Microtel and 
Hawthorn Suites Systems". 

Business Strategy 

   
   The Company's business strategy is to (i) rapidly increase the number of 
open Microtels and Hawthorn Suites, (ii) operate its administrative and 
franchisee support departments in order to maximize the operating leverage 
inherent in the franchising business and (iii) acquire additional lodging or 
other service-oriented brands that provide attractive unit economics to 
franchisees and significant growth opportunities for the Company (to the 
extent permitted under the Hawthorn Acquisition Agreement). See 
"Business--Acquisition of the Microtel and Hawthorn Suites Systems". While 
the Company currently has no agreements, commitments or formal understandings 
with respect to any acquisitions, the Company may in the future acquire and 
franchise brands both in and out of the lodging industry. 
    

   The Company has developed several programs designed to accelerate the 
opening of new properties and expand its brands' attractiveness to 
franchisees. First, in May 1996, the Company reached an agreement in 
principle with Nomura Asset Capital Corporation ("NACC"), a subsidiary of The 
Nomura Securities Co., Ltd., one of the world's largest investment banks 
("Nomura Securities"), pursuant to which NACC would make available to 
prospective Microtel and Hawthorn Suites franchisees up to $200 million in 
construction and long-term mortgage financing, subject to certain terms and 
conditions. This program is intended to add speed and certainty to the hotel 
development process, enabling the Company's franchisees to devote more time 
to identifying acceptable hotel sites and developing properties and less time 
obtaining financing. There can be no assurance, however, that any loans will 
be made under this program. See "Business--Special Programs--Franchisee 
Financing Facility." Second, the Company has reached an understanding in 
principle with a hotel developer to construct Microtels for lease to 
prospective franchisees. This program, "American Dream|PS by Microtel" (the 
"American Dream Program"), is designed to enable hotel operators with limited 
capital resources and/or little or no building experience to operate, and 
possibly to own, a Microtel and thereby increase the number of potential 
Microtel franchisees. See "Business--Special Programs--American Dream 
Program." Third, the Company has extended the Microtel and Hawthorn Suites 
brands from two to five distinct products, which the Company believes 
increases the appeal and viability of the brands to franchisees by offering 
multiple formats that can be tailored to specific markets, development 
requirements and guest preferences. To date, more than 50% of the Microtel 
franchises sold by the Company relate to Microtel Inn & Suites or Microtel 
Suites, two formats designed by the Company after its acquisition of the 
Microtel brand. 

   The Company was formed in August 1995 as a Delaware corporation. Its 
executive offices are located at 13 Corporate Square, Suite 250, Atlanta, 
Georgia 30329. Its telephone number is (404) 321-4045. 

                                      5 
 

                                 THE OFFERING 



                                         
Common Stock offered by: 
 The Company                             1,825,000 shares of Class A Common Stock 
 The Selling Stockholders                  500,000 shares of Class A Common Stock 

Common Stock to be outstanding after     9,872,490 shares of Class A Common Stock 
  the Offering                           2,707,919 shares of Class B Common Stock 
                                         ---------

                                         12,580,409 total shares of Common Stock 
                                         ==========

Use of Proceeds                          The proceeds of the Offering will be used for working capital and 
                                         general corporate purposes, which may include (i) funding the 
                                         Company's remaining obligations (approximately $2 million) under 
                                         the agreement pursuant to which it acquired the Microtel brand 
                                         (the "Microtel Acquisition Agreement"), (ii) acquiring additional 
                                         lodging or other service-oriented brands or exclusive franchise 
                                         rights (to the extent permitted under the Hawthorn Acquisition 
                                         Agreement), (iii) making initial deposits in connection with the 
                                         American Dream Program until qualified lessees can be identified, 
                                         (iv) investing in financing programs developed by its wholly owned 
                                         subsidiary, US Funding Corp., and (v) investing in entities that 
                                         make equity investments in hotel properties built and managed by 
                                         certain franchisees with the potential for multi-unit development. 
                                         See "Use of Proceeds", "Business-- Acquisition of the Microtel and 
                                         Hawthorn Suites Systems" and "--Special Programs". 

Voting Rights                            Shares of Class A Common Stock have one vote per share, while 
                                         shares of Class B Common Stock have ten votes per share. The Class 
                                         B Common Stock, the holders of which have effective control of the 
                                         Company, is voted only by Messrs. Leven and Aronson. Class B 
                                         Common Stock is convertible into Class A Common Stock on a 
                                         share-for-share basis and, with limited exceptions, will 
                                         automatically convert into Class A Common Stock upon transfer. The 
                                         Class B Common Stock is not being offered by this Prospectus. See 
                                         "Risk Factors--Control by Management and Anti-Takeover Effect of 
                                         Dual Classes of Stock", "Description of Capital Stock--Common 
                                         Stock" and "Principal Stockholders--Management's Shares of Common 
                                         Stock". 

Nasdaq National Market symbol            USFS 


                                      6 
 

                        SUMMARY FINANCIAL AND OTHER DATA

   The following table sets forth consolidated financial information for the
Company and its subsidiaries as of December 31, 1995 and June 30, 1996, for the
period from August 28, 1995, the date of the Company's inception, to December
31, 1995 and for the six months ended June 30, 1996. The table includes
operating data for the Company since its inception and should be read in
conjunction with the Consolidated Financial Statements and related Notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", which are contained elsewhere in this Prospectus.



                                                                      Period from 
                                                                  August 28, 1995 to  Six Months Ended 
                                                                   December 31, 1995   June 30, 1996 
                                                                   ------------------ ---------------- 
                                                                    (In thousands of dollars, except 
                                                                        share and per share data) 
                                                                                   
Statement of Operations Data: 
Revenues                                                             $     --           $        395 
Operating expenses                                                          1,327              3,849 
Operating loss                                                              1,327              3,454 
Interest income                                                               195                331 
Interest expense                                                               36                 72 
Net loss                                                                    1,168              3,195 
Loss applicable to common stockholders                                      1,645              4,033 
Net loss applicable to common stockholders per share (1)                     0.15               0.38 
Weighted average number of common shares  outstanding (2)              10,755,409         10,755,409 

Balance Sheet Data (at period end): 
Working capital                                                      $    13,265        $      8,029 
Total assets                                                               18,072             19,027 
Total liabilities                                                           1,845              5,992 
Redeemable Preferred Stock                                                 16,759             17,597 
Redeemable Common Stock                                                       330                330 
Stockholders' deficit                                                         862              4,892 


- ------------- 

   
(1) Based upon 8,047,490 shares of Class A Common Stock and 2,707,919 shares 
    of Class B Common Stock outstanding after the Reclassification but before 
    the Offering. 
    

(2) Includes 3,186,294 shares of Class A Common Stock that are redeemable 
    under certain circumstances by the Company for reasons not under the 
    Company's control. See "Principal Stockholders--Management's Shares of 
    Common Stock". 

                                      7 
 

                              Franchised Hotels 



                                      Microtel(1)                         Hawthorn Suites (2) 
                         --------------------------------------  ------------------------------------- 
                               As of               As of               As of               As of 
                         December 31, 1995  September 30, 1996   December 31, 1995  September 30, 1996 
                         ------------------  ------------------  -----------------  ------------------ 
                                                                                
Properties Open                 23                   27                 17                  18 
Properties Under 
  Construction                   0                    7                  0                   2 
Executed Franchise 
  Agreements                     3                  145                  0                   5 
Franchise 
  Applications 
  Accepted (3)                  10                   74                  0                  16 


- ------------- 

(1) The Company will not receive royalties from the 23 Microtels open as of 
    December 31, 1995 and from 26 of the 27 Microtels open as of September 
    30, 1996, but does receive marketing fees from the franchisees of these 
    properties. See "Business--Microtel" and "Business--Acquisition of the 
    Microtel and Hawthorn Suites Systems". 

(2) The Company will not receive royalties from the 17 Hawthorn Suites hotels 
    open as of December 31, 1995 and the 18 Hawthorn Suites hotels open as of 
    September 30, 1996, but does receive reservation and marketing fees from 
    the franchisees of these properties. See "Business--Hawthorn Suites" and 
    "Business-- Acquisition of the Microtel and Hawthorn Suites Systems." 

(3) Represents franchise applications as to which the Company has approved 
    the proposed site and the prospective franchisee but has not yet executed 
    a franchise agreement. 

   
                              Operating Data(1) 
    




                                           Microtel 
                      ----------------------------------------------- 
                                             For the Six Months Ended 
                      For the Year Ended     ------------------------ 
                         December 31,        June 30,       June 30, 
                             1995              1995           1996 
                      ------------------     --------       -------- 
                                                    
Average Daily Room 
   Rate ("ADR")             $35.75           $34.32          $35.40 
Average Occupancy             69.3%             66.1%          66.6% 
Average Revenue Per 
   Available Room           $24.77            $22.68         $23.57 
Number of Hotels                15                15             15 




                                         Hawthorn Suites 
                      ----------------------------------------------- 
                                             For the Six Months Ended 
                      For the Year Ended     ------------------------ 
                         December 31,        June 30,       June 30, 
                             1995              1995           1996 
                      ------------------     --------       -------- 
                                                    
Average Daily Room 
   Rate ("ADR")             $78.27           $77.50          $82.02 
Average Occupancy             78.1%             77.8%          80.6% 
Average Revenue Per 
   Available Room           $61.13            $60.29         $66.11 
Number of Hotels                15                15             15 


- ------------- 

(1) Includes data only from those Microtels and Hawthorn Suites hotels that 
    have been operating as part of the applicable franchise system for two 
    years or more as of June 30, 1996. 

                                      8 
 

                                 RISK FACTORS 

   The following risks should be carefully considered in evaluating the 
Company and its business before purchasing the Class A Common Stock offered 
by this Prospectus. Such risks represent all material risks associated with 
an investment in the Class A Common Stock. 

Limited Operating History; Dependence on Hotel Openings 

   The Company began operating in October 1995 and therefore has a very 
limited operating history upon which investors can evaluate the Company's 
performance. While the Company believes that it has a well-conceived strategy 
and that it has assembled an experienced and well-qualified management team 
to implement this strategy, the Company has incurred losses to date and there 
can be no assurance that the Company will be profitable in the future. As of 
June 30, 1996, the Company had an accumulated deficit of $4,970,000. 

   The Company expects that in the future a principal source of revenues will 
be royalty fees received from its franchisees. However, the terms of the 
Microtel Acquisition Agreement and the Hawthorn Acquisition Agreement 
expressly provide that the Company is not entitled to royalties with respect 
to Microtels and Hawthorn Suites hotels that were open or under construction, 
or with respect to which franchise agreements had been executed or 
applications accepted, at the time of the acquisition by the Company of the 
right to franchise these brands. Similarly, the Company is not entitled to 
royalties with respect to the 23 additional Microtels and the 10 Microtel 
all-suites hotels that Hudson Hotels Corporation, the entity from which the 
Company acquired the Microtel brand ("Hudson"), its affiliates and certain 
other persons are entitled to franchise pursuant to the terms of the Microtel 
Acquisition Agreement. Of the existing Microtel and Hawthorn Suites 
properties, the Company is entitled to receive royalty fees from one 
Microtel. Accordingly, the Company is dependent upon future hotel openings to 
recognize franchise application fees as revenue and to generate franchise 
royalty fees. There can be no assurance that accepted franchise applications 
will result in executed franchise agreements or that executed franchise 
agreements will result in open properties. See "Business--Acquisition of the 
Microtel and Hawthorn Suites Systems". 

Management, By Virtue of Ownership of Supervoting Class B Common Stock, 
Will Control the Company Following the Offering 

   Holders of the Company's Class A Common Stock are entitled to one vote per 
share and holders of the Company's Class B Common Stock are entitled to ten 
votes per share. Each share of Class B Common Stock is convertible at any 
time into one share of Class A Common Stock and, with limited exceptions, 
converts automatically upon any transfer thereof. Immediately after the 
Offering, Mr. Leven and Mr. Aronson will have the right to vote all of the 
outstanding shares of Class B Common Stock, which, together with their shares 
of Class A Common Stock, will represent approximately 78% of the combined 
voting power of the Company's outstanding Common Stock after the Offering. By 
reason of their right to vote the Class B Common Stock, Messrs. Leven and 
Aronson will be able to (i) elect all of the Company's directors, (ii) amend 
the Charter with respect to most matters, (iii) effect a merger, sale of 
assets or other major corporate transaction, (iv) defeat an unsolicited 
takeover attempt and (v) generally direct the affairs of the Company. 
However, Mr. Leven and Mr. Aronson do not have any agreements or other 
obligations to vote together on matters involving the Company (although Mr. 
Aronson has granted Mr. Leven the right to vote some of his shares of Class A 
Common Stock and some of his shares of Class B Common Stock). See 
"Description of Capital Stock", "Principal Stockholders", and "Certain 
Relationships and Related Transactions". 

Management of Growth 

   The Company has experienced rapid growth in the number of its employees 
and the scope of its operations since its inception. This growth has resulted 
in, and is expected to continue to create, new and increased responsibilities 
for management personnel, as well as added demands on the Company's operating 
and financial systems. The Company's continued growth will depend on its 
ability to manage this growth while implementing its strategy. The efforts of 
key management personnel and the Company's ability to attract or develop new 
management personnel and to integrate these new employees into its overall 
operations will be crucial to continued growth. If the Company is unable to 
manage growth effectively, the Company's business and results of operations 
could be materially and adversely affected. See "Management". 

Dependence on Senior Management 

   The success of the Company is largely dependent on the efforts and 
abilities of its senior management and certain other key personnel, 
particularly Mr. Leven, Chairman, President and Chief Executive Officer, Mr. 
Aronson, 

                                      9 
 

Executive Vice President and Chief Financial Officer, and Steven Romaniello, 
Executive Vice President, Franchise Sales and Development. The Company's 
success will depend in large part on its ability to retain these individuals 
and other current members of its senior management team and to attract and 
retain qualified personnel in the future. The loss of members of senior 
management or of certain other key employees or the Company's inability to 
retain other qualified employees could have an adverse impact on the 
Company's business and results of operations. Currently, except with respect 
to Mr. Leven, the Company does not maintain key person life insurance on 
behalf of the lives of any of its officers or employees. See "Management". 

   The terms of the Company's 10% Cumulative Redeemable Exchangeable 
Preferred Stock (the "Redeemable Preferred Stock") expressly require the 
Company to redeem any shares of Redeemable Preferred Stock outstanding in the 
event the employment of Mr. Leven is terminated by the Company for any reason 
(including resignation) at a redemption price per share equal to $100 plus 
all accrued and unpaid dividends thereon. As of June 30, 1996, the aggregate 
redemption price for all outstanding shares of Redeemable Preferred Stock, 
including accrued but unpaid dividends thereon, was $17,597,000. In addition, 
the Hawthorn Acquisition Agreement, by its terms, may be terminated by HSA 
Properties, L.L.C. ("HSA"), the entity from which the Company acquired the 
exclusive rights to franchise the Hawthorn Suites brand, if Mr. Leven is no 
longer employed by the Company, or upon his death or disability, at any time 
prior to a permitted transfer of the Company's rights thereunder or, if 
earlier, the satisfaction by the Company of certain hotel development levels 
set forth in such agreement. See "Risk Factors--Mandatory Redemption of 
Redeemable Preferred Stock", "Description of Capital Stock--Preferred Stock" 
and "Business-- Acquisition of the Microtel and Hawthorn Suites Systems". 

Management's Discretion With Respect to Proceeds of the Offering 

   Although the Company intends to apply the net proceeds of the Offering in 
the manner described under "Use of Proceeds", the Company's management has 
broad discretion as to the precise allocation of the net proceeds, the timing 
of expenditures and all other aspects of the use thereof. As a result, the 
success of the Company will be substantially dependent upon the discretion 
and judgment of the management of the Company with respect to the application 
and allocation of the net proceeds. See "Use of Proceeds". 

Risks Relating to Microtel Acquisition Agreement 

   The Microtel Acquisition Agreement obligates the Company to execute new 
franchise agreements and have open or under construction a specified number 
of Microtels each year. Specifically, the Microtel Acquisition Agreement 
requires that there are, on a cumulative basis, at least 50 new Microtels 
open or under construction by December 1997, 100 by December 1998, 175 by 
December 1999, and 250 by December 2000. The Microtel Acquisition Agreement 
further provides that if the Company is unable to comply with the development 
schedule for two consecutive years but opens or has under construction at 
least 75% of the number of Microtels required by such schedule, the Company 
may cure the default by paying a $1 million penalty within 30 days of notice 
of such default. If the Company fails to comply with this development 
schedule and to make the requisite cure payment or payments, all rights to 
the Microtel system automatically revert to Hudson. There can be no assurance 
that the Company will comply with the foregoing development schedule, and the 
Company's failure to meet such schedule or to pay the requisite cure payments 
would have a material adverse effect on the Company. See 
"Business--Acquisition of the Microtel and Hawthorn Suites Systems". 

Risks Relating to Hawthorn Acquisition Agreement 

   Under the Hawthorn Acquisition Agreement, the Company is obligated to 
execute a minimum number of Qualified License Agreements (as defined below) 
for new Hawthorn Suites by certain dates (the "Termination Standard"). 
Specifically, the Hawthorn Acquisition Agreement requires that the Company 
have executed, on a cumulative basis, a minimum of 10 Qualified License 
Agreements by June 26, 1997, 20 by June 26, 1998, 40 by June 26, 1999, 60 by 
June 26, 2000, 80 by June 26, 2001, and 100 by June 26, 2002. The term 
"Qualified License Agreement" is generally defined in the Hawthorn 
Acquisition Agreement as any license agreement granted by the Company for the 
use of the Hawthorn Suites brand, provided that (i) the hotel to which such 
agreement relates is an all-suites hotel (i.e., a hotel in which greater than 
50% of the available rooms are suites) with more than 40 suites, (ii) all 
application fees required to be paid by the franchisee to the Company have 
been paid, (iii) the licensee owns or controls through long-term lease the 
land on which the hotel is located or is to be constructed and (iv) the 
average number of suites in hotels covered by Qualified License Agreements is 
greater than 50. If the Company fails to meet any of these development 
milestones and the default has not been cured prior to the delivery of a 
default notice, HSA may terminate the Hawthorn Acquisition Agreement. 

                                      10 
 

   If the Company meets the Termination Standard, but fails to achieve 
specified higher development goals (the "Royalty Reduction Standard"), the 
percentage of franchise royalties payable to HSA will increase. The Hawthorn 
Acquisition Agreement may also be terminated, at the election of HSA, on the 
death, disability, retirement, resignation or termination of employment of 
Mr. Leven as Chief Executive Officer of the Company prior to such time as the 
Royalty Reduction Standard has been met or such time as there are 75 new 
Hawthorn Suites with a minimum aggregate total of 11,375 rooms ("Hawthorn 
Brand Saturation"). See "Business--Acquisition of the Microtel and Hawthorn 
Suites Systems". 

Limitations on New Brands 

   Under the Hawthorn Acquisition Agreement, the Company and its affiliates 
are generally restricted until June 26, 1998 from franchising any lodging 
brands other than (i) Hawthorn Suites brand hotels, (ii) Microtel brand 
hotels and (iii) other limited-service, non-suite hotel brands with an ADR of 
$49 and under. Until June 26, 1997, the Company must also refrain from 
franchising any brands outside of the lodging industry. In addition, until 
such time as Hawthorn Brand Saturation has been achieved or, if Hawthorn 
Brand Saturation is not achieved, for the duration of the term (unless 
earlier terminated) of the Hawthorn Acquisition Agreement and for six months 
thereafter, the Company may not franchise another all-suite hotel brand 
(other than Microtels costing under a certain amount to construct). If the 
Company decides to franchise another all-suite hotel brand after Hawthorn 
Brand Saturation has been achieved, HSA has the option to sell its interest 
in the Hawthorn Suites brand and system of operation to the Company for a sum 
equal to 10 times the portion of franchise royalty fees earned or accrued by 
HSA in the 12 months prior to such sale. See "Business--Acquisition of the 
Microtel and Hawthorn Suites Systems". 

Competition for New Franchise Properties and Hotel Guests 

   Competition among national brand franchisors and smaller chains in the 
lodging industry to grow their franchise systems is intense. The Company 
believes that competition for the sale of lodging franchises is based 
principally upon (i) the perceived value and quality of the brand, (ii) the 
nature and quality of services provided to franchisees, (iii) the 
franchisees' view of the relationship of building or conversion costs and 
operating expenses to the potential for revenues and profitability during 
operation and upon sale and (iv) the franchisee's ability to finance and sell 
the property. The Company's franchisees are generally in intense competition 
for guests with franchisees of other hotel chains, independent properties and 
owner-operated chains. The success of the Company's franchisees affects the 
profitability of the Company, as the Company's receipt of royalty fees under 
its franchise agreements is tied directly to the gross room revenues earned 
by its franchisees. 

   In choosing a particular hotel or motel, consumers consider differences in 
room rates, quality and condition of accommodations, name recognition, 
availability of alternative lodging (including short-term lease apartments), 
service levels, reputation, safety, reservation systems and convenience of 
location. 

   Both among consumers and potential franchisees, Microtel competes with 
budget and economy hotels such as Comfort Inn, Days Inn, Econo Lodge, 
Fairfield Inn, Sleep Inn, Red Roof Inn, Budgetel Inn, Super 8, Ramada 
Limited, Motel 6, Jameson Inns, Travelodge, Thriftlodge, Knights Inn, Red 
Carpet Inn and Scottish Inns. In the upscale, extended-stay sector, Hawthorn 
Suites hotels compete for consumers and potential franchisees with Residence 
Inn, Homewood Suites, Summerfield Suites and Woodfin Suites. In the transient 
suites sector of the lodging industry, where the Company will be competing 
through its Hawthorn Suites LTD brand, the Company's principal competitors 
will include AmeriSuites, Hampton Inn and Suites, Fairfield SuitesSM, 
MainStaySM, CandlewoodSM, Wingate InnSM, Towne PlaceSM and Courtyard by 
Marriott, among others. Many of the Company's competitors are affiliated with 
larger chains with substantially more properties, greater marketing budgets 
and greater brand identity than the Company. There can be no assurance that 
the Company can franchise a sufficient number of properties to generate 
operating efficiencies that will enable it to compete with these larger 
chains. 

General Risks of the Lodging Industry 

   Although the Company does not currently own hotel properties, because the 
Company's revenues vary directly with its franchisees' gross room revenues, 
the Company's business is impacted by the effects of risks experienced by 
hotel operators generally. The budget, extended-stay and transient suite 
segments of the lodging industry, the segments in which hotels franchised 
under the Company's brands currently operate or plan to operate, may be 
adversely affected by changes in national or local economic conditions and 
other local market conditions, such as an oversupply of or a reduction in 
demand for lodging or a scarcity of potential sites in a geographic area, 
changes 

                                      11 
 

in travel patterns, extreme weather conditions, changes in governmental 
regulations that influence or determine wages, prices, construction costs or 
methods of operation, changes in interest rates, the availability of 
financing for operating or capital needs and changes in real estate tax rates 
and other operating expenses. In addition, due in part to the strong 
correlation between the lodging industry's performance and economic 
conditions, the lodging industry is subject to cyclical changes in revenues 
and profits. These risks may be exacerbated by the relatively illiquid nature 
of real estate holdings. Downturns or prolonged adverse conditions in real 
estate or capital markets or in national or local economies could have a 
material adverse impact on the Company's ability to locate new franchisees. 

   As a hotel franchisor, the Company expects to experience seasonal revenue 
patterns similar to those experienced by participants in the lodging industry 
generally. Accordingly, the summer months, because of increases in leisure 
travel, are expected to produce higher franchise royalty revenues for the 
Company than other periods during the year. In addition, developers of new 
hotels typically attempt, whenever feasible, to schedule the opening of a new 
property to occur prior to the spring and summer seasons. This may have a 
seasonal impact on the Company's revenues, a significant portion of which is 
not recognized until the opening of a property. Accordingly, the Company may 
experience lower revenues and profits in the first and fourth quarters and 
higher revenues and profits in the second and third quarters. 

Development Risk 

   Although the Company does not currently own hotel properties, because its 
revenues are dependent on the revenues of its franchisees, the Company is 
subject to risks associated with developing hotel properties. These risks, 
which are applicable to Microtels as new construction properties and Hawthorn 
Suites as both new construction and conversion properties, include delays in 
completion of construction, failure to obtain all necessary zoning and 
construction permits, discovery of environmental hazards, unavailability of 
financing on favorable terms, if at all, the failure of developed properties 
to achieve desired revenue or profitability levels once opened, competition 
for suitable development sites from competing franchise chains, the risk of 
incurring substantial costs in the event a development project must be 
abandoned prior to completion, changes in governmental rules, regulations and 
interpretations and general economic and business conditions. The Company's 
revenues may also be adversely affected by increases in interest rates, which 
could increase the costs of financing new hotel construction or the 
conversion of existing hotels. Any one of these risks could discourage or 
prohibit potential franchisees from beginning or completing hotel projects. 
In addition, in connection with the American Dream Program, the Company may 
in the future lease and, ultimately, own Microtels. To the extent the Company 
leases and/or owns hotel properties it would be subject to risks experienced 
by hotel operators generally. 

Risks Relating to the Franchisee Financing Facility 

   In May 1996, the Company reached an agreement in principle with NACC, 
pursuant to which NACC would make available to the Company's franchisees over 
a two-year period up to $200 million in construction and long-term mortgage 
financing, subject to certain terms and conditions (the "Franchisee Financing 
Facility"). Under the Franchisee Financing Facility, the ultimate decision 
regarding the provision of loans to franchisees will be made by NACC. There 
can be no assurance that any loans will be made in connection with the 
Franchisee Financing Facility or any other financing facility. See 
"Business--Special Programs--Franchisee Financing Facility". 

   The Company generally does not make construction or mortgage loans to its 
franchisees. However, in connection with the Franchisee Financing Facility, 
the Company may in the future participate in construction loans and long-term 
mortgage loans made to franchisees, including through direct subordinated 
loans to such franchisees. In such cases, the Company would be subject to the 
risks experienced by lenders generally, including risks of 
franchisee/borrower defaults and bankruptcies. In the event of a default 
under such loans, the Company, as a subordinated lender, would bear the risk 
of loss of principal to the extent the value of the collateral was not 
sufficient to pay both the senior lender and the Company, as subordinated 
lender. See "Risk Factors--Regulation" and "Business--Special 
Programs--Franchisee Financing Facility". 

Regulation 

   The sale of franchises is regulated by various state laws, as well as by 
the Federal Trade Commission (the "FTC"). The FTC requires that franchisors 
make extensive disclosure to prospective franchisees, although it does not 
require registration of offers to prospective franchisees. A number of states 
require registration and disclosure in connection with franchise offers and 
sales. In addition, several states have "franchise relationship laws" that 
limit the ability of 

                                      12 
 

franchisors to terminate franchise agreements or to withhold consent to the 
renewal or transfer of these agreements. While the Company's franchising 
operations currently are not materially adversely affected by such 
regulations, the Company cannot predict the effect any future legislation or 
regulation may have on its business operations or financial condition. 

   Additionally, various national, state and local laws and regulations may 
affect activities undertaken by the Company in connection with the Franchisee 
Financing Facility and under an agreement with PMC Commercial Trust ("PMC"), 
pursuant to which the Company has agreed to, among other things, make 
available to potential Microtel franchisees information regarding PMC's 
financing programs for land acquisition and construction costs (the "PMC 
Agreement"). In particular, the Company may be required to obtain a license 
or to register in certain states in order to arrange loans to be made by NACC 
or PMC, as the case may be, under such programs or in the event the Company 
determines to make loans itself under the Franchisee Financing Facility. See 
"Business--Special Programs-- Franchisee Financing Facility" and "--PMC 
Agreement". 

Mandatory Redemption of Redeemable Preferred Stock 

   As of June 30, 1996, there were 163,500 shares of the Company's Redeemable 
Preferred Stock outstanding. Pursuant to the terms of the Company's Amended 
and Restated Certificate of Incorporation (the "Charter"), the Company is 
required, upon the earlier of (i) September 29, 2007 or (ii) a Change of 
Control (as defined below) of the Company, to redeem each outstanding share 
of Redeemable Preferred Stock at a cash price per share equal to $100 plus 
all accrued and unpaid dividends thereon. A "Change of Control" is defined 
generally as (A) the sale of all or substantially all of the Company's 
assets, (B) the transfer of more than 50% of its Common Stock to persons who 
are not employees of the Company and were not stockholders prior to the 
Offering or (C) the termination of the employment of Mr. Leven for any reason 
by the Company (including resignation). If Mr. Leven's employment were to be 
terminated by the Company for any reason or the Company were to otherwise 
experience a Change of Control, the Company would be obligated to redeem all 
outstanding shares of Redeemable Preferred Stock at a cost, as of June 30, 
1996, of $17,597,000. See "Description of Capital Stock--Preferred Stock". 

No Prior Market for Class A Common Stock; Possible Volatility of Stock Price 

   Prior to the Offering, there has been no public market for the Class A 
Common Stock, and there can be no assurance that a regular trading market for 
the Class A Common Stock will develop after the Offering or that, if 
developed, it will be sustained. The initial public offering price of the 
Class A Common Stock will be determined by negotiation between the Company 
and the Underwriters based on several factors and will not necessarily 
reflect the market price of the Class A Common Stock after the Offering or 
the price at which the Class A Common Stock may be sold in the public market 
after the Offering. 

   The market price for the Class A Common Stock may be significantly 
affected by such factors as the Company's operating results, changes in any 
earnings estimates publicly announced by the Company or by analysts, 
announcements of new brands acquired by the Company or its competitors, 
seasonal effects on revenues and various factors affecting the economy in 
general. In addition, the stock market has experienced a high level of price 
and volume volatility, and market prices for the stock of many companies, 
especially newly public companies, have experienced wide price fluctuations 
not necessarily related to the fundamentals or operating performance of such 
companies. 

Dilution 

   The amount by which the initial public offering price per share of Class A 
Common Stock exceeds the pro forma net tangible book value per share of 
Common Stock after the Offering constitutes dilution to investors in the 
Offering. Based on an assumed initial public offering price of $13.00 per 
share (the midpoint of the range of prices set forth on the cover of this 
Prospectus), purchasers of shares of Class A Common Stock in the Offering 
would experience an immediate and substantial dilution of net tangible book 
value of $12.06 per share. See "Dilution". 

Absence of Dividends 

   The Company intends to retain any earnings to finance its growth and for 
general corporate purposes and therefore does not anticipate paying any cash 
dividends in the foreseeable future. In addition, the terms of the Company's 
Redeemable Preferred Stock contain, and future financing agreements may 
contain, limitations on the payment of cash dividends or other distributions 
of assets to the holders of Common Stock. See "Dividend Policy". 

                                      13 
 

Anti-Takeover Devices 

   Certain provisions of the Charter and the Company's Amended and Restated 
By-Laws (the "By-laws") that will become operative prior to or simultaneously 
with the closing of the Offering may be deemed to have anti-takeover effects 
and may delay, deter or prevent a change in control of the Company that 
stockholders might otherwise consider in their best interests. These 
provisions (i) allow only the Board of Directors, the Chairman of the Board 
of Directors or the Chief Executive Officer of the Company to call special 
meetings of the stockholders, (ii) eliminate the ability of stockholders to 
take any action without a meeting, (iii) establish certain advance notice 
procedures for nomination of candidates for election as directors and for 
stockholder proposals to be considered at stockholders' meetings, (iv) 
generally authorize the issuance of one or more classes of "blank check" 
preferred stock (in addition to the Redeemable Preferred Stock), with such 
designations, rights and preferences as may be determined from time to time 
by the Board of Directors, (v) require approval of holders of 75% of the 
outstanding Class B Common Stock for the Board of Directors to create a 
series of Preferred Stock with general voting rights or with the right to 
elect a majority of directors under any circumstances and (vi) require 
approval of holders of 75% of the outstanding voting power to amend or repeal 
items (i), (ii), (v) and (vi) above. See "Description of Capital 
Stock--Delaware Law and Certain Charter and By-Law Provisions". 

Shares Eligible for Future Sale 

   Upon the consummation of the Offering, the Company will have 9,872,490 
shares of Class A Common Stock outstanding and 2,707,919 shares of Class B 
Common Stock outstanding. Of these shares, the 2,325,000 shares of Class A 
Common Stock offered hereby will be freely tradeable by persons other than 
affiliates of the Company, without restriction under the Securities Act of 
1933, as amended (the "Securities Act"). In addition, approximately 9,425,000 
shares of Class A Common Stock (including shares of Class A Common Stock into 
which the Class B Common Stock is convertible) will be eligible for sale 
under Rule 144 beginning on September 29, 1997 (subject to certain volume 
limitations and other restrictions prescribed by Rule 144). At such time as 
at least 20% of the outstanding Common Stock has been registered for public 
sale, certain holders of Common Stock (who, following the Offering, will own 
in the aggregate 7,547,490 shares of Class A Common Stock and 2,707,919 
shares of Class B Common Stock) will have "piggyback" registration rights 
permitting such holders to include a portion of their shares (including, in 
the case of Class B Common Stock, the shares of Class A Common Stock into 
which such shares are convertible), at the Company's expense, in certain 
registration statements filed by the Company (the "piggyback shares"). The 
maximum number of shares of Class A Common Stock that may be included in such 
registration by such holders is determined by multiplying all of the 
piggyback shares by a fraction, the numerator of which is the number of 
shares being registered by the Company and the denominator of which is the 
number of shares to be outstanding after such registration (excluding the 
piggyback shares). In addition, subsequent to September 29, 2000, holders of 
a majority of such shares will have the right to request on one occasion 
(subject to certain limitations) that such shares (including, in the case of 
Class B Common Stock, the shares of Class A Common Stock into which such 
shares are convertible) be registered for resale under the Securities Act at 
the Company's expense. See "Certain Relationships and Related Transactions" 
and "Description of Capital Stock--Registration Rights". No prediction can be 
made as to the effect, if any, that sales of shares of Class A Common Stock 
or the availability of such shares for sale will have on the market prices 
prevailing from time to time. The Company, its officers and directors and 
certain of its other stockholders have agreed with the Underwriters not to 
sell or otherwise dispose of any of their shares of Class A Common Stock or 
Class B Common Stock for a period of 180 days from the date of this 
Prospectus without the prior written consent of the representatives of the 
Underwriters. Nevertheless, the possibility that substantial amounts of Class 
A Common Stock (including those shares into which the Class B Common Stock is 
convertible) may be sold in the public market may adversely affect prevailing 
market prices for the Class A Common Stock and could impair the Company's 
ability to raise equity capital in the future. 

                                      14 
 

                               USE OF PROCEEDS 

   The net proceeds to the Company from the sale of the shares of Class A 
Common Stock offered hereby are estimated to be approximately $21,364,000 
($24,673,887 if the Underwriters' over-allotment option is exercised in 
full), based on an initial public offering price of $13.00 per share (the 
midpoint of the range of prices set forth on the cover of this Prospectus), 
after deducting the underwriting discounts and commissions and estimated 
expenses of the Offering payable by the Company. 

   The proceeds of the Offering will be used for working capital and general 
corporate purposes, which may include (i) funding the Company's remaining 
obligations (approximately $2 million) under the Microtel Acquisition 
Agreement , (ii) acquiring additional lodging or other service-oriented 
brands or exclusive franchise rights (to the extent permitted under the 
Hawthorn Acquisition Agreement), (iii) making initial deposits in connection 
with the American Dream Program until qualified lessees can be identified, 
(iv) investing in financing programs developed by its wholly owned 
subsidiary, US Funding Corp., and (v) investing in entities that make equity 
investments in hotel properties built and managed by certain franchisees with 
the potential for multi-unit development. The Company currently has no 
agreements, commitments or formal understandings with respect to any 
acquisitions and, accordingly, is unable to estimate the aggregate amount of 
the net proceeds that may be used for any such purposes. Pending such uses, 
the Company intends to invest such funds in cash and marketable securities; 
provided that the Company intends to invest and to use the net proceeds of 
the Offering so as not to be considered an investment company within the 
meaning of the Investment Company Act of 1940. See "Business--Acquisition of 
the Microtel and Hawthorn Suites Systems", "--Business 
Strategy--Acquisitions" and "--Special Programs". 

   The Offering is also intended to increase the Company's equity base, 
provide a public market for the Company's Class A Common Stock, facilitate 
future access by the Company to the public equity markets and possibly 
provide an additional form of currency for future acquisitions. 

                               DIVIDEND POLICY 

   The Company has never declared or paid cash dividends on its Common Stock. 
The Company currently intends to retain its earnings to provide funds for the 
operation and expansion of its business and, therefore, does not anticipate 
declaring or paying cash dividends in the foreseeable future. The terms of 
the Company's Redeemable Preferred Stock prohibit the Company from declaring 
or paying dividends on its Common Stock at any time when dividends have not 
been paid in full with respect to its Redeemable Preferred Stock (although 
dividends are payable in additional shares of Redeemable Preferred Stock). 
Any payment of future dividends will be at the discretion of the Board of 
Directors and will depend upon, among other things, the Company's earnings, 
financial condition, capital requirements, level of indebtedness, contractual 
restrictions with respect to the payment of dividends and other relevant 
factors. See "Management's Discussion and Analysis of Financial Condition and 
Results of Operations--Liquidity and Capital Resources" and "Description of 
Capital Stock--Preferred Stock". 

                                      15 
 

                                CAPITALIZATION 

   The following table sets forth the capitalization of the Company at June 
30, 1996 on a historical basis and on a pro forma basis reflecting the 
Reclassification, certain amendments (collectively, the "1996 Amendment") to 
be made to the agreements pursuant to which Messrs. Leven and Aronson 
purchased shares of Old Common Stock (the "Old Stock Purchase Agreements"), 
and the Offering (including the application of the proceeds therefrom), 
assuming an initial public offering price per share of $13.00 (the midpoint 
of the range of prices set forth on the cover of this Prospectus). The table 
should be read in conjunction with the Selected Financial Data and the 
Consolidated Financial Statements of the Company and the Notes thereto 
included elsewhere in this Prospectus. See "Selected Financial Data", 
"Management's Discussion and Analysis of Financial Condition and Results of 
Operations" and "Principal Stockholders--Management's Shares of Common 
Stock". 



                                                                      June 30, 1996 
                                                                -------------------------- 
                                                                 Historical      Pro Forma 
                                                                -----------      --------- 
                                                                          
Long Term Debt 
  Due to Hudson                                                 $   731,000     $   731,000 

Redeemable Stock 
  10% Cumulative Redeemable Exchangeable Preferred Stock, par 
    value $.01 per share; up to 525,000 authorized; 163,500 
    shares issued and outstanding as of June 30, 1996            17,597,000      17,597,000 
  Redeemable shares of Class A Common Stock, par value $.01 
    per share; 3,186,294 shares issued and outstanding as of 
    June 30, 1996 (1)                                               330,000 
  Redeemable shares of Class A Common Stock, par value $0.01 
    per share; 2,006,559 shares issued and outstanding after 
    the Reclassification, the 1996 Amendment and the Offering (1)        --         208,000 
Stockholders' Equity (Deficit) 
  Common Stock, par value $.01 per share; 7,569,115 shares of 
    Class A Common Stock issued and outstanding as of June 
    30, 1996                                                         78,000 
  Common Stock, par value $0.01 per share; 30,000,000 
    shares of Class A Common Stock and 5,000,000 shares of 
    Class B Common Stock authorized; 7,865,931 shares of 
    Class A Common Stock and 2,707,919 shares of Class B 
    Common Stock issued and outstanding after the 
    Reclassification, the 1996 Amendment and the Offering (2)                       106,000 
  Capital in excess of par                                                       21,458,000 
  Accumulated Deficit                                            (4,970,000)     (4,970,000) 
                                                                -----------     ----------- 
  Total Stockholders' Equity (Deficit)                           (4,892,000)     16,594,000 
                                                                -----------     ----------- 

Total Capitalization                                            $13,766,000     $35,130,000 
                                                                ===========     =========== 


- ------------- 

(1) These shares are redeemable under certain conditions by the Company for 
    reasons not under the Company's control. See "Principal 
    Stockholders--Management's Shares of Common Stock". 

(2) Excludes 325,000 shares of Class A Common Stock reserved for issuance 
    under the U.S. Franchise Systems, Inc. 1996 Stock Option Plan (the 
    "Option Plan") and 125,000 shares of Class A Common Stock reserved for 
    issuance under the U.S. Franchise Systems, Inc. 1996 Stock Option Plan 
    for Non-Employee Directors ("The Directors Plan"). 

                                      16 
 

                                   DILUTION 

   At June 30, 1996, the net tangible book value of the Company was a deficit 
of $9,569,000 or ($0.89) per share of outstanding Common Stock (taking into 
account the Reclassification). After giving effect to the Reclassification 
and to the sale of the 1,825,000 shares of Class A Common Stock being offered 
by the Company hereby at an assumed initial offering price of $13.00 per 
share (the midpoint of the range of prices set forth on the cover page of 
this Prospectus) and the application of the net proceeds therefrom (after 
deducting estimated offering expenses and underwriting discounts and 
commissions), the pro forma net tangible book value of the Company at June 
30, 1996 would have been $11,795,000, or $0.94 per share, representing an 
immediate increase in net tangible book value of $1.83 per share to existing 
stockholders and an immediate dilution of $12.06 per share to persons 
purchasing shares of Class A Common Stock in the Offering. The following 
table illustrates this per share dilution: 



                                                             
Assumed initial public offering price per share (1)                $13.00 

Net tangible book value per share of 
Common Stock at June 30, 1996 
(adjusted for the Reclassification 
but excluding the Offering)                              $(0.89) 

Increase in net tangible book value per 
share of Common Stock attributable to 
new investors in the Offering                              1.83 
                                                         ------ 
Pro forma net tangible book value per share 
of Common Stock after the Offering                                    0.94 
                                                                    ------ 
Dilution per share to purchasers of Class A 
Common Stock in the Offering                                        $12.06 
                                                                    ------ 


- ------------- 

(1) Before deduction of underwriting discounts and commissions and offering 
    expenses. 

   The following table sets forth, as of June 30, 1996, and after giving 
effect to the Reclassification and the Offering, the number of shares of 
Common Stock issued by the Company, the total consideration paid and the 
average price per share paid by existing stockholders and to be paid by 
purchasers of shares in the Offering, assuming that shares purchased in the 
Offering are sold at $13.00 per share (the midpoint of the range of prices 
set forth on the cover page of this Prospectus) and before deducting the 
underwriting discounts and commissions and estimated offering expenses 
payable by the Company: 



                                                                               
                              Shares Purchased         Total Consideration      Average  
                           -----------------------    ---------------------      Price   
                              Number       Percent      Amount      Percent    Per Share 
                         ---------------  --------- --------------  ---------  --------- 
                                                                  
Existing Stockholders       10,755,409       85.0%    $ 1,112,000      5.0%      $ 0.10 
New Investors                1,825,000 (1)   15.0      23,725,000     95.0       $13.00 
                         ---------------  --------- --------------  ---------  --------- 
                            12,580,409      100.0%    $24,837,000    100.0% 
                         ===============  ========= ==============  ========= 


- ------------- 

(1) Does not include shares of Class A Common Stock to be purchased in the 
    Offering from the Selling Stockholders, as the Company will not receive 
    any proceeds from the sale of such shares. 

                                      17 
 

                           SELECTED FINANCIAL DATA 

   Set forth below is certain selected consolidated historical financial 
information of the Company and its subsidiaries as of December 31, 1995 and 
June 30, 1996, for the period from August 28, 1995, the date of the Company's 
inception, to December 31, 1995 and the six months ended June 30, 1996. Such 
information has been derived from the Company's Consolidated Financial 
Statements and related Notes thereto as of such dates and with respect to 
such periods, which financial statements have been audited by Deloitte & 
Touche LLP, independent auditors. Their report on the Company's financial 
statements as of such dates and for such periods is included elsewhere in 
this Prospectus. See the Consolidated Financial Statements and related Notes 
included elsewhere in this Prospectus and "Management's Discussion and 
Analysis of Financial Condition and Results of Operations". 



                                                                      Period from 
                                                                  August 28, 1995 to  Six Months Ended 
                                                                   December 31, 1995   June 30, 1996 
                                                                   ------------------ ---------------- 
                                                                    (in thousands of dollars, except 
                                                                        share and per share data) 
                                                                                  
Statement of Operations Data: 
Revenues                                                             $     --            $       395 
Operating expenses                                                          1,327              3,849 
Operating loss                                                              1,327              3,454 
Interest income                                                               195                331 
Interest expense                                                               36                 72 
Net loss                                                                    1,168              3,195 
Loss applicable to common stockholders                                      1,645              4,033 
Net loss applicable to common stockholders per share (1)                     0.15               0.38 
Weighted average number of common shares 
   outstanding (2)                                                     10,755,409         10,755,409 

Balance Sheet Data (at period end): 
Working capital                                                       $    13,265        $     8,029 
Total assets                                                               18,072             19,027 
Total liabilities                                                           1,845              5,992 
Redeemable Preferred Stock                                                 16,759             17,597 
Redeemable Common Stock                                                       330                330 
Stockholders' deficit                                                         862              4,892 


   
- ------------- 
(1)  Based upon 8,047,490 shares of Class A Common Stock and 2,707,919 shares of
     Class B Common Stock outstanding after the Reclassification but before the
     Offering.
(2)  Includes 3,186,294 shares of Class A Common Stock that are redeemable under
     certain circumstances by the Company for reasons not under the Company's
     control. See "Principal Stockholders--Management's Shares of Common Stock".
    


                                      18 
 

                     MANAGEMENT'S DISCUSSION AND ANALYSIS 
               OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 

General 

   The Company was formed in August 1995 to acquire, market and expand 
high-quality, well-positioned brands with potential for rapid unit growth 
through the sale of franchises to third-party operators. The Company 
commenced operations in October 1995 and has since focused on acquiring 
brands and developing the infrastructure necessary to increase the size and 
scope of each brand. 

   Since October 1995, the Company has acquired two lodging brands--Microtel 
(October 1995) and Hawthorn Suites (March 1996). The Company has hired and 
trained a staff of 73 employees, including a franchise sales force of 28, 
which management believes is the third largest franchise sales organization 
in the lodging industry. In addition, the Company has hired executive and 
other management employees to head its marketing, administration, 
construction and design, finance, training, personnel, national accounts 
purchasing and public relations departments. As a result of these hirings, 
the Company believes that it has established the infrastructure sufficient to 
support significant growth of its brands without further large increases in 
its senior management team. Most of the Company's employees have extensive 
experience with franchise companies in general and lodging companies 
specifically. 

   In addition, the Company has prepared documentation required under various 
federal and state laws for the sale of new franchises under both the Microtel 
and Hawthorn Suites brands, including a Uniform Franchise Offering Circular 
(a "UFOC"), a form of Franchise Agreement and an application form for each 
brand. Subsidiaries of the Company are currently registered to sell Microtels 
and Hawthorn Suites hotels in all 50 states. The Company has also developed 
the marketing materials, architectural and construction plans, training 
programs, reservation systems and franchisee assistance programs to support 
the sale of Microtel and Hawthorn Suites franchises. 

   In order to support its franchise sales effort, the Company has arranged 
for a third party to make financing available to its franchisees. In May 
1996, the Company reached an agreement in principle with NACC with respect to 
the Franchisee Financing Facility, pursuant to which NACC would make 
available to the Company's franchisees, over a two-year period, up to $200 
million in construction and long-term mortgage financing, subject to certain 
terms and conditions. Under the Franchisee Financing Facility, the ultimate 
decision regarding the provision of loans to franchisees will be made by 
NACC. See "Business--Special Programs--Franchisee Financing Facility". 

Results of Operations 

   Comparison of the four month period ended December 31, 1995 to the six 
month period ended June 30, 1996 

   General. Although the Company was formed in August 1995, it did not begin 
operations until October 1995, making the period from August 28, 1995 
(inception) to December 31, 1995 (the "1995 Period") effectively a three 
month time period from an operations perspective. During the 1995 Period, the 
Company's primary focus was the hiring of its executive staff and the 
acquisition of the Microtel brand. The Company experienced a three to four 
month period between the closing of its acquisition of the exclusive 
worldwide franchising rights of the Microtel hotel system (the "Microtel 
Acquisition") and the beginning of significant franchise sales activities, 
during which time the Company (i) hired and trained its key executive staff 
and franchise sales personnel, (ii) developed sales materials, prototypical 
architectural drawings and various employee and franchisee training manuals 
and (iii) completed legal documentation and filings necessary to allow the 
Company to sell franchises in all states. The Company experienced a similar 
three to four month lag period between the closing of its acquisition of the 
exclusive worldwide rights to franchise hotels under the Hawthorn Suites 
brand (the "Hawthorn Acquisition") and the beginning of significant franchise 
sales activities. Accordingly, the full-time franchise sales efforts for the 
Microtel and Hawthorn Suites brands did not begin until January 1996 and July 
1996, respectively. The Company did not acquire the rights to royalties 
related to properties that were open or under development at the time of the 
Microtel Acquisition or the Hawthorn Acquisition, although the Company will 
receive reservation and marketing fees from the franchisees of such 
properties. See "Business--Acquisition of the Microtel and Hawthorn Suites 
Systems". 

                                      19 
 

   The table below summarizes the results of the Company's franchise sales 
efforts as of the dates below. 



                             Executed        Franchise        Properties 
                            Franchise      Applications          Under 
        Microtel            Agreements     Accepted (1)      Construction 
        --------            ----------     ------------      ------------ 
                                                         
December 31, 1995                3              10                 0 
March 31, 1996                  47              32                 1 
June 30, 1996                   93              63                 1 
September 30, 1996             145              74                 7 

    Hawthorn Suites 
    --------------- 
June 30, 1996                    0               1                 0 
September 30, 1996               5              16                 2 


- ------------- 
(1) Represents franchise applications as to which the Company has approved the 
    proposed site and the prospective franchisee but has not yet executed a 
    franchise agreement. 

   Revenue. The Company generated $395,000 of revenues, representing 
reservation and marketing fees collected from franchisees, during the six 
months ended June 30, 1996. The Company began collecting such fees from 
Microtel and Hawthorn Suites franchisees in February 1996 and April 1996, 
respectively, and, accordingly, no such revenues were earned during the 1995 
Period. While the Company recognizes reservation and marketing fees as 
revenues, such fees are intended to reimburse the Company for the expenses 
associated with providing support services to its franchisees and do not 
produce any profit for the Company. The Company also received franchise 
application fees of $2,722,000 for the six months ended June 30, 1996, 
compared to $120,000 for the 1995 Period. However, such fees are recognized 
as revenue only when the applicable hotel opens, and therefore, the Company 
did not recognize revenues related to such fees during the applicable 
periods. 

   Expenses. Reservation and marketing costs were $13,000 for the 1995 Period 
and $490,000 for the six months ended June 30, 1996. The increase in 
marketing and reservation costs in the latter period reflects the 
availability of reservation and marketing fees paid to the Company by 
franchisees, as well as additional spending by the Company to promote the 
Microtel brand to travelers. In the second half of 1996 and through 1997 as 
well, the Company expects to spend more on marketing and reservations than it 
receives from its franchisees, as it continues its efforts to build 
recognition and acceptance of its newly-acquired brands among the traveling 
public. Sales commissions of $41,000 were paid during the 1995 Period for the 
three license agreements executed during such period compared to commissions 
of $1,241,000 which were paid with respect to the 90 license agreements 
executed during the six months ended June 30, 1996, reflecting the higher 
level of sales activity in the latter period. Such payments will not be 
recognized as expenses until the applicable hotel opens and the related 
application fee is recognized as revenue. Other franchise sales and 
advertising costs, which are costs related to the Company's franchise sales 
effort, were $550,000 for the 1995 Period and $1,263,000 for the six months 
ended June 30, 1996. This increase primarily relates to the addition of six 
sales people in connection with the Hawthorn Acquisition. Corporate salaries, 
wages and benefits, which are non-selling personnel costs, were $423,000 
during the 1995 Period and $993,000 for the six months ended June 30, 1996. 
Approximately $120,000 of this increase was the result of 11 hirings made 
necessary by the Hawthorn Acquisition. The remainder reflects the comparison 
of the six months ended June 30, 1996 with the 1995 Period, which was 
effectively a three-month operating period. Other general and administrative 
expenses were $215,000 during the 1995 Period compared to $835,000 (including 
a $200,000 non- recurring charge related to the anticipated termination of 
the Company's corporate office lease) for the six months ended June 30, 1996. 
In addition to the $200,000 non-recurring charge, the difference reflects the 
increased activity experienced by the Company during the first six months of 
1996 as compared to the last three months of 1995, when it was in its 
start-up phase. Depreciation and amortization expense includes depreciation 
of equipment for the corporate and regional sales offices, amortization of 
the cost of acquiring the Microtel brand and the exclusive rights to 
franchise the Hawthorn Suites brand, amortization of consulting payments made 
to Hudson under the Microtel Acquisition Agreement and amortization of costs 
related to the formation of the Company. Such costs were $126,000 in the 1995 
Period and $268,000 in the six months ended June 30, 1996. 

   Other Income/Expense. During the 1995 Period and the six months ended June 
30, 1996, interest expense of $36,000 and $72,000, respectively, was accrued 
on the remaining portion of the purchase price of the Microtel 

                                      20 
 

brand. Interest income of $195,000 in the 1995 Period and $331,000 in the six 
months ended June 30, 1996 resulted from investments in cash and marketable 
securities held by the Company. 

   Net Loss. The Company had a net loss of $1,168,000 and net loss applicable 
to common stockholders of $1,645,000 (including $477,000 of accumulated but 
undeclared and unpaid dividends on Redeemable Preferred Stock) for the 1995 
Period. For the six months ended June 30, 1996, the net loss was $3,195,000 
and the loss applicable to common stockholders was $4,033,000 (including 
$838,000 of accumulated but undeclared and unpaid dividends on the Redeemable 
Preferred Stock). The Company had a net operating loss carryforward for 
income tax purposes on December 31, 1995 and June 30, 1996 of $1,037,000 and 
$2,792,000, respectively. Given the limited operating history of the Company, 
management has recorded a valuation allowance for the full amount of the 
deferred tax asset on December 31, 1995 and June 30, 1996 . 

Liquidity and Capital Resources 

   The Company has financed its operations since its inception primarily 
through a private placement of securities, franchise application fees and 
interest income. In October 1995, the Company raised approximately $17.5 
million in gross proceeds through sales of shares of Old Common Stock and 
Redeemable Preferred Stock. Franchise application fees and interest income 
generated cash of $120,000 and $195,000, respectively, for the 1995 Period 
and $2,306,000 and $331,000, respectively, for the six months ended June 30, 
1996. In the 1995 Period, the Company invested $3,720,000, of which 
$3,428,000 related to the Microtel Acquisition, $137,000 went toward the 
acquisition of equipment and $155,000 was for organization costs. Of the 
approximately $3.4 million spent to acquire the Microtel brand, $1,437,000 
was paid in the form of a note, with the remainder paid in cash. In the six 
months ended June 30, 1996, the Company spent a total of $388,000, $271,000 
of which was used to purchase equipment and $117,000 was spent primarily on 
legal costs relating to the Hawthorn Acquisition. 

   In the future, the Company will support the American Dream Program by 
committing to make initial deposits under such program until qualified 
lessees can be identified. In the event a qualified lessee is not identified 
for a particular property, the Company may become the lessee under the 
program. If the Company becomes the lessee with respect to a particular 
property, it may also acquire the Microtel from the franchisee under the 
terms of the American Dream Program. See "Business--Special 
Programs--American Dream Program". The Company anticipates that the net 
proceeds of the Offering, together with cash on hand and interest thereon, 
will be sufficient to fund the Company's working capital requirements and to 
carry out part of the Company's business strategy. See "Business--Business 
Strategy". The Company may fund its future cash needs through additional 
equity or debt offerings, although there can be no assurance that the Company 
will be able to do so. The Company had outstanding indebtedness related to 
the Microtel Acquisition of $1,437,000 as of both December 31, 1996 and June 
30, 1996. 

   As of June 30, 1996, there were 163,500 shares of the Company's Redeemable 
Preferred Stock outstanding. Pursuant to the terms of the Charter, the 
Company is required, upon the earlier of (i) September 29, 2007 or (ii) a 
Change of Control of the Company, to redeem each outstanding share of 
Redeemable Preferred Stock at a cash price per share equal to $100 plus all 
accrued and unpaid dividends thereon. If Mr. Leven's employment were to be 
terminated by the Company for any reason (including resignation) or the 
Company were to otherwise experience a Change of Control, the Company would 
be obligated to redeem all outstanding shares of Redeemable Preferred Stock 
at a cost, as of June 30, 1996, of $17,597,000. See "Risk Factors--Mandatory 
Redemption of Redeemable Preferred Stock" and "Description of Capital 
Stock--Preferred Stock". 

Seasonality 

   As a hotel franchisor, the Company expects to experience seasonal revenue 
patterns similar to those experienced by participants in the lodging industry 
generally. Accordingly, the summer months, because of increases in leisure 
travel, are expected to produce higher franchise royalty revenues for the 
Company than other periods during the year. In addition, developers of new 
hotels typically attempt, whenever feasible, to schedule the opening of a new 
property to occur prior to the spring and summer seasons. This may have a 
seasonal impact on the Company's revenues, a significant portion of which is 
not recognized until the opening of a property. Accordingly, the Company may 
experience lower revenues and profits in the first and fourth quarters and 
higher revenues and profits in the second and third quarters. 

Inflation 

   The rate of inflation has not had a material effect on the revenues or 
operating results of the Company since its inception. 

                                      21 
 

                                   BUSINESS 

Overview 

   U.S. Franchise Systems, Inc. ("USFS" or the "Company") was formed in 
August 1995 to acquire, market and expand high-quality, well-positioned 
brands with potential for rapid unit growth through the sale of franchises to 
third- party operators. The Company's initial brands, which are in the 
lodging industry, are the Microtel budget hotel brand ("Microtel") and the 
Hawthorn Suites upscale, extended-stay hotel brand ("Hawthorn Suites"). The 
Company acquired the rights to these brands because of their potential for 
significant growth, which reflects, among other things, their profitability 
for franchisees at the property level and their positions in attractive 
segments of the lodging industry. 

   The Company has assembled an experienced management team and sales force 
led by its Chairman, President and Chief Executive Officer, Michael A. Leven, 
who has 35 years of experience in the lodging industry, and its Executive 
Vice President and Chief Financial Officer, Neal K. Aronson, a former 
principal of the New York investment firm Odyssey Partners, L.P.  Mr. Leven 
most recently served as President and Chief Operating Officer of Holiday Inn 
Worldwide (1990-95) and President and Chief Operating Officer of Days Inn of 
America, Inc. (1985-90), franchisors of the two largest lodging brands in the 
world. The Company has hired and trained a staff of 73 employees, including a 
28-person sales force, which management believes is the third largest 
franchise sales organization in the lodging industry. Mr. Leven and the 
Company's sales force have collectively sold over 2,200 hotel franchises on 
behalf of other hotel chains. Since acquiring the Microtel brand in October 
1995 and establishing a sales force by January 1996, the Company has executed 
145 franchise agreements and accepted applications for an additional 74 
hotels as of September 30, 1996, expanding the number of states in which 
Microtels are or may be located from 10 to 44. Since acquiring the exclusive 
rights to franchise the Hawthorn Suites brand in March 1996 and establishing 
a sales force by July 1996, the Company has executed five franchise 
agreements and accepted applications for 16 additional hotel sites as of 
September 30, 1996. 

   As a franchisor, USFS licenses the use of its brand names to independent 
hotel owners and operators (i.e., franchisees). The Company provides its 
franchisees with a variety of benefits and services designed to (i) decrease 
development costs, (ii) shorten the time frame and reduce the complexity of 
the construction process and (iii) increase the occupancy rates, revenues and 
profitability of the franchised properties. The Company offers prospective 
franchisees access to financing, a business format, design and construction 
assistance (including architectural plans), uniform quality standards, 
training programs, national reservations systems, national and local 
advertising and promotional campaigns and volume purchasing discounts. The 
Company does not currently build, own or manage properties. 

   The Company expects that its future revenues will consist primarily of (i) 
franchise royalty fees, (ii) franchise application fees, (iii) reservation 
and marketing fees, (iv) various fees and other revenues from third-party 
financing arranged by the Company for its franchisees and (v) payments made 
by vendors who supply the Company's franchisees with various products and 
services. Currently, the Company derives substantially all of its revenues 
from reservation and marketing fees collected from its franchisees. The 
Company also receives cash from its franchisees in the form of application 
fees, which are recognized as revenue only upon the opening of the underlying 
hotels. See the Consolidated Financial Statements and the related Notes 
included elsewhere in this Prospectus and "Management's Discussion and 
Analysis of Financial Condition and Results of Operations". 

Business Strategy 

   The Company's business strategy is to (i) rapidly increase the number of 
open Microtels and Hawthorn Suites, (ii) operate its administrative and 
franchisee support departments in order to maximize the operating leverage 
inherent in the franchising business and (iii) acquire additional lodging or 
other service-oriented brands that provide attractive unit economics to 
franchisees and significant growth opportunities for the Company (to the 
extent permitted under the Hawthorn Acquisition Agreement). See 
"--Acquisition of the Microtel and Hawthorn Suites Systems". 

   Growth of the Franchise Systems. The Company is focused on accelerating 
the growth of the Microtel and Hawthorn Suites franchise systems through the 
sale of franchises to third-party owners and operators. To this end, the 
Company has hired a 28-person sales force (which the Company believes is the 
third largest in the lodging industry) whose members have sold 150 franchises 
and secured an additional 90 franchise applications on behalf of the Company 
since its inception. The Company also benefits from the extensive experience 
of Mr. Leven, who has served as President and Chief Operating Officer of the 
franchisors of the world's two largest lodging brands. The sales force 
targets a broad 

                                      22 
 

pool of potential franchisees, including both franchisees with experience 
developing and operating multiple hotel properties and single-unit 
franchisees, including first-time hotel owners. 

   In addition to direct sales, management is actively developing programs 
designed to accelerate the growth of the Microtel and Hawthorn Suites 
systems. For example, the Company has developed a financing program through 
which NACC would make construction and long-term mortgage financing available 
to franchisees. This program is intended to add speed and certainty to the 
hotel development process, enabling franchisees to spend more time 
identifying hotel locations and developing properties and less time obtaining 
financing. The Company has also created the American Dream Program, which is 
designed to enable first-time hotel owners to lease and own a Microtel with a 
low initial investment and thereby increase the number of potential Microtel 
franchisees. The Company expects to participate in the American Dream Program 
by committing to make initial deposits on and to lease Microtels under this 
program until qualified lessees can be identified. See "--Special Programs". 

   Finally, the Company has extended the Microtel and Hawthorn Suites brands 
from two products at the time of their respective acquisitions (Microtel Inn 
and Hawthorn Suites) to five products currently (including Microtel Inn & 
Suites, Microtel Suites and Hawthorn Suites LTD). The Company believes that 
brand extensions allow it to capitalize on the recognition of its brands 
among consumers and franchisees and to compete in new markets without the 
costs associated with acquiring an existing brand. Of the 145 Microtel 
franchise agreements executed by the Company since the Microtel Acquisition, 
over 50% relate to Microtel Inn & Suites or Microtel Suites, two of the 
products that the Company developed since acquiring the Microtel brand. 

   Operating Leverage. The Company expects to benefit in the future from the 
operating leverage inherent in its cost structure. As new Microtels and 
Hawthorn Suites open, the Company expects that recurring royalty revenues 
(derived from its franchisees' gross room revenues) will represent an 
increasing percentage of the Company's total revenues. At the same time, the 
Company expects to incur relatively limited incremental expenses associated 
with these royalty revenues because the Company (i) has hired and trained the 
sales force and has staffed teams of marketing, franchise administration, 
construction and design, reservations and other professionals at levels it 
believes are necessary to support the intended expansion of the Microtel and 
Hawthorn Suites brands and (ii) earns reservation and marketing fees from 
franchisees to offset a large portion of its expenditures on these 
activities. At the same time, the Company, as a franchisor, does not incur 
the significant capital costs and operating expenses associated with owning 
hotels. 

   Acquisitions. A principal focus of the Company's business strategy is on 
the acquisition of additional lodging and other service-oriented franchise 
brands. In evaluating potential acquisitions, the Company seeks brands that 
have clear market positions and significant multi-unit expansion potential, 
are profitable and relatively easy to manage at the unit level and, at the 
same time, can be integrated on a cost-effective basis into the Company's 
franchise sales and franchisee support organization. From time to time, the 
Company engages in discussions with owners of various lodging and non-lodging 
brands. However, under the terms of the Hawthorn Acquisition Agreement, the 
Company is generally prohibited until June 26, 1998 from franchising any 
lodging brand other than (i) Hawthorn Suites brand hotels, (ii) Microtel 
brand hotels and (iii) other limited-service, non-suite hotel brands with an 
ADR of $49 and under. In addition, until June 26, 1997, the Company generally 
may not franchise any non-lodging brands. Also, until 175 Hawthorn Suites 
with 11,375 rooms have been developed, the Company may not franchise another 
all-suite hotel brand (other than Microtels costing under a certain amount to 
construct). As of September 30, 1996, the Company did not have any 
agreements, commitments or formal understandings with third parties regarding 
possible acquisitions. See "--Acquisition of the Microtel and Hawthorn Suites 
Systems". 

The Hotel Franchising and Lodging Industries 

   Hotel Franchising. In recent years, owners of hotels not affiliated with 
regional or national lodging companies have increasingly chosen to join hotel 
franchise chains. The Company and other hotel franchise chains provide a 
number of services designed to directly or indirectly increase hotel 
occupancy rates, revenues and profitability. The Company believes that hotel 
operators often view franchise chain membership as an important means of 
remaining competitive with hotels that are either owned by or affiliated with 
national or regional lodging companies. In determining whether to affiliate 
with a franchise chain, hotel operators will compare costs of affiliation 
with the incremental revenues anticipated to be derived from chain 
membership. Costs of affiliation include capital expenditures and operating 
costs required to meet a chain's quality and operating standards, plus the 
ongoing payment of franchise royalties and assessments for the reservations 
system and marketing programs maintained by the franchisor. 

                                      23 
 

   Lodging Industry. The lodging industry has traditionally been divided into 
five segments, each of which is identified by the average daily room rate 
generally charged by hotel operators in the segment (the "ADR"). According to 
an industry study, in 1995 the various segments and their respective ADRs 
were: budget (approximately $36), economy (approximately $47), mid-price 
(approximately $61), upscale (approximately $80) and luxury (approximately 
$118). Hotels are further segmented into limited-service and full-service, 
depending on the degree of food and beverage and other services offered, and 
hotels are also segmented into transient hotels, which serve short-term 
guests, and extended-stay hotels, which serve guests on multiple night or 
multiple week stays. The Company's franchised properties operate in the 
budget segment of the limited-service sector through its Microtel brand and 
the extended-stay segment through its Hawthorn Suites brand. 

   The lodging industry as a whole has shown significant improvement in 
recent years. Industry reports indicate that the lodging industry marked its 
third consecutive year of profitability in 1995, resulting from a favorable 
supply/ demand relationship, with increases in room demand exceeding 
increases in room supply in 1992, 1993, 1994 and 1995. According to a study 
prepared in January 1996, these trends are expected to continue, with demand 
projected to increase at 2.5% annually from 1996 to 1998 compared to 
projected supply growth of 2.0% for this same period. However, demand 
historically has been sensitive to shifts in economic activity, which has 
resulted in cyclical changes in room and occupancy rates, and there can be no 
assurance that industry projections will be met. 

   The Company believes that the budget and the extended-stay segments of the 
lodging industry offer particularly attractive industry dynamics relative to 
other segments of the lodging industry, for the reasons set forth below. 

   Budget Segment. 

   Room supply growth in the budget segment has been and is expected to 
continue to be lower than in the other segments of the market. Growth since 
1994 in the numbers of rooms in the various segments, according to an 
industry report, was as follows: 

                       Annual Room Supply Growth (in %) 



                                   1996 
Segment         1994   1995   (through June) 
- -------         ----   ----   -------------- 
                           
Luxury          1.0%    0.9%        1.4% 
Upscale         2.0     1.9         2.7 
Mid-price       2.0     2.4         2.7 
Economy         1.1     2.0         1.7 
Budget          0.3     0.6         0.5 


Another study indicates that room supply growth in the budget segment through 
1998 is expected to be the lowest of all five segments. The industry report 
referred to above also shows that the relationship between growth in room 
demand and room supply in the budget segment continues to be favorable 
relative to other segments of the lodging industry. The following table 
compiled from such report compares the ratio of room demand growth to room 
supply growth since 1994. 



      Ratio of Change in Room Demand to 
            Change in Room Supply 
                                   1996 
Segment         1994   1995   (through June) 
- -------         ----   ----   -------------- 
                          
Luxury          4.4x   2.4x        2.0x 
Upscale         1.9    1.4         1.1 
Mid-price       2.1    1.6         1.3 
Economy         2.4    1.5         1.5 
Budget          4.0    2.2         3.4 


   Extended-Stay Segment. 

   The extended-stay segment consists of hotels that offer rooms with full 
kitchen facilities and that target travelers staying five or more consecutive 
nights. This segment is a growing segment of the lodging industry, as 
travelers' demand for better value and for environments that feel more like 
home have contributed to increased demand for extended-stay rooms. Corporate 
downsizing has resulted in an increasing need for consultants, long-term 
project work and growth in corporate training programs. Moreover, with 
extensive corporate relocations each year, more people are away from home on 
longer trips. Leisure and vacation travelers are also discovering the value 
of extended- 

                                      24 
 
stay hotels. According to lodging consultant D.K. Shifflet & Associates Ltd., 
approximately 292 million extended-stay room nights were sold in the United 
States in 1995, representing over 30% of all hotel room nights sold in the 
United States during the year. However, dedicated extended-stay rooms 
constituted only 1.3% of the lodging industry's total rooms at the end of 
1995. While growth in room supply in the extended-stay sector is expected to 
outpace room supply growth in other segments of the lodging industry in the 
next several years, management believes that the projected growth in supply 
will be insufficient to meet demand for extended-stay rooms. 

   Extended-stay properties offer attractive economics to franchisees because 
of the relatively high occupancy rates in this segment and the lower 
operating costs relative to similarly priced, full-service hotel properties. 
According to an industry survey, in 1995, extended-stay properties 
experienced an average occupancy rate of 80.8%, compared to an overall 
average occupancy rate for the lodging industry of 65.5%. Due to the longer 
average stay of the extended-stay guest and lower guest turnover, operators 
of extended-stay hotels enjoy reduced staffing needs, both at the front desk 
and in housekeeping, relative to operators of transient hotels. At the same 
time, reduced guest turnover contributes to lower supply costs, as hotel 
operators are not required to replenish amenities such as soap and shampoo on 
a daily basis. These factors, combined with the elimination of the high costs 
of operating full service restaurants, allow extended-stay hotels to realize 
higher profit margins than typical full-service hotels. 

Microtel 

   Microtels include three types of properties: Microtel Inns, which have 
single and double rooms; Microtel Suites, which are all-suite properties; and 
Microtel Inn & Suites, which contain singles, doubles and suites. All 
Microtels operate in the budget segment of the lodging industry, which is the 
lowest priced segment in the industry with an average daily room rate in 1995 
of approximately $36. Microtels are distinctively styled hotels with a 
residential look that offer travelers an attractive and consistent 
appearance, clean, comfortable rooms and the safety of interior corridor room 
access, all for a competitive room rate. Management believes that the 
Microtel system is one of the only brands in the budget segment that 
franchises only newly constructed, interior corridor properties. In contrast, 
many other budget hotels are older properties with rooms that are accessible 
only through outside entrances and that may have been converted from 
independent hotels or other brands. Management believes that Microtels' 
strict new construction and interior corridor requirements provide travelers 
with a brand that is among the safest, most consistent and highest quality in 
the budget segment. 

   The Company believes that Microtels offer financial advantages to 
franchisees. Microtels feature a distinctive architectural design that 
minimizes construction costs and maintenance expenses through smaller room 
sizes, limited common areas, smaller land requirements and built-in 
standardized furniture, all of which enable franchisees to own and operate a 
Microtel at a lower cost. These lower costs may reduce a franchisee's equity 
investment and may broaden its debt financing alternatives, thereby expanding 
the appeal of the Microtel brand to prospective franchisees. 

   Today's security conscious, value oriented travelers have shown their 
approval of Microtels. Although there were no national advertising or 
significant promotional campaigns prior to the Company's acquisition of the 
Microtel brand, the 15 properties open more than two years as of June 30, 
1996 achieved a 69.3% occupancy rate in 1995 compared to an approximately 
61.9% occupancy rate for the budget sector as a whole. Further evidence of 
the appeal of Microtels is found in its "intent-to-return" rating, which 
measures customers' overall satisfaction and willingness to return to a 
Microtel in the future. Based on surveys of approximately 5,000 Microtel 
guests conducted by franchisees from 1989 to 1994, more than 95% of Microtel 
guests expressed an intent to return to a Microtel in the future. 

   Since acquiring the Microtel brand in October 1995 and establishing its 
sales force by January 1996, the Company has realized franchise sales growth 
as follows: 


                                          As of               As of 
                                    December 31, 1995  September 30, 1996 
                                    -----------------  ------------------ 
                                                         
Microtel Franchise Data (1) 
Properties Open                            23                   27 
Properties Under Construction               0                    7 
Executed Franchise Agreements               3                  145 
Franchise Applications Accepted            10                   74 


- ------------- 
(1) The Company will not receive royalties from the 23 Microtels open as of 
    December 31, 1995 and from 26 of the 27 Microtels open as of September 
    30, 1996, but does receive reservation and marketing fees from the 
    franchisees of these properties. See "--Acquisition of the Microtel and 
    Hawthorn Suites Systems". 

                                      25 
 

   Microtels are designed to offer the following advantages to franchisees: 

   Lower Construction Costs. Compact and consistently designed rooms, vinyl 
exteriors, minimal public space and the elimination of low profit margin 
areas such as kitchen and restaurant facilities, exercise rooms and expansive 
lobbies combine to lower total development costs. As a result, a Microtel can 
be completed for as little as $23,000 per room (including soft costs, 
furniture, fixtures and equipment, but excluding land costs). These lower 
construction costs may reduce a franchisee's equity investment and may 
broaden its debt financing alternatives, thereby expanding the appeal of the 
Microtel brand to prospective franchisees. 

   Lower Land Costs/More Available Sites. Microtels' innovative architectural 
designs, particularly their smaller room size, built-in standardized 
furniture and limited public areas, eliminate wasted space, enabling 
Microtels to be built on as little as one acre of land. In addition to 
minimizing development costs, the ability to build a Microtel on smaller 
parcels of land significantly increases the number of available sites, some 
of which have traditionally been unsuitable for hotel projects. 

   Shorter Construction Time. The Company provides Microtel franchisees with 
a detailed construction prototype (including mechanical and electrical 
working drawings) that requires a local architect only to make changes 
related to site adaptation and local zoning codes. Microtel franchisees may 
choose from among several different prototypes depending upon the size of the 
property and the number and type of rooms. The Company also provides its 
franchisees with ongoing construction and design assistance during the 
building phase. The result is a shorter construction period (estimated at a 
total of 120 to 151 days), which reduces construction period interest costs 
and accelerates market entry and the growth of the Microtel system. 

   Lower Operating Costs. Compact rooms, built-in standardized furniture and 
minimal public space lower the number of people required to clean and 
maintain a Microtel, reduce heat, light and power consumption, minimize 
repair and maintenance costs and reduce capital expenditures. 

   Lower Reservation Costs. The Company maintains a toll-free referral system 
on behalf of its franchisees, which is designed to generate guest 
reservations at a lower cost. The toll-free number connects callers to an 
operator who refers callers directly to the appropriate Microtel. By reducing 
the need for complex and high-cost computer hardware, software and training 
at the property level, less of the franchisees' reservation and marketing 
fees must be dedicated to maintaining a reservation system, allowing a 
greater portion of such fees to fund brand marketing expenditures to end 
consumers. 

   For the hotel guest, Microtel provides a high quality, aesthetically 
appealing, safe and secure property at a competitive room rate, as described 
in greater detail below: 

   Strong Price/Value Relationship. A Microtel has a residential-looking 
exterior, attractive landscaping and interior corridor design, 
differentiating it from other budget properties, many of which are older and 
have exterior guest room entrances. As one of the only 100% interior 
corridor, new construction brands in the budget segment, Microtel provides 
the safety and price conscious customer with an appealing alternative to 
other budget hotels. 

   High Quality/Consistent Product. All Microtels are newly constructed in 
accordance with working drawings provided by the Company. The Company does 
not allow conversions from existing properties, as is permitted by many of 
its competitors. Strict adherence to these construction standards is 
monitored by Microtel's in-house design and construction department, which 
must approve all franchisee building plans. Management believes that the 
result is one of the most consistent chains in the budget segment. 

   Focus on Safety and Security. Microtels are designed with security in 
mind, featuring interior corridors, well-lit lobbies, hallways and parking 
areas and a single general access entrance through the lobby to all guest 
rooms. All Microtels that have been built subsequent to the Microtel 
Acquisition contain, and all Microtels built in the future will contain, 
electronic door-locking systems as an additional security feature. These 
features, particularly popular with women travelers, combine to provide 
enhanced safety for Microtel guests. 

Hawthorn Suites 

   As an upscale, extended-stay hotel, Hawthorn Suites provide the traveler 
with the convenience of a hotel and the amenities typically found in an 
apartment. Hawthorn Suites' hotel rooms contain full-service kitchens with 
appliances, 

                                      26 
 

cookware and utensils, video cassette players, modem ports, exercise 
facilities and valet service. Hawthorn Suites hotels also offer a hot 
breakfast buffet every morning and guests are invited to an evening social 
hour held four times a week. A center courtyard, an outdoor pool, a multi-use 
sport court, a barbecue area and a retail store selling sundry and meal 
items, snacks and beverages, will also be part of newly constructed Hawthorn 
Suites hotels. 

   In addition to participating in the upscale, extended-stay segment through 
its Hawthorn Suites brand, the Company has recently developed a prototype 
called Hawthorn Suites LTD. Hawthorn Suites LTD is a mid-price, all- suites 
hotel brand that is designed to meet the needs of both the extended-stay and 
transient guests. The prototype developed by the Company for Hawthorn Suites 
LTD targets development costs and average daily rates approximately 20% below 
those for Hawthorn Suites hotels. 

   Hotels that are part of the Hawthorn Suites system use the Spirit 
Reservation System ("Spirit"), a system operated by Regency Systems Solutions 
("Regency"), which receives and processes calls made to a toll-free number 
dedicated to Hawthorn Suites. The Spirit system is directly linked by 
computer to all Hawthorn Suites hotels. Regency, which is owned by Hyatt 
Hotel Corporation ("Hyatt"), also currently operates the reservation system 
for Hyatt hotels. The Company benefits from a unique relationship with Hyatt. 
Persons calling the Hyatt toll-free number who experience a sold out Hyatt or 
no Hyatt in their desired market are automatically referred to the closest 
Hawthorn Suites hotel. Revenue generated from reservations made through the 
Spirit system accounted for 25% of Hawthorn Suites' total room sales in 1995. 
Management believes its franchisees derive substantial benefits from use of 
the Spirit system at a low cost. As and when Hawthorn Suites LTD properties 
are opened, these properties will also be linked to the Spirit system and 
will benefit in the manner described above from any overflow at Hyatt hotels. 
There can be no assurance, however, that Regency will continue to service the 
Company's or Hyatt's reservation needs in the future or that the Company will 
continue to use the reservation services of Regency. 

Operations 

   The following departments of the Company are responsible for identifying 
potential franchisees and locations, obtaining franchise applications, 
executing franchise agreements, assisting franchisees in building and opening 
properties and providing ongoing support, training and services: 

   Franchise Sales. The Company employs a national franchise sales force 
consisting of 28 people who, collectively with Mr. Leven, have sold over 
2,200 hotel franchises as employees of other hotel chains. The primary 
objectives of the Company's franchise sales strategy are to identify 
potential franchisees and possible locations for each of the Company's brands 
and to create an awareness and general acceptance of its products with 
numerous participants in the hospitality industry, including hotel owners, 
lodging consultants, vendors, operators and educational institutions. The 
sales force seeks to achieve these objectives through the implementation of a 
multi- faceted sales strategy, which includes cold calling, telemarketing, 
direct mail, trade advertising and public relations. The compensation program 
is structured so that each franchise salesperson is expected to earn at least 
50% of his or her annual income in sales commissions. 

   Design and Construction. The Company's design and construction department 
provides development expertise in the disciplines associated with new 
construction and renovation, with emphasis on low development costs, low 
maintenance expense, quality construction and profit maximization for its 
franchisees. The Company provides detailed architectural plans, CAD-CAM 
computer files, specifications, system standards and manuals, and makes the 
services of the department available to franchisees at various stages of the 
development process. In addition, in order to maintain consistent product 
quality and brand identity, the design and construction department approves, 
among other things, all architectural plans of Microtel and Hawthorn Suites 
franchisees. 

   Quality Assurance. Quality control is essential to maintaining and 
increasing the value of the Company's brands and in generating repeat 
business among travelers. Franchise quality control is accomplished through 
inspections prior to a franchisee's entry into the system and on an ongoing 
basis. Quality assurance programs promote uniform standards throughout each 
of the Company's franchise systems, an important factor in increasing 
consumer demand for lodging facilities. The Company inspects each property 
two times per year. Hotels that fail to meet certain franchise standards are 
notified and are generally given 30 days to either correct the conditions 
that led to the failure or to implement a plan to correct the failure. If 
they do not correct the deficiencies, the Company can rescind the franchise. 
Since the Company acquired the Microtel brand, one property has been 
terminated from the Microtel system due to quality deficiencies. 

                                      27 
 

   Marketing. The Company's marketing strategy is designed to increase brand 
awareness among potential franchisees and consumers. In the franchise 
community, the Company's marketing campaign is focused on publications that 
target the hospitality industry, direct mail and attendance at industry trade 
shows. In targeting the end consumer, the Company supplies franchise 
properties with a marketing guide, local radio spots, print advertising, 
outdoor billboard designs and rack cards. In addition, national directories 
are published for each brand and made available to hotel guests at the 
property level, through advertising and via the Internet. In 1996, the 
primary vehicles for advertising the Microtel brand to end consumers and 
reinforcing Microtel's national message that "There's Room for Everyone" have 
been USA Today, the Internet and billboards at 20 major airports in the 
communities where Microtels are located (including two prominently displayed 
billboards at Atlanta's Hartsfield Airport during the 1996 Olympic games). 
Microtel's Internet address is http://www.microtelinn.com. Due to the nature 
of the extended-stay market, direct sales (i.e. sales and marketing efforts 
by the hotel operator targeted at local demand generators) plays a major role 
in marketing for Hawthorn Suites. Specialized pre-opening and post-opening 
collateral material is targeted to travel agents, travel planners and buyers 
of extended-stay rooms, instead of the end consumer. Hawthorn Suites' 
Internet address is http://www.hawthorn.com. 

   
   Public Relations. A targeted public relations program supports both the 
marketing and franchise sales efforts by promoting awareness of the Company 
generally. Since its inception, the Company has been featured in such 
national publications as in USA Today, Business Week and National Business 
Employment Weekly (a subsidiary of The Wall Street Journal), as well as 
industry trade publications such as Hotel & Motel Management, Hotel Business, 
Lodging, Lodging Hospitality, Hotels, Travel Weekly and Real Estate Forum. 
    

   Training. The Company maintains mandatory training programs for its 
franchisees that are designed to teach franchisees how to best utilize the 
Company's reservations system and marketing programs, as well as the 
fundamentals of hotel operations, such as recruiting, housekeeping, repairs 
and maintenance and personnel policies. The Company also provides special 
on-site training upon request. The Company has developed and maintains a 
library of training videos, cassettes and tapes, as well as printed training 
material, which are available to franchisees. In addition, each franchise 
sales person must complete a structured initial training program and regular 
retraining. 

   Franchise Services. The franchise services department functions as a 
single point of contact for all franchisees to call for support on all issues 
prior to, during and after construction. Franchise services acts as a liaison 
between the franchisee and all departments of the Company. The Company 
recognizes the personal service aspect of the franchising business and 
intends to assign a designated member of the franchise service department to 
each franchisee. 

   Purchasing. The Company provides its franchisees with volume purchasing 
discounts for products, services, furnishings and equipment used in 
construction and ongoing operations. The Company has established 
relationships with vendors to the lodging industry and negotiates discounts 
for purchases by its customers. In certain cases, the Company receives 
payments from the vendors as well. Currently, the Company does not maintain 
inventory, directly supply any of the products or extend credit to 
franchisees for such purchases. 

Franchise Agreements 

   The Company's franchise agreements grant hotel owners the right to utilize 
one of the brand names associated with the Microtel or Hawthorn Suites hotel 
systems under long-term franchise agreements. In order to qualify for a 
franchise from the Company, a candidate must undergo a screening process, 
which typically includes a review of the potential franchisee's operational 
ability and financial condition and the proposed lodging location. A 
representative of the Company conducts a site inspection to determine whether 
the location meets standards and whether the brand name selected is 
appropriate at that location. The Company considers such factors as 
accessibility, visibility, location, economics, demographics, the extent of 
commercial development and, in the case of Hawthorn Suites conversions, 
facility condition. When executed, both Microtel and Hawthorn Suites 
franchise agreements offer an area of exclusivity to each location, the 
degree of which is negotiated individually with each franchisee. 

   The Company's current standard agreements are for 20-year terms for new 
construction properties and 10-year terms for conversion properties (in the 
case of Hawthorn Suites only). The standard franchise agreements generally 
require franchisees to satisfy certain development milestones, including a 
requirement that construction begin within six to nine months of execution of 
the franchise agreement, although generally there exists a 30-day cure 
period. Franchisees are required to pay royalty fees to the Company based 
upon the gross room revenues of the franchised 

                                      28 
 

hotel during the term of the agreement and an application fee. Franchise 
application fees are non-refundable and are generally collected from 
potential franchisees by the time the franchise agreement is executed. 

   Franchise fees are comprised of two components: a royalty portion and a 
reservation and marketing portion, both of which are based upon a percentage 
of the franchisee's gross room revenues. The royalty portion of the franchise 
fee is intended to cover the operating expenses of the franchisor, such as 
costs incurred in providing quality assurance, administrative support and 
other franchise services, and to provide the Company with operating profits. 
The reservation and marketing portion of the franchise fee is intended to 
reimburse the Company for the expenses associated with providing such 
franchise services as a reservation system, national advertising and certain 
promotional programs. Marketing and reservation fees do not produce any 
profit for the Company, but mitigate a significant cost of business for 
franchisees and are an important consideration for potential franchisees when 
evaluating competing brands. The Company does not receive royalty fees from 
those Microtels and those Hawthorn Suites hotels that were open or under 
development at the time the Company acquired the right to franchise the 
respective brands. The Company does, however, receive reservation and 
marketing fees from the franchisees of these properties. 

   The terms of the Company's current standard forms of franchise agreements 
state that, by year of operation, franchisees are required to pay the 
following ongoing royalty fees and reservation and marketing fees (each, as a 
percentage of gross room revenues), although the actual fees may vary: 



                                         Microtel      Hawthorn Suites 
                                      ------------- --------------------- 
                                              
Franchise Royalty Fees 
- ----------------------
Year 1                                     4.0%              5.0% 
Year 2                                     5.0%              5.0% 
Year 3 and thereafter                      6.0%              5.0% 

Reservation and Marketing Fees 
- ------------------------------ 
Year 1                                     3.0%              2.5% 
Year 2                                     2.5%              2.5% 
Year 3 and thereafter                      2.0%              2.5% 

Total Franchise Fees 
- --------------------
Year 1                                     7.0%              7.5% 
Year 2                                     7.5%              7.5% 
Year 3 and thereafter                      8.0%              7.5% 


   
   During the first quarter of 1996, when the Company began its full-time 
franchise sales efforts, prospective Microtel franchisees were offered a 
three month royalty-free period during Year 1 as an inducement to join the 
Company's franchise system. The Company is no longer offering this discount 
and currently has no intention to do so in the future. With respect to 
Hawthorn Suites, two franchisees have received discounts from the Company's 
standard fee structure. Discounts were granted in these two instances due to 
the unique property size and accelerated opening schedule of these 
franchises. With respect to both Microtel and Hawthorn Suites, the Company 
also has agreed in certain situations to dedicate a portion of a particular 
franchisee's marketing fees to local (as opposed to national) promotion of 
the applicable brand. 
    

   The Company has modified its standard forms of license agreements in an 
attempt to reduce negotiations with potential franchisees, modifications that 
the Company believes have reduced the burden on its sales force and 
administrative staff. The Company believes that these changes make the 
Company's franchise agreements more attractive to potential franchisees 
without sacrificing the protection typically afforded to franchisors under 
franchise agreements. The Company's standard form of franchise agreement is 
terminable by the Company if the franchisee fails to maintain certain quality 
standards or to pay royalties, reservation and marketing fees or other 
charges. In the event of termination, the Company is generally entitled to 
liquidated damages. 

Special Programs 

   American Dream Program. American Dream by Microtel is a unique program 
that the Company has developed to enable potential first-time hotel owners 
with limited financial resources and/or little or no building experience to 
lease and ultimately acquire a Microtel (the "American Dream Program"). Under 
the American Dream Program, qualified potential Microtel franchisees would 
lease a Microtel for an initial deposit and, at the lessees' option, acquire 
the hotel for additional payments over a fixed period. The American Dream 
Program is designed to accelerate the 

                                      29 
 

growth of the Microtel system by permitting those who otherwise could not 
afford to build a Microtel an opportunity to become a hotel owner. Although 
the Company did not begin marketing this program until August 1996, five 
franchise agreements were executed under this program by September 30, 1996. 

   The Company has reached an understanding in principle with TAD Properties, 
L.L.C. ("TAD"), an affiliate of Motels of America, Inc. ("MOA"), pursuant to 
which TAD or one of its affiliates will be the exclusive developer, 
franchisee and owner-lessor of properties under the American Dream Program. 
MOA owns and manages more than 140 hotels, making it one of the largest 
owners of limited-service hotel properties in the United States. The Company 
will support the American Dream Program by committing to make initial 
deposits on individual properties and to lease the hotels until qualified 
lessees can be identified. In the event a qualified lessee is not identified 
for a particular property, the Company may become the lessee under the 
program. If the Company becomes the lessee with respect to a particular 
property, it may also acquire the Microtel from the franchisee under the 
terms of the American Dream Program. However, no specific amount of capital 
has been committed to this program. The Company's UFOC is being amended to 
describe the American Dream Program. See "--Regulation". 

   Franchisee Financing Facility. In May 1996, the Company reached an 
agreement in principle with NACC, pursuant to which NACC would make available 
to the Company's franchisees, over a two year period, up to $200 million in 
construction and long-term mortgage financing, subject to certain terms and 
conditions (the "Franchisee Financing Facility"). The Company believes that 
the Franchisee Financing Facility can add speed and certainty to the 
development process by enabling the Company's franchisees to devote more time 
to identifying acceptable hotel locations and constructing properties and 
less time obtaining financing. The Company is currently revising its UFOC to 
describe the Franchisee Financing Facility. See "--Regulation". 

   Under the Franchisee Financing Facility, neither the Company nor the 
subsidiary through which the Company operates the program, US Funding Corp., 
is obligated to provide any credit or credit support. Rather, it is expected 
that US Funding Corp. will provide the Company's franchisees with access to 
financing from NACC. Under the Franchisee Financing Facility, NACC is 
expected to provide eligible franchisees with 27-to-30 month construction 
loans, which convert into 10-year mortgage loans at maturity or earlier under 
certain circumstances. The program is expected to be subject to a 
comprehensive underwriting process, which will be conducted by US Funding 
Corp. and NACC and which will be separate from the franchise application 
process. The ultimate decision as to whether to make any loan will be made by 
NACC. There can be no assurance that applications preliminarily approved by 
US Funding Corp. under this program will ultimately result in loans being 
made. To date, no loans have been made to franchisees under the Franchisee 
Financing Facility. Franchisees will be required to contribute at least 30% 
of the development cost (through the contribution of cash or other assets), 
financing the remaining portion from the facility. During the construction 
phase, interest will accrue and principal payments will be deferred. The 
loans will become secured by the hotel property and will be non-recourse to 
the franchisee once the franchisee has received a certificate of occupancy 
for the property. 

   In addition to facilitating the development process, the Company expects 
to earn revenues when its franchisees borrow under the Franchisee Financing 
Facility. Specifically, the Company expects to receive to a portion of 
certain upfront fees payable by the franchisee to NACC, plus a portion of 
certain ongoing interest charges payable by the franchisee during the 
construction phase. For many reasons, a loan preliminarily approved under 
this program may not be made, including if NACC does not approve the loan or 
if conditions to lending are not satisfied. 

   Although the Company generally does not make construction or mortgage 
loans to its franchisees, the Company is considering becoming a participant 
in both the construction loans and the long-term mortgage loans made to 
franchisees under this program, including by making direct subordinated loans 
to franchisees. In such cases, the Company would be subject to the risks 
ordinarily experienced by lenders, including risks of franchisee/borrower 
defaults and bankruptcies. In the event of a default in construction and/or 
long-term mortgage loans, the Company, as a subordinated lender, would bear 
the risk of loss of principal to the extent the value of the collateral was 
not sufficient to pay both the senior lender and the Company, as subordinated 
lender. If the Company were to make loans directly, its UFOC would have to be 
further amended before any such loans could be offered or made. See 
"--Regulation". 

   PMC Agreement. Under an agreement with PMC Commercial Trust, a Texas real 
estate investment trust ("PMC"), the Company has also agreed to make 
available to potential Microtel franchisees information regarding PMC's 
financing programs for land acquisition and construction costs (the "PMC 
Agreement"). The Company earns a marketing fee based on the average principal 
amount of the outstanding and performing loans extended by PMC to Microtel 
franchisees. The Company and PMC jointly agree as to which franchisee loan 
applications will be covered by the PMC Agreement, but the Company may not 
participate in the approval or underwriting of any loan applications, and 
PMC, in its sole discretion, 

                                      30 
 

determines whether and the terms under which loans will be made. The PMC 
Agreement may be terminated by either party upon 30 days' notice. The Company 
is currently updating its UFOC to describe this program. See "--Regulation". 

Acquisition of the Microtel and Hawthorn Suites Systems 

   Microtel Acquisition. On September 7, 1995, the Company entered into the 
Microtel Acquisition Agreement with Hudson, a public company then called 
Microtel Franchise and Development Corporation, to acquire the exclusive 
worldwide franchising rights and operating assets of the Microtel hotel 
system. The purchase price for these franchise rights and operating assets 
was $3,037,000, of which the Company paid $1,600,000 at the closing on 
October 5, 1995 and agreed to pay a total of $1,437,000 over the following 
three years, plus interest at 10% (for a total payment of approximately 
$1,700,000). In addition, royalties are payable to Hudson, as described 
below, for the right to all trade names, trademarks, service marks and other 
intellectual property used in connection with the Microtel business, 
including the Microtel name (the "Proprietary Marks"). 

   The operating assets of the Microtel system acquired from Hudson included 
(i) all prototype architectural plans and designs used in connection with the 
Microtel business and (ii) the Microtel reservation referral system, 
directories, manuals and marketing materials. 

   Pursuant to the Microtel Acquisition, the Company also acquired Hudson's 
rights under then existing Microtel franchising agreements relating to the 27 
Microtels open or under development at the time of the acquisition. Although 
the Company acquired the existing franchises from Hudson and is obligated to 
fulfill all of the obligations of the franchisor thereunder, Hudson retained 
the right to receive all franchise royalties and franchise renewal fees 
payable by the existing franchisees under such agreements. The Microtel 
Acquisition Agreement does, however, permit the Company to retain any 
reservation and marketing fees and any other one-time or non-recurring fees 
or charges payable to the franchisor under the applicable franchise 
agreement, such as those relating to the initial placement, substitution, 
amendment, organization, termination or transfer of the franchise. 

   The Microtel Acquisition Agreement also grants Hudson, its affiliates and 
certain other persons the right to acquire from the Company up to an 
additional 23 Microtel hotel franchises and up to an additional 10 Microtel 
all-suites hotels and to retain the franchise application fees and the 
franchise royalties from such franchises (provided Hudson, its affiliates or 
such other persons own and operate the hotels covered by such franchises). 
Since the closing of the Microtel Acquisition, Hudson, its affiliates or such 
other persons have executed franchise agreements for eight additional 
Microtels, which, when opened, will be included in the 23 Microtel franchises 
referred to above. 

   In consideration for the transfer of the Proprietary Marks, the Microtel 
Acquisition Agreement provides that, for each new Microtel or Microtel 
all-suites hotel (collectively, the "Microtel Properties") opened after the 
closing of the Microtel Acquisition, other than the additional franchises 
referred to in the preceding paragraph, the Company is required to pay 
monthly royalties to Hudson as follows: 1.0% of the "revenues subject to 
royalties" on the first 100 Microtels opened after the closing, 0.75% of such 
revenues for the next 150 Microtels opened, and 0.50% of such revenues for 
each Microtel opened after the first 250 have opened. "Revenues subject to 
royalties" generally are those payable by the franchisees to the Company 
based on gross room revenues, as well as other royalty payments payable by 
such franchisees under the applicable franchise agreement. The Company is 
entitled to all other fees (other than termination fees, which must be shared 
with Hudson) payable by the Microtel franchisees, including the franchise 
application fees, all of the remaining royalties, reservation and marketing 
fees and fees applicable to any financing arranged through the Company. 

   The Microtel Acquisition Agreement requires the Company to satisfy a 
development schedule, which requires that new Microtel Properties be opened 
or under construction in the following numbers, on a cumulative basis, by 
December of each of the following years: 



                       Number of 
Year          Microtel Properties (1) 
- ----          ----------------------- 
                    
1996                     0 
1997                    50 
1998                   100 
1999                   175 
2000                   250 


- ------------- 
(1) Excluding (i) the 27 Microtels that were open or under construction or 
    with respect to which franchise agreements had been executed or 
    applications accepted at the time of the Microtel Acquisition and (ii) 
    the 23 additional Microtels 

                                      31 
 

    (with respect to which eight franchise agreements have been executed 
    since the closing of the Microtel Acquisition) and the 10 Microtel 
    all-suites hotels that Hudson, its affiliates and certain other persons 
    are entitled to franchise under the Microtel Acquisition Agreement. 

   Under the Microtel Acquisition Agreement, the development schedule is 
deemed to have been complied with unless such schedule has not been met for 
two consecutive years (including 1996, where applicable). That is, the 
Company will not violate its development obligations under the Microtel 
Acquisition Agreement unless it has failed to meet the targets for two 
consecutive years. If, however, at the end of any two year period, at least 
75% (but less than 100%) of the number of Microtel Properties scheduled to 
have been opened by such date have been opened, the Microtel Acquisition 
Agreement permits the Company to cure the default by paying a fee of $1 
million. Upon such payment, the Company will be deemed to have fully complied 
with the development schedule for such two year period (including when 
determining whether it complies with such schedule in future periods). 

   The Microtel Acquisition Agreement further provides that, in the event the 
Company fails to satisfy the development schedule, fails to pay any monies 
due to Hudson or otherwise fails to fulfill its material obligations under 
the Microtel Acquisition Agreement, in each case subject to the Company's 
right to cure such breach within the applicable notice and cure periods, all 
of the rights to the Microtel system and all operating assets associated 
therewith will revert to Hudson. In such instance, the Company will, however, 
retain the rights to any franchise royalty payments due to it under franchise 
agreements entered into by the Company after the closing of the Microtel 
Acquisition, less a servicing fee payable to Hudson in an amount equal to 
0.75% of all revenues subject to royalties under such agreements. 

   Also in connection with the Microtel Acquisition, Hudson agreed to provide 
consulting services to the Company over the three-year period beginning 
October 5, 1995, for which the Company agreed to pay Hudson a total of 
$700,000 ($400,000 of which was paid at the closing of the Microtel 
Acquisition). The Company also received warrants to purchase 100,000 common 
shares of Hudson at an exercise price of $8.375 per share. The warrants 
expire on September 1, 2000. 

   Hawthorn Acquisition. On March 27, 1996, the Company entered into the 
Hawthorn Acquisition Agreement with HSA, an entity indirectly controlled by 
the Pritzker family, pursuant to which the Company acquired the exclusive, 
worldwide rights to franchise and to control the development and operation of 
the Hawthorn Suites brand of hotels (the "Hawthorn Acquisition"). In 
connection with the Hawthorn Acquisition, HSA also assigned to the Company 
all of HSA's rights in the licenses (other than the right to receive royalty 
payments) for the then existing Hawthorn Suites brand hotels (the "Existing 
Hawthorn Hotels"), HSA's agreement with Regency to provide reservation 
support services and certain other agreements relating to the operation of 
the Hawthorn Suites brand hotels. No money was paid by the Company at the 
closing of the Hawthorn Acquisition. The Company is, however, required to 
make royalty payments to HSA under circumstances described below. 

   Under the Hawthorn Acquisition Agreement, the Company remits to HSA all 
franchise royalty fees paid to the Company by franchisees of the Existing 
Hawthorn Hotels, with the Company and HSA generally dividing royalty fees 
paid with respect to any Hawthorn Suites brand hotels opened subsequent to 
the Hawthorn Acquisition (the "New Hotels"), as described below. All other 
fees and other charges payable under the licenses for the Existing Hawthorn 
Hotels or New Hotels, including marketing and advertising fees and 
origination or initial franchise application fees, will be retained by the 
Company. Pursuant to the Hawthorn Acquisition Agreement, as indicated on the 
chart below, the percentage of such royalties payable to HSA will decrease as 
the aggregate number of rooms in New Hotels increases. 

                       Division of Franchise Royalties
                       -------------------------------



Rooms (1)               HSA      Company 
- ---------              ------    ------- 
                            
First 3,600 Rooms:      66.7%     33.3% 
Next 3,150 Rooms:       50.0%     50.0% 
Next 2,160 Rooms:       37.5%     62.5% 
Next 4,410 Rooms:       33.3%     66.7% 
Above 13,320 Rooms:     25.0%     75.0% 


- ------------- 
(1) For this purpose, a suite is considered to be one "room". 

                                      32 
 

   In the event, however, that the Company fails to achieve certain specified 
development milestones (the "Royalty Reduction Standard"), the royalty fees 
payable to HSA will increase. Specifically, the amount of additional royalty 
fees payable to HSA during the period that the Company fails to comply with 
the Royalty Reduction Standard is determined by multiplying the Company's 
share of royalty fees (in dollars) for the calendar quarter in which the 
default occurs by a fraction, the numerator of which is the number of 
additional Qualified License Agreements required in order for the Company to 
comply with the Royalty Reduction Standard and the denominator of which is 
the minimum number of Qualified License Agreements required in order for the 
Company to have complied with the Royalty Reduction Standard. The Hawthorn 
Acquisition Agreement further provides that if the franchise royalty payable 
by a New Hotel is less than 4% of that hotel's gross room revenue, the 
percentage of the royalty payable to HSA for that particular hotel will 
increase. 

   The Hawthorn Acquisition Agreement also restricts the Company's ability to 
franchise other hotel brands for certain periods if the Company fails to meet 
certain development targets. Specifically, the agreement provides that unless 
and until such time as the Company's franchisees have opened 175 Hawthorn 
Suites with a minimum aggregate total of 11,375 rooms ("Hawthorn Brand 
Saturation"), the Company generally may not franchise another all-suite hotel 
brand. The Company's new combined extended-stay/transient all-suite hotel 
property, Hawthorn Suites LTD, may be counted toward Hawthorn Brand 
Saturation so long as they are "all suite" hotels, as defined below. The 
Company may, however, franchise Microtel Suites at any time so long as they 
cost $40,000 (subject to adjustment for inflation) or less per suite to 
build, excluding the cost of land. For purposes of the Hawthorn Acquisition 
Agreement, a hotel that is at least 50% suites or uses "suites" in its name 
is an "all-suite" hotel. If the Company decides to franchise or license 
another all-suite hotel brand after Hawthorn Brand Saturation is achieved, 
HSA retains the option within a limited period to sell its right and interest 
in the Hawthorn Suites brand and system of operation, including the relevant 
intellectual property and the royalty stream, to the Company for a sum equal 
to 10 times the franchise royalty fees earned or accrued by HSA in the 12 
months prior to such sale. 

   Until the earlier of June 26, 1998 and the date on which Hawthorn Brand 
Saturation is achieved, the Company is restricted from franchising any 
lodging brand other than (i) Hawthorn Suites hotels, (ii) Microtel hotels and 
(iii) other limited- service, non-suite hotels with an ADR of $49 and under. 
In addition, until June 26, 1997, the Company must also refrain from 
franchising any non-lodging brands. 

   Until Hawthorn Brand Saturation is achieved, the Company is obligated to 
receive HSA's approval for any material changes in its approved standard form 
franchise agreement, and all UFOCs and related materials delivered to 
prospective franchisees. The Hawthorn Acquisition Agreement also requires 
that the Company have a total of at least 15 full-time sales persons selling 
licenses for the Hawthorn Suites and Microtel brands and that the Company 
spend more than $100,000 in each of 1996 and 1997 to promote the Hawthorn 
Suites brand. 

   The Hawthorn Acquisition Agreement requires that the Company adhere to a 
development schedule under which a minimum number of Qualified License 
Agreements must be executed as of certain dates (the "Termination Standard"). 
The term Qualified License Agreements is defined in the Hawthorn Acquisition 
Agreement to mean a license granted by the Company to use the Hawthorn brand, 
provided that (i) the licensed hotel is an all-suites hotel (i.e., a hotel in 
which at least 50% of the rooms are suites or that uses "suites" in its name) 
with more than 40 suites, (ii) the Company has received all application fees 
from the licensee and (iii) the licensee either owns or controls through 
long-term lease the land on which the hotel is located or to be constructed. 
If any of these development milestones are not met and the default has not 
been cured prior to the delivery of a default notice, HSA may elect to 
terminate the Hawthorn Acquisition Agreement. If HSA opts to terminate the 
Hawthorn Acquisition Agreement, the Company may only retain a percentage of 
the franchise royalties to which it would otherwise be entitled on previously 
opened hotels. The portion retained by the Company ranges from 15% to 40% of 
the franchise royalties it would have received but for the termination, 
depending on the percentage of the Termination Standard achieved. As noted 
above, in the event that the Company surpasses the Termination Standard, but 
fails to meet the higher Royalty Reduction Standard, or for such time as HSA 
opts not to terminate for failure to achieve the Termination Standard, the 
percentage of franchise royalties payable to HSA increases. 

                                      33 
 

   The minimum development requirements are as follows: 

                             Development Schedule
                             --------------------

                        (Qualified License Agreements) 



                    Royalty Reduction 
       Date             Standard       Termination Standard 
       ----         -----------------  -------------------- 
                                          
June 27, 1997               20                   10 
December 27, 1997           30                  N/A 
June 27, 1998               40                   20 
June 27, 1999               65                   40 
June 27, 2000               90                   60 
June 27, 2001              115                   80 
June 27, 2002              140                  100 


  The Hawthorn Acquisition Agreement may also be terminated by the mutual 
agreement of the parties or in various other circumstances, including, at the 
election of HSA, on the death, disability, retirement, resignation or 
termination of the employment of Michael A. Leven as Chief Executive Officer 
of the Company prior to a permitted transfer of the Company's rights under 
such agreement or, if earlier, prior to such time as the Royalty Reduction 
Standard has been met or the Hawthorn Brand Saturation achieved. If the 
Hawthorn Acquisition Agreement is terminated for any reason, HSA has the 
right to require the Company to continue to administer the licenses for 
Hawthorn Suites brand hotels then in effect as of the date of such 
termination for up to one year in exchange for a fee equal to 0.5% of the 
gross room revenues of such hotels. 

Seasonality 

   In the future, royalties generated by gross room revenues of franchised 
properties are expected to be the principal source of revenue for the 
Company. As a result, the Company expects to experience seasonal revenue 
patterns similar to those experienced by the lodging industry generally. 
Accordingly, the summer months, because of increases in leisure travel, are 
expected to produce higher revenues for the Company than other periods during 
the year. See "Management's Discussion and Analysis of Financial Condition 
and Results of Operations". 

Competition 

   Competition among national brand franchisors and smaller chains in the 
lodging industry to grow their franchise systems is intense. The Company 
believes that competition for the sale of lodging franchises is based 
principally upon (i) the perceived value and quality of the brand, (ii) the 
nature and quality of services provided to franchisees, (iii) the 
franchisee's view of the relationship of building or conversion costs and 
operating expenses to the potential for revenues and profitability during 
operation and upon sale and (iv) the franchisee's ability to finance and sell 
the property. The Company's franchisees are generally in intense competition 
for guests with franchisees of other hotel chains, independent properties and 
owner-operated chains. The success of the Company's franchisees affects the 
profitability of the Company, as the Company's receipt of royalty fees under 
its franchise agreements is tied directly to the gross room revenues earned 
by its franchisees. 

   In choosing a particular hotel, consumers consider differences in room 
rates, quality and condition of accommodations, name recognition, 
availability of alternative lodging (including short-term lease apartments), 
service levels, reputation, safety, reservation systems and convenience of 
location. 

   Both among consumers and potential franchisees, Microtel competes with 
budget and economy hotels such as Comfort Inn, Days Inn, Econo Lodge, 
Fairfield Inn, Sleep Inn, Red Roof Inn, Budgetel Inn, Super 8, Ramada 
Limited, Motel 6, Jameson Inns, Travelodge, Thriftlodge, Knights Inn, Red 
Carpet Inn and Scottish Inns. In the upscale, extended-stay sector, Hawthorn 
Suites hotels compete for consumers and potential franchisees with Residence 
Inn, Homewood Suites, Summerfield Suites and Woodfin Suites. In the transient 
suites sector of the lodging industry, where the Company will be competing 
through its Hawthorn Suites LTD brand, the Company's principal competitors 
will include AmeriSuites, Hampton Inn and Suites, Fairfield SuitesSM, 
MainStaySM, CandlewoodSM, Wingate InnSM, Towne PlaceSM and Courtyard by 
Marriott, among others. Many of the Company's competitors are affiliated with 
larger chains with substantially more properties, greater marketing budgets 
and greater brand identity than the Company. There can be no assurance that 
the Company can franchise a sufficient number of properties to generate the 
operating efficiencies to enable it to compete with these larger chains. 

                                      34 
 

Regulation 

   The sale of franchises is regulated by various state laws, as well as by 
the FTC. The FTC requires that franchisors make extensive disclosure to 
prospective franchisees, although it does not require registration of offers 
to prospective franchisees. The required disclosure is made through a Uniform 
Franchise Offering Circular (a "UFOC"), which must be provided to potential 
franchisees at least 10 days prior to execution of a franchise agreement. A 
number of states require registration and disclosure in connection with 
franchise offers and sales. In addition, several states have "franchise 
relationship laws" that limit the ability of franchisors to terminate 
franchise agreements or to withhold consent to the renewal or transfer of 
these agreements. While the Company's franchising operations currently are 
not materially adversely affected by such regulations, the Company cannot 
predict the effect any future legislation or regulation may have on its 
business operations or financial condition. 

   Additionally, various national, state and local laws and regulations may 
affect activities undertaken by the Company in connection with the Franchisee 
Financing Facility and the PMC Agreement. In particular, the Company may be 
required to obtain a license or to register in certain states in order to 
underwrite or promote loans to be made by NACC and PMC under such programs or 
in the event the Company determines to make loans itself under the Franchisee 
Financing Facility. See "--Special Programs--Franchisee Financing Facility" 
and "--PMC Agreement." 

Trademarks and Licenses 

   
   The Company owns and uses certain trademarks and service marks, including, 
among others, US FRANCHISE SYSTEMS, USFS, US FUNDING CORP., MICROTEL, 
MICROTEL with design, MICROTEL INN, MICROTEL SUITES, MICROTEL INN & SUITES, 
AMERICAN DREAM, AMERICAN DREAM with design, "FIRST THE HOTEL, THEN THE MOTEL, 
NOW MICROTEL" and "SAVINGS YOU CAN SLEEP ON". The Company's rights to such 
trademarks and service marks will last indefinitely so long as the Company 
continues to use and police the marks and, with respect to registered marks, 
to renew filings with the applicable government agencies. Pursuant to the 
Hawthorn Acquisition Agreement, the Company is the exclusive licensee of the 
Hawthorn Suites brand of hotels. Pursuant to such right, the Company uses 
certain other marks, including, among others, HAWTHORN SUITES, the tree logo, 
HAWTHORN SUITES with the tree logo and the Company's newly created brand, 
HAWTHORN SUITES LTD. Upon the expiration of the 99-year term of the Hawthorn 
Acquisition Agreement (unless sooner terminated), HSA will transfer all of 
its right, interest and title in those marks to the Company. The Company 
considers the foregoing marks to be material to its business and certain of 
such marks are registered with or applications for registration are pending 
in the United States Patent and Trademark Office. Certain of the marks are 
also registered with or applications for registration are pending with 
various state and foreign government agencies. The Company is not aware of 
any adverse claim concerning its owned or licensed marks. 
    

Employees 

   As of October 7, 1996, the Company had 73 employees. None of the Company's 
employees are represented by unions. The Company considers its employee 
relations to be satisfactory. 

Properties 

   The principal executive and administrative offices of the Company are 
located at 13 Corporate Square, Suite 250, Atlanta, Georgia 30329. The 
Company currently leases 10,083 square feet of office space at the foregoing 
address, pursuant to a lease that expires September 30, 2000. The Company 
expects to leave its current office space due to its growth and therefore is 
in the process of discussing with its landlord the possibility of leasing 
additional space in the office park in which its current office is located. 

Legal Proceedings 

   The Company is not a party to any material litigation. However, claims and 
litigation may arise in the normal course of business. 

                                      35 
 

                                    MANAGEMENT 

Directors and Executive Officers 

   The following table sets forth certain information with respect to the 
directors and executive officers of the Company and their ages as of October 
1, 1996. 




          Name           Age                            Office or Position Held 
          ----           ---                            ----------------------- 
                            
Michael A. Leven          58      Chairman, President and Chief Executive Officer 
Neal K. Aronson           31      Executive Vice President, Chief Financial Officer and Director 
David E. Shaw, Sr.        53      Executive Vice President--Administration 
Steven Romaniello         29      Executive Vice President--Franchise Sales and Development 
Dean S. Adler             39      Director 
Irwin Chafetz             60      Director 
Richard D. Goldstein      44      Director 
Jeffrey A. Sonnenfeld     42      Director 
Barry S. Sternlicht       35      Director 
 

- ------------- 

   Each director is elected to serve until a successor is elected and 
qualified or, if earlier, until the director's death, resignation or removal. 
Officers, subject to the terms of their respective employment agreements, 
serve at the pleasure of the Board of Directors. See "--Employment 
Agreements". Each of the directors of the Company, other than Dean Adler and 
Jeffrey A. Sonnenfeld, has served as such since September 30, 1995. Messrs. 
Adler and Sonnenfeld were elected to the Board of Directors on October 11, 
1996, effective as of the effective date of the Registration Statement of 
which this Prospectus is a part. 

   Certain additional information concerning the persons listed above is set 
forth below. 

   Michael A. Leven, Chairman, President and Chief Executive Officer. Mr. 
Leven has been Chairman, President and Chief Executive Officer of the Company 
since October 1995. From October 1990 to September 1995, Mr. Leven was 
President and Chief Operating Officer for Holiday Inn Worldwide in Atlanta, 
Georgia. From April 1985 to May 1990, he was President and Chief Operating 
Officer of Days Inn of America, Inc. in Atlanta, Georgia. Mr. Leven is a 
director of Starwood Lodging Trust, the nation's largest hotel REIT. Mr. 
Leven is also a member of the Board of Governors of the American Red Cross, a 
Director of the Biomedical Services Board of the American Red Cross and a 
Trustee of National Realty Trust, the largest franchisee of Coldwell Banker 
Corporation, a subsidiary of HFS Incorporated. On September 27, 1991, 
approximately 16 months after Mr. Leven resigned from Days Inn, Days Inn 
filed a voluntary petition under Chapter 11 of Title 11 of the United States 
Bankruptcy Code. Mr. Leven is an uncle of Mr. Aronson. 

   Neal K. Aronson, Executive Vice President, Chief Financial Officer and 
Director. Mr. Aronson has been Executive Vice President and Chief Financial 
Officer of the Company since October 1995. Mr. Aronson was the founding 
partner of Growth Capital Partners in New York, New York, and was with the 
partnership from September 1994 to October 1995. From December 1993 to 
September 1994, he was Managing Director of Rosecliff, Inc., a private equity 
investment group in New York, New York. From January 1992 to December 1993, 
he was a principal of Odyssey Partners, L.P. in New York, New York. From June 
1989 to December 1991, Mr. Aronson was a principal of Acadia Partners, L.P. 
in New York, New York. Mr. Aronson is a nephew of Michael A. Leven. 

   David E. Shaw, Sr., Executive Vice President, Administration. Mr. Shaw has 
been Executive Vice President, Administration of the Company since October 
1995. From January 1991 to September 1995 he was Vice President of Operations 
Administration for Holiday Inn Worldwide in Atlanta, Georgia. From July 1990 
to January 1991, Mr. Shaw was Executive Vice President, Administration for 
Hospitality Franchise Systems, Inc. (now known as HFS Incorporated) in Wayne, 
New Jersey. 

   Steven Romaniello, Executive Vice President, Franchise Sales and 
Development. Mr. Romaniello has been Executive Vice President, Franchise 
Sales and Development of the Company since August 1996. From October 1995 
through July 1996, he served as Senior Vice President, Franchise Sales and 
Development of the Company. From March 1991 through September 1995, Mr. 
Romaniello was Vice President, Franchise Sales and Services for Holiday Inn 
Worldwide in Atlanta, Georgia. From December 1988 to March 1991 he was 
Regional Vice President, Franchise Sales for Days Inn of America, Inc. in 
Atlanta, Georgia and in Boston, Massachusetts. 

                                      36 
 

   Dean S. Adler, Director. Since 1988, Mr. Adler has been a principal and 
Managing Director of private equity investments for CMS Companies ("CMS"), a 
Philadelphia based investment firm that manages approximately $1.7 billion of 
assets. Mr. Adler is a member of the Board of Directors of the Lane Company, 
which specializes in the management and development of multifamily housing, 
Jacoby Development, Inc., which specializes in shopping center development, 
and RMS Technologies, a leading provider of information technology services 
to federal and other governmental institutions. 

   Irwin Chafetz, Director. Since 1990, Mr. Chafetz has been the President 
and a Director of Interface Group- Massachusetts, Inc., a privately held 
company that owns and operates GWV International, New England's largest tour 
operator. From 1990 until April 1995, Mr. Chafetz was a Vice President and 
Director of the Interface Group- Nevada, Inc., which owned and operated 
COMDEX, a computer trade show that is the largest American trade show. From 
1989 to 1995, Mr. Chafetz was also a Vice President and a director of Las 
Vegas Sands, Inc., which owned the Sands Hotel and Casino in Las Vegas and 
the adjacent Sands Expo and Convention Center. Mr. Chafetz is a member of the 
Board of Directors of Syratech Corporation, a New York Stock Exchange listed 
company, and of Back Bay Restaurants Group, Inc., a Nasdaq company. 

   Richard D. Goldstein, Director. Since 1990, Mr. Goldstein has been a 
Managing Director of Alpine Capital Group Inc., a specialized investment 
banking firm located in New York. Prior to joining Alpine, Mr. Goldstein was 
a partner at the law firm of Paul, Weiss, Rifkind, Wharton & Garrison. Mr. 
Goldstein serves as Trustee, member of the Executive Committee and Treasurer 
of the Queens College Foundation, Trustee of the North Shore Hospital System 
and a member of the Corporate Advisory Board of the State University of New 
York at Stony Brook. 

   Jeffrey A. Sonnenfeld, Director. Since 1989, Mr. Sonnenfeld has been a 
Professor of Organization and Management at the Goizueta Business School of 
Emory University in Atlanta, Georgia, where Mr. Sonnenfeld is currently the 
Director of the Center for Leadership & Career Studies. Mr. Sonnenfeld has 
published five books and numerous articles in the areas of career management, 
executive training and development, and the management of corporate social 
performance. Mr. Sonnenfeld serves on the Board of Directors of the American 
Association of Retired Persons, Moseley Securities Corporation, National 
Council on the Aging, Transmedia-CBS, Inc., and the Hyatt Executive Travel 
Council. 

   Barry S. Sternlicht, Director. Since 1993, Mr. Sternlicht has been the 
President and Chief Executive Officer of Starwood Capital Group, L.P. 
("Starwood Capital"), a real estate investment firm that he founded in 1993. 
From 1991 to 1993, Mr. Sternlicht was the President of Starwood Capital 
Partners, L.P., predecessor of Starwood Capital. Mr. Sternlicht is the 
Chairman of the Board of Starwood Lodging Trust, the nation's largest hotel 
REIT, in which Starwood Capital controls 30% of the stock. He is the 
co-Chairman of the Board of Westin Hotel & Resorts Company, which Starwood 
purchased in 1995 for $537 million. Mr. Sternlicht is also a trustee of 
Equity Residential Properties Trust, a multi-family REIT, and of Angeles 
Participating Mortgage Trust, which is also a REIT. 

Agreements Regarding Board Positions 

   Pursuant to the terms of a Stockholders' Agreement entered into in 
connection with the initial capitalization of the Company (the "Old 
Stockholders' Agreement"), the original investors in the Company (the 
"Original Investors"), which included Messrs. Leven and Aronson, agreed to 
cause the Board of Directors to consist of five members and to vote their 
shares of Old Common Stock to elect as a director the stockholder of the 
Company or his nominee (other than Messrs. Leven and Aronson) holding, 
together with his immediate family members, the largest number of shares of 
Old Common Stock. Irwin Chafetz, together with his two sons, has been the 
largest stockholder of the Company (other than Messrs. Leven and Aronson) 
since the initial capitalization of the Company and was elected to the Board 
pursuant to this provision. Pursuant to the Old Stockholders' Agreement, the 
Original Investors also agreed to vote their shares of Old Common Stock in 
favor of the election of Messrs. Leven and Aronson as directors of the 
Company and granted Mr. Leven the right to nominate persons to fill the 
remaining two board positions. Pursuant to this provision, Mr. Leven 
nominated Messrs. Goldstein and Sternlicht to serve as directors, who were 
then elected to serve as such by the Original Investors. The foregoing 
governance provisions were deleted as part of amendments to the Old 
Stockholders' Agreement that will become effective simultaneously with the 
completion of the Offering. See "Certain Relationships and Related 
Transactions--Transactions Entered into in Connection with the Offering-- 
Restated Stockholders' Agreement". 

                                      37 
 

Compensation of Directors 

   In 1995, directors of the Company were not paid any cash compensation for 
their services but were reimbursed for their out-of-pocket expenses. The 
Company recently adopted a stock option plan for its non-employee directors, 
the material terms of which are described in "--Stock Option Plans--Directors 
Plan" below, and authorized the payment of $5,000 annually to each director 
as compensation for services provided. Messrs. Leven and Aronson, as 
employees of the Company, are not eligible to participate in the Directors 
Plan (as defined below), and accordingly, will receive no compensation as 
directors other than $5,000 in annual compensation and reimbursement for 
out-of- pocket expenses incurred in connection with their service as 
directors. 

Executive Compensation 

   The following table sets forth information with respect to the 
compensation of Michael A. Leven, the Company's Chairman, President and Chief 
Executive Officer, and Neal K. Aronson, Executive Vice President and Chief 
Financial Officer of the Company. No other executive officers of the Company 
received salary and bonus in excess of $100,000 for the period from August 
28, 1995, the date of the Company's inception, through December 31, 1995. The 
Company anticipates that during 1996, its most highly compensated officers 
and their estimated salaries will be: Mr. Leven ($375,000), Mr. Aronson 
($200,000), Steven Romaniello ($100,000) and David Shaw, Sr. ($150,000). In 
addition to their respective base salaries, Messrs. Leven, Aronson and 
Romaniello will each receive a bonus based on the number of franchises sold 
during 1996. See "--Employment Agreements". The Company may also pay 
discretionary bonuses. 

                          Summary Compensation Table 


                                                                        Long Term Compensation 
                                                                   ---------------------------------- 
                                                                           Awards           Payouts 
                                          1995                     ----------------------- --------- 
                                  Annual Compensation 
                       ------------------------------------------ 
       Name and                                        Other       Restricted                               All 
       Principal                                      Annual          Stock      Options/    LTIP          Other 
       Position          Salary        Bonus       Compensation      Awards        SARs     Payouts    Compensation 
       ---------        --------     ---------     ------------    ----------    --------   -------    ------------
                                                                                      
Michael A. Leven 
   Chairman, President 
   and Chief Executive 
   Officer              $93,750     $ 153,000(1)(2)     $0             --           --        --            -- 

Neal K. Aronson 
   Executive Vice 
   President and Chief 
   Financial Officer    $50,000     $ 151,500(1)(2)     $0             --           --        --            -- 


- ------------- 

(1) Mr. Leven and Mr. Aronson each received a transaction bonus of $150,000 
    for their efforts in organizing the Company and successfully negotiating 
    and completing the Microtel Acquisition on behalf of the Company. 

(2) Mr. Leven and Mr. Aronson, pursuant to the terms of their respective 
    employment agreements with the Company, are each entitled to receive 
    bonuses based upon the number of franchises sold each year. See 
    "--Employment Agreements". During 1995, neither Mr. Leven nor Mr. Aronson 
    received a bonus for the three franchises sold during 1995, although the 
    Company accrued $3,000 and $1,500 for bonuses owed to Mr. Leven and Mr. 
    Aronson, respectively, with respect to such franchise agreements. 

Employment Agreements 

   The Company has entered into employment agreements with Messrs. Leven and 
Aronson, the material terms of which are described below. 

   Michael A. Leven. Mr. Leven's employment agreement with the Company 
provides for his employment as Chairman of the Board of Directors, President 
and Chief Executive Officer of the Company for a 10-year term expiring on 
September 30, 2005. Mr. Leven is entitled to a base salary of at least 
$375,000 per year, subject to annual cost of living increases and other 
annual increases determined by the Company based on the performance of Mr. 
Leven and the Company and on prevailing economic circumstances. 

   Certain insurance benefits, if available on commercially reasonable terms, 
are to be provided to Mr. Leven under his Employment Agreement, including 
term life insurance in the amount of $1,500,000, executive health, dental and 
medical insurance, long term disability and long term home care. The Company 
has obtained all of the foregoing benefits for Mr. Leven. In addition, Mr. 
Leven is entitled to a monthly automobile allowance in the amount of $1,000. 

                                      38 
 

   Mr. Leven's employment agreement provides for a performance bonus of (i) 
$1,000 for each franchise agreement executed in a given Year (defined as each 
12 month period commencing October 1st and ending on September 30th of each 
year during the term of such agreement) up to 150 franchise agreements and 
(ii) $2,000 for each franchise agreement above the first 150 franchise 
agreements entered into in a given Year. 

   Mr. Leven's employment agreement also contains confidentiality provisions 
that prohibit him from disclosing company trade secrets at any time in the 
future and from disclosing any confidential information relating to the 
Company for a period extending five years after the termination of his 
employment agreement. In addition, the agreement contains non-competition 
provisions that prohibit Mr. Leven from competing in the franchising business 
generally and in the business of franchising, operating or managing of hotels 
and motels for a period of five years following the termination of his 
employment for "cause" or his resignation without "good reason". The 
enforceability of these non-disclosure and non-competition provisions under 
Georgia law, which governs Mr. Leven's agreement, is uncertain. 

   In addition to allowing Mr. Leven to resign at any time for "good reason", 
his employment agreement provides that, after the first five years of such 
agreement and provided the Redeemable Preferred Stock has been redeemed, Mr. 
Leven may resign at any time upon six months notice. If his resignation is 
without "good reason", the Company is required to pay Mr. Leven only his base 
salary, unused vacation time, and performance bonus actually earned through 
the effective date of resignation. The employment agreement further provides 
that if Mr. Leven resigns without good reason during the first five years, he 
will not be liable for any consequential damages or damages for loss of 
economic opportunity or profits to the Company. If Mr. Leven resigns for 
"good reason", or if his employment is terminated "without cause", he is 
entitled to severance pay in accordance with the terms of his employment 
agreement. For the purpose of Mr. Leven's employment agreement, "good reason" 
includes, but is not limited to, the failure to elect and continue Mr. 
Leven's membership on the Board of Directors of the Company or his 
involuntary relocation outside of Atlanta, Georgia. In addition, pursuant to 
the Company's By-Laws, Mr. Leven's employment agreement may not be terminated 
without the approval of 75% of the Board of Directors (excluding Mr. Leven). 

   Neal K. Aronson. Mr. Aronson's employment agreement, pursuant to which he 
is to serve as Chief Financial Officer of the Company, is substantially 
similar to Mr. Leven's agreement, except that (i) his base salary is $200,000 
per year, (ii) the term life insurance benefit is $500,000, (iii) his 
automobile allowance is $750 per month, (iv) the bonus is $500 for each 
franchise agreement executed within a Year (as defined above) up to 150 
franchise agreements, and $1,000 for each agreement executed in any Year in 
excess of 150 and (v) Mr. Aronson is not entitled to receive long-term 
disability or long-term home care insurance coverage from the Company. 
Pursuant to the Company's By- Laws, Mr. Aronson's employment agreement may 
not be terminated without the approval of 75% of the Board of Directors 
(excluding Mr. Aronson). 

   See "Principal Stockholders--Management's Shares of Common Stock" as to 
the effect of termination of employment on the Class A Common Stock held by 
Messrs. Leven and Aronson. 

Stock Option Plans 

   1996 Stock Option Plan. On September 27, 1996, the Board of Directors of 
the Company (the "Board") adopted, subject to the approval of the Company's 
stockholders, the U.S. Franchise Systems, Inc. 1996 Stock Option Plan (the 
"Option Plan"). The Company's stockholders approved the Option Plan on 
October 11, 1996. The following is a summary of the material features of the 
Option Plan. 

   
   The purpose of the Option Plan is to promote the interests of the Company 
and its stockholders by (i) attracting and retaining exceptional officers and 
other key employees of the Company and its subsidiaries, and consultants, 
advisors and others whose skills would be an asset to the Company or any of 
its subsidiaries; (ii) motivating such individuals by means of 
performance-related incentives to achieve long-range performance goals and 
(iii) enabling such individuals to participate in the long-term growth and 
financial success of the Company. Any officer or other key employee of the 
Company or any of its subsidiaries who is not a member of the committee that 
administers the Option Plan (the "Option Committee") shall be eligible to 
participate under the Option Plan. 
    

   The Option Committee consists of two or more members of the Board 
designated by the Board to administer the Option Plan, each of whom is 
intended to be a "Non-Employee Director" (within the meaning of Rule 16b-3 
promulgated under the Securities Exchange Act of 1934, as amended (the 
"Exchange Act")) and an "outside director" 

                                      39 
 

(within the meaning of Internal Revenue Code (the "Code") section 162(m)) to 
the extent Rule 16b-3 and section 162(m), respectively, are applicable to the 
Company. 

   The Option Plan authorizes the grant of awards to participants of a 
maximum of 325,000 shares of the Company's Class A Common Stock ("Shares"), 
which maximum number is subject to adjustment in certain circumstances to 
prevent dilution or enlargement. Awards under the Option Plan may be made in 
the form of (i) nonqualified stock options and (ii) stock options intended to 
qualify as incentive stock options under section 422 of the Code; provided 
that the maximum number of Shares with respect to which stock options may be 
granted to any participant in the Option Plan in any calendar year may not 
exceed 250,000. If, after the effective date of the Option Plan, any Shares 
covered by an award granted under the Option Plan, or to which such an award 
relates, are forfeited, or if an award has expired, terminated or been 
canceled for any reason whatsoever (other than by reason of exercise), then 
the Shares covered by such award shall again be, or shall become, Shares with 
respect to which awards may be granted under the Option Plan. 

   Non-qualified and incentive stock options granted under the Option Plan 
shall be subject to such terms, including exercise price and timing of 
exercise, and conditions as may be determined by the Option Plan Committee 
and specified in the applicable award agreement or thereafter; provided that 
stock options that are intended to qualify as incentive stock options will be 
subject to terms and conditions that comply with such rules as may be 
prescribed by section 422 of the Code. Payment in respect of the exercise of 
an option granted under the Option Plan may be made in cash, or its 
equivalent, or if, and to the extent permitted by the Option Plan Committee, 
(i) by exchanging Shares owned by the optionee (which are not the subject of 
any pledge or other security interest and which have been owned by such 
optionee for at least six months) or (ii) subject to such rules as may be 
established by the Committee, through delivery of irrevocable instructions to 
a broker to sell the Shares being acquired upon exercise of the option and to 
deliver promptly to the Company an amount equal to the aggregate exercise 
price, or by a combination of the foregoing. 

   The Board may amend, alter, suspend, discontinue or terminate the Option 
Plan or any portion thereof at any time; provided that no such amendment, 
alteration, suspension, discontinuation or termination shall be made without 
stockholder approval if such approval is necessary to comply with any tax or 
regulatory requirement, including for these purposes any approval requirement 
which is a prerequisite for exemptive relief from section 16(b) of the 
Exchange Act or Code section 162(m) (provided that the Company is subject to 
the requirements of section 16 of the Exchange Act or Code section 162(m), as 
the case may be, as of the date of such action). 

   Directors Plan. On September 27, 1996, the Board of Directors adopted, 
subject to the approval of the Company's stockholders, the U.S. Franchise 
Systems, Inc. 1996 Stock Option Plan for Non-Employee Directors (the 
"Directors Plan"). The Directors Plan was approved by the Company's 
stockholders on October 11, 1996. 

   The purpose of the Directors Plan is to secure for the Company the 
benefits of the additional incentive inherent in the ownership of Shares by 
non-employee directors of the Company and to help the Company secure and 
retain the services of such non-employee directors. The Directors Plan is 
intended to be a self-governing formula plan. To this end, the Directors Plan 
requires minimal discretionary action by any administrative body with regard 
to any transaction under the Directors Plan. To the extent, if any, that 
questions of administration arise, such issues will be resolved by the Board 
of Directors. Eligible persons under the Directors Plan are directors of the 
Company who are not employees of the Company or any affiliate of the Company 
("Outside Directors"). 

   A maximum of 125,000 Shares has been reserved by the Company for issuance 
pursuant to options under the Directors Plan, which number is subject to 
adjustment in certain circumstances in order to prevent dilution or 
enlargement. If, after the effective date of the Directors Plan, any Shares 
covered by an award granted under the Directors Plan, or to which such an 
award relates, are forfeited, or if an award has expired, terminated or been 
canceled for any reason whatsoever (other than by reason of exercise), then 
the Shares covered by such award shall again be, or shall become, Shares with 
respect to which awards may be granted under the Directors Plan. 

   As of the effective date of the Offering, each Outside Director will be 
granted an option to purchase 2,000 shares of Class A Common Stock. 
Thereafter, each person who is an Outside Director as of January 1st of each 
calendar year during the term of the Directors Plan shall receive an option 
to purchase 2,000 shares of Class A Common Stock as of such date. All options 
granted under the Directors Plan shall be "nonqualified" stock options 
subject to the provisions of section 83 of the Code. 

                                      40 
 

   Options shall become exercisable on the first anniversary of the date of 
grant provided that the optionee shall continue to serve as a director of the 
Company on such date, and shall terminate on the earliest of the following: 
(i) the expiration of ten years from the date of grant, (ii) the expiration 
of one year from the termination of the optionee's service as an Outside 
Director due to death or disability, (iii) the date the optionee's service as 
an Outside Director terminates for cause (as defined in the Directors Plan) 
and (iv) the expiration of three months from the date the optionee's service 
as an Outside Director terminates other than by reason of death, disability 
or cause. 

   The exercise price per share of Class A Common Stock purchasable under 
each option granted upon the consummation of the Offering shall be the 
initial public offering price per share, and the exercise price per share of 
Class A Common Stock purchasable under all other options granted under the 
Directors Plan shall be the Fair Market Value (as defined in the Directors 
Plan) of a share of Class A Common Stock on the date the option is granted. 
Shares of Class A Common Stock purchased upon the exercise of an option are 
to be paid for in cash, check or money order or by shares of Class A Common 
Stock owned by the optionee for at least six months prior to exercise. 

   The Directors Plan may be terminated or amended at any time by the Board 
of Directors; provided that (i) such amendment complies with all applicable 
laws and applicable stock exchange listing requirements, (ii) the provisions 
of the Directors Plan with respect to eligibility for participation or the 
timing or amount of grants of awards and the option price shall not be 
amended more than once every six months (other than to comport with changes 
in the Code or the Employee Retirement Income Security Act of 1974, as 
amended) and (iii) any amendment for which stockholder approval is necessary 
to comply with any tax or regulatory requirement, including for these 
purposes any approval requirement which is a prerequisite for exemptive 
relief from section 16(b) of the Exchange Act (provided that the Company is 
subject to the requirements of such section as of the date of such action), 
shall not be effective until such approval has been obtained. 

                                      41 
 

                CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 

Transactions Entered into in Connection with the Offering 

   Reclassification. In connection with the Offering, the Company intends to 
effect the Reclassification. Pursuant to the Reclassification, each share of 
Old Common Stock will be converted into 9.67 shares of Class A Common Stock. 
Also in connection with the Offering, pursuant to the 1996 Amendment (see 
"Principal Stockholders-- Management's Shares of Common Stock"), Mr. Leven, 
his wife, Andrea Leven, and Mr. Aronson will exchange 2,707,919 shares of 
Class A Common Stock held directly by them (which shares do not include those 
shares of Class A Common Stock that will continue to be held as Restricted 
Shares (as defined herein) pursuant to the 1996 Amendment) for the same 
number of shares of Class B Common Stock. See "Description of Capital 
Stock--Common Stock" for a description of the relative rights of holders of 
Class A Common Stock and Class B Common Stock. 

   Voting. Simultaneously with the completion of the Offering, Mr. Leven will 
enter into a voting agreement with his wife, Andrea, pursuant to which she 
will grant him the right to vote all of the 233,032 shares of Class A Common 
Stock and all of the 770,801 shares of Class B Common Stock to be owned by 
her following the Offering. At the same time, Mr. Leven will enter into a 
voting agreement with Mr. Aronson, pursuant to which Mr. Aronson will grant 
Mr. Leven the right to vote 111,347 shares of his Class A Common Stock and 
311,007 shares of his Class B Common Stock. Mr. Aronson will continue to vote 
the remaining 1,198,466 shares of his Class B Common Stock. As a result of 
these agreements, Mr. Leven will vote a total of 942,440 shares of Class A 
Common Stock and 1,509,453 shares of Class B Common Stock, which shares 
together represent approximately 43.4% of the total outstanding voting power 
of the Company immediately following the Offering. 

   Immediately following the Offering, Messrs. Leven and Aronson will have 
the right to vote a total of 1,773,533 shares of Class A Common Stock and 
2,707,919 shares of Class B Common Stock, which will represent approximately 
78% of the outstanding voting power of the Common Stock after the Offering. 
Accordingly, Messrs. Leven and Aronson will be able to (i) elect all of the 
Company's directors, (ii) amend the Charter with respect to most matters, 
(iii) effect a merger, sale of assets or other major corporate transaction, 
(iv) defeat an unsolicited takeover attempt and (v) generally direct the 
affairs of the Company. However, Mr. Leven and Mr. Aronson do not have any 
agreements or other obligations to vote together on matters involving the 
Company. See "Risk Factors-- Management, By Virtue of Ownership of 
Supervoting Class B Common Stock, Will Control the Company Following the 
Offering" and "Principal Stockholders--Management's Shares of Common Stock". 

   Restated Stockholders' Agreement. Effective simultaneously with the 
closing of the Offering, the Company will amend and restate the Old 
Stockholders' Agreement that was entered into with the Original Investors in 
connection with the initial capitalization of the Company (the "Restated 
Stockholders' Agreement"). The purpose of the amendment is to remove certain 
voting and corporate governance provisions that were determined to be more 
suitable for a private company, including provisions (i) restricting the 
transfer of shares of Old Common Stock, (ii) authorizing each of the Original 
Investors to cause the Company's remaining stockholders to sell their 
interests in the Company in certain circumstances, (iii) fixing the size of 
the Board of Directors at five, (iv) pursuant to which the Original Investors 
agreed to vote for Messrs. Leven and Aronson and the Original Investor (other 
than Messrs. Leven and Aronson) owning the most shares of Old Common Stock 
(or his nominee) as directors of the Company, (v) that generally prohibited 
Messrs. Leven and Aronson from transferring their shares of Old Common Stock 
for a three-year period ending in September 1998 and (vi) granting the 
Original Investors preemptive rights in certain circumstances. The Restated 
Stockholders' Agreement continues only to grant the Original Investors 
certain piggy-back registration rights, although such rights are not 
exercisable until 20% of the Company's outstanding Common Stock has been 
registered under the Securities Act, and the right to cause the Company to 
file a registration statement under the Securities Act on one occasion, 
commencing September 29, 2000. See "Shares Eligible for Future Sale" and 
"Description of Capital Stock--Registration Rights". 

   1996 Amendment. See "Principal Stockholders--Management's Shares of Common 
Stock--1996 Amendment" for a description of amendments to Messrs. Leven's and 
Aronson's Old Stock Purchase Agreements and those of certain other executive 
officers of the Company. 

                                      42 
 

Miscellaneous 

   In consideration for their efforts in organizing the Company and 
negotiating and consummating the Microtel Acquisition, Messrs. Leven and 
Aronson each received a bonus of $150,000 from the Company. 

   The Company has obtained $15 million of key man life insurance on the life 
of Mr. Leven. 

   Howard and Lawrence Chafetz, sons of Irwin Chafetz, a director of the 
Company, have established a limited liability company to acquire and operate 
Microtels. To date, the limited liability company has not acquired any 
Microtel franchises or entered into any agreements with the Company regarding 
the same. 

   The Company expects to invest from time to time in entities that make 
investments in Microtel and Hawthorn Suites franchisees with a successful 
track record of multi-unit development. The Company will receive management 
fees and other fees based on the total investments made by these entities. To 
date, no investments have been made by these entities. 

                                      43 
 

                            PRINCIPAL STOCKHOLDERS 

   The following table sets forth (i) as of October 1, 1996 and (ii) as 
adjusted for the Reclassification and the 1996 Amendment and for the sale by 
the Company of the shares of Class A Common Stock pursuant to the Offering, 
certain information regarding the beneficial ownership of the Class A Common 
Stock and the Class B Common Stock by each person known by the Company to be 
the beneficial owner of 5% or more of the outstanding Class A Common Stock or 
Class B Common Stock, by each of the Company's directors and by all directors 
and executive officers of the Company as a group. Unless otherwise indicated, 
the persons listed below have sole investment and sole voting power with 
respect to the shares of Class A Common Stock and Class B Common Stock listed 
across from their names in the table below. See "--Management's Shares of 
Common Stock" for a discussion of restrictions on certain shares of Class A 
Common Stock held by Mr. Leven and Mr. Aronson. 



                              Beneficial Ownership 
                                      Prior 
                               to the Offering and            Beneficial Ownership Subsequent 
                              the Reclassification                    to the Offering 
                              ---------------------    ------------------------------------------------ 
                               Shares of                Shares          Shares                   Total 
Name and Address of              Common                   of              of          Total     Voting 
Beneficial Owner                 Stock         %        Class A        Class B       Equity**    Power 
- -------------------           -----------  -------     ---------      ---------     ----------  ------- 
                                                                                  (Class A and Class B) 
                                                                               
Michael A. Leven 
13 Corporate Square 
Suite 250 
Atlanta, Georgia 30329          185,031 (1)  16.6%       942,440 (2)  1,509,453 (3)    19.5%     43.4% 

Neal K. Aronson 
13 Corporate Square 
Suite 250 
Atlanta, Georgia 30329          233,223 (4)  21.0%       942,440 (5)  1,509,453 (6)    19.5%     34.7% 

Dean Adler 
CMS Companies 
1926 Arch Street 
Philadelphia, PA 19103                0         *              0              0           *         * 

Irwin Chafetz (7) 
c/o The Interface Group 
300 First Avenue 
Needham, MA 02194                30,000       2.7%       290,100              0           *         * 

Richard D. Goldstein (8) 
c/o Alpine Microtel LLC 
1285 Avenue of the 
Americas 
New York, NY 10019               16,500       1.5%       159,555              0           *         * 

Andrea Leven 
c/o U.S. Franchise Systems, 
Inc. 
13 Corporate Square 
Suite 250 
Atlanta, Georgia 30329          103,809 (9)   9.3%       233,032(10)    770,801(11)     8.0%        * 

Jeffrey A. Sonnenfeld 
1602 Mizell Drive 
Room 310 
Atlanta, Georgia 30322                0         *              0              0           *         * 

Barry Sternlicht (12) 
c/o Starwood Capital Group 
3 Pickwick Plaza 
Greenwich, CT 06830              31,000       2.8%       299,770              0           *         * 

All officers and 
directors as a group 
(9 persons)**                   526,340      47.3%     2,818,725      2,707,919        43.9%     80.9% 


- ------------- 

*  Represents less than 1% of the outstanding Common Stock, both in number 
   and in terms of voting power. 

** Duplications eliminated. 

                                      44 
 

(1)  Consists of (i) 31,422 shares held directly by Mr. Leven as Unrestricted
     Shares under his Old Stock Purchase Agreement, over which Mr. Leven has
     sole voting and investment power, (ii) 55,612 shares held by Mr. Leven's
     wife as Unrestricted Shares, (iii) 24,192 shares that were designated as
     Unrestricted Shares under the Old Stock Purchase Agreement, which have
     been reallocated to other members of management and are voted by them in
     the same manner that Mr. Leven votes his Unrestricted Shares, (iv) 25,608
     shares that were designated as Restricted Shares under Mr. Leven's Old
     Stock Purchase Agreement, which are voted by Mr. Leven in the same
     proportion as the Original Investors (other than Messrs. Leven and
     Aronson) vote their shares and (v) 48,197 shares that were designated as
     Restricted Shares under Mr. Leven's Old Stock Purchase Agreement, which
     were given by Mr. Leven to his wife and are voted in the same proportion
     as the Original Investors (other than Messrs. Leven and Aronson) vote
     their shares. Mr. Leven disclaims beneficial ownership of the shares
     owned by his wife. The number shown in the table does not include 103,806
     shares that have been transferred by Mr. Leven to his adult sons.

(2)  Consists of (i) 123,815 shares held directly by Mr. Leven, which will
     continue as Restricted Shares following the 1996 Amendment and as to
     which Mr. Leven has sole voting power, (ii) 233,032 Restricted Shares
     held by Mr. Leven's wife, which are voted by Mr. Leven, (iii) 365,012
     Unrestricted Shares, which have been reallocated to other members of
     management and are voted in the same manner that Mr. Leven votes his
     shares, (iv) 109,234 shares that were designated as Restricted Shares
     pursuant to Mr. Leven's Old Stock Purchase Agreement, which have been
     reallocated to other members of management and by virtue of the 1996
     Amendment are voted in the same manner that Mr. Leven votes his
     Unrestricted Shares, and (v) 111,347 Restricted Shares owned by Mr.
     Aronson, which are voted by Mr. Leven.

(3)  Consists of (i) 427,665 Unrestricted Shares, as to which Mr. Leven has
     sole voting power, (ii) 770,801 shares held by Mr. Leven's wife as
     Unrestricted Shares, which are voted by Mr. Leven, and (iii) 311,007
     Unrestricted Shares owned by Mr. Aronson, which are voted by Mr. Leven.

(4)  Consists of (i) 95,097 shares held directly by Mr. Aronson as
     Unrestricted Shares under his Old Stock Purchase Agreement, over which
     Mr. Aronson has sole voting and investment power, (ii) 16,127 shares that
     were designated as Unrestricted Shares under the Old Stock Purchase
     Agreements, which have been reallocated to other members of management
     and are voted by them in the same manner that Mr. Aronson votes his
     Unrestricted Shares and (iii) 121,999 shares that were designated as
     Restricted Shares under Mr. Aronson's Old Stock Purchase Agreement, which
     are voted by Mr. Aronson in the same proportion as the Original Investors
     (other than Messrs. Leven and Aronson) vote their shares.

(5)  Consists of (i) 589,865 shares held directly by Mr. Aronson, which will
     continue as Restricted Shares following the 1996 Amendment and as to
     which Mr. Aronson has sole voting power, (ii) 109,234 shares that were
     designated as Restricted Shares pursuant to Mr. Aronson's Old Stock
     Purchase Agreement, which have been reallocated to other members of
     management and by virtue of the 1996 Amendment are voted by them in the
     same manner that Mr. Aronson votes his shares and (iii) 243,341 shares
     that were designated as Unrestricted Shares under the Old Stock Purchase
     Agreements, which have been reallocated to other members of management
     and are voted by them in the same manner that Mr. Aronson votes his
     shares. Mr. Aronson has transferred voting power to Mr. Leven with
     respect to 111,347 of such shares.

(6)  Consists of 1,509,453 shares designated as Unrestricted Shares, of which
     Mr. Aronson has sole voting power as to 1,198,466 shares and has
     transferred voting power to Mr. Leven as to 311,007 shares.

(7)  Prior to the 1996 Amendment, Mr. Chafetz, by virtue of provisions in the
     Old Stock Purchase Agreements that required Messrs. Aronson and Leven to
     vote their Restricted Shares in the same manner and the same proportion
     as the Original Investors (other than Messrs. Leven and Aronson),
     effectively had the right to vote a portion of such Restricted Shares.
     These provisions were eliminated in the 1996 Amendment.

(8)  Such shares are owned by G(2) Investment Partners, an investment
     partnership of which Mr. Goldstein is a general partner. Mr. Goldstein
     shares voting and investment power with respect to such shares. Prior to
     the 1996 Amendment, G(2) Investment Partners, by virtue of provisions in
     the Old Stock Purchase Agreements that required Messrs. Aronson and Leven
     to vote their Restricted Shares in the same manner and the same
     proportion as the Original Investors (other than Messrs. Leven and
     Aronson), effectively had the right to vote a portion of such Restricted
     Shares. These provisions were eliminated in the 1996 Amendment.

(9)  Consists of (i) 55,612 Unrestricted Shares of Old Common Stock received
     from Mr. Leven and (ii) 48,197 Restricted Shares of Old Common Stock
     received from Mr. Leven.

                                      45 
 

(10) Represents shares that were designated under Mr. Leven's Old Stock
     Purchase Agreement as Restricted Shares, which will continue as the same
     following the 1996 Amendment and which have been transferred to Mrs.
     Leven. Pursuant to a voting agreement to be entered into simultaneously
     with the closing of the Offering, Mrs. Leven has transferred voting power
     with respect to these shares to Mr. Leven.

(11) Represents shares of Class B Common Stock that were originally designated
     as Unrestricted Shares under Mr. Leven's Old Stock Purchase Agreement,
     which were subsequently transferred to Mrs. Leven and which, pursuant to
     a voting agreement to be entered into simultaneously with the closing of
     the Offering, are voted by Mr. Leven.

(12) Such shares are owned by Starwood Opportunity Fund II, L.P., a Delaware
     limited partnership whose general partner is Starwood Capital, which is
     indirectly controlled by Mr. Sternlicht. Prior to the 1996 Amendment, the
     holder of such shares, by virtue of provisions in the Old Stock Purchase
     Agreements that required Messrs. Aronson and Leven to vote their
     Restricted Shares in the same manner and the same proportion as the
     Original Investors (other than Messrs. Leven and Aronson), effectively
     had the right to vote a portion of such Restricted Shares. These
     provisions were eliminated in the 1996 Amendment.

   Personal Holding Company Tax. Under section 541 of the Code, a personal 
holding company is subject to a 39.6% tax on its undistributed personal 
holding company income (the "PHC Tax"). In order to be considered a personal 
holding company in any taxable year, a corporation must satisfy two tests. 
First, at any time during the last half of the taxable year more than 50% in 
value of its outstanding stock must be owned, directly or indirectly, by or 
for not more than five individuals (the "Stock Ownership Test"). Second, at 
least 60% of its adjusted ordinary gross income for the taxable year must be 
personal holding company income, which generally consists of passive forms of 
income such as dividends, interest, rents and royalties, as defined for tax 
purposes, but generally does not include income from the provision of 
services (the "Income Test"). Certain attribution rules that are included as 
part of the Stock Ownership Test could be interpreted in such a manner as to 
result in the Stock Ownership Test being satisfied in the case of the 
Company. While there can be no assurance that the Company will not satisfy 
both the Stock Ownership Test and the Income Test, the Company believes that 
the nature of its activities and its expected sources of income will be such 
that the PHC Tax will not apply. 

Management's Shares of Common Stock 

   
   Background. On October 5, 1995, simultaneously with the closing of the 
Microtel Acquisition, Messrs. Leven and Aronson purchased 5,485,259 shares or 
51% of the then outstanding Class A Common Stock for an aggregate purchase 
price of $567,245 or $.1034 per share (the Original Issue Price). Twenty-five 
percent (25%) of the then outstanding Class A Common Stock was acquired by 
Messrs. Leven and Aronson outright (i.e., without restriction on their 
ability to vote or receive dividends with respect to such shares and free of 
any risk of forfeiture), although a limited number of such shares could be 
repurchased from Messrs. Leven and Aronson and reissued to other employees 
under certain circumstances described below (the "Unrestricted Shares"). 
Immediately following such acquisition, Mr. Leven owned 15% and Mr. Aronson 
owned 10% of the then outstanding Class A Common Stock in the form of 
Unrestricted Shares. 
    
   
   The remaining shares of Class A Common Stock acquired by Messrs. Leven and 
Aronson, representing 26% of the then outstanding Class A Common Stock, were 
subject to significant restrictions with respect to voting and dividend 
rights and substantial risks of forfeiture (the "Restricted Shares"), as 
described below. Mr. Leven and Mr. Aronson each acquired 13% of the then 
outstanding Class A Common Stock in the form of Restricted Shares. Messrs. 
Leven and Aronson elected to be taxed on such shares pursuant to section 
83(b) of the Code and therefore the Company will not be entitled to a 
deduction if the fair market value of such shares at the time the 
restrictions or the risks of forfeiture lapse is greater than the Original 
Issue Price. 
    
   
   On August 23, 1996, the Board of Directors voted to amend the respective 
Employee Stock Purchase Agreements pursuant to which Messrs. Leven and 
Aronson purchased the Class A Common Stock (the "Old Stock Purchase 
Agreements") to eliminate the restrictions with respect to one-half of the 
Restricted Shares, so that an additional 13% of the pre-Offering outstanding 
Class A Common Stock will become Unrestricted Shares, effective as of the 
completion of the Offering (the "1996 Amendment"). See "--1996 Amendment" 
below for a description of the amendment. 
    

   
   Resale of Shares to Other Management. The Old Stock Purchase Agreements 
provide that Unrestricted Shares representing 5% of the Class A Common Stock 
then outstanding and Restricted Shares representing 6% 
    

                                      46 
 

   
of the Class A Common Stock then outstanding could be repurchased by the 
Company from Messrs. Leven and Aronson at $.1034 per share and then reissued 
to other members of the Company's management at fair market value. Such 
agreements further provide for the appointment of a Compensation Committee 
(which has subsequently been renamed the Stock Allocation Committee) to 
determine the timing and the number of shares to be repurchased from Messrs. 
Leven and Aronson and reissued to other members of the Company's management. 
The Stock Allocation Committee, which will continue in effect following the 
Offering, currently consists of Messrs. Leven, Aronson and Chafetz. By virtue 
of the 1996 Amendment, no other shares will be repurchased for resale to 
other management. 
    

   
   To date, a total of approximately 7.7% of the pre-Offering outstanding 
Class A Common Stock (approximately 3.6% from the Unrestricted Shares and 
approximately 4.1% from the Restricted Shares) has been repurchased from 
Messrs. Leven and Aronson and reissued to other members of management. 
Specifically, on February 7, 1996 (the "February Transaction"), Messrs. Leven 
and Aronson sold a total of 826,833 shares of Class A Common Stock to the 
Company for $85,505 or $.1034 per share. The Company in turn immediately 
reissued these 826,833 shares to other members of the Company's management at 
the same price of $.1034 per share. In April 1996 (the "April Transaction"), 
the Company redeemed 322,669 shares of Class A Common Stock from certain 
members of management for $.1034 per share. The Company subsequently reissued 
these 322,669 shares to members of the Company's management at the price of 
$.1137 per share. The April Transaction occurred at $.1137 per share instead 
of $.1034 per share due to the increase in the value of the Company from 
February 7, 1996 to April 1996 resulting from the beginning of the Company's 
franchise sales activities and the execution of the Hawthorn Acquisition 
Agreement. By virtue of the 1996 Amendment, members of management who 
acquired these shares are required to vote those shares that are Restricted 
Shares, on a one vote per share basis, one-half in the same manner as Mr. 
Leven votes his shares and one-half as Mr. Aronson votes his shares (prior to 
the 1996 Amendment, such management members were required to vote those 
shares that were Restricted Shares in the same manner and the same 
proportions as the Original Investors in the Company (other than Messrs. 
Leven and Aronson) voted their shares of Class A Common Stock). With respect 
to those shares that are Unrestricted Shares, the management holders continue 
to be required to vote 60% of such shares in the manner that Mr. Leven votes 
his shares and 40% in the manner that Mr. Aronson votes his shares. The 
Company's right to cause the redemption and reissuance of the remaining 
shares (approximately 3.3% of the pre-Offering Class A Common Stock) was 
eliminated by the 1996 Amendment. All shares which have been repurchased from 
Messrs. Leven and Aronson and reissued to other members of management 
pursuant to the Old Stock Purchase Agreements are subject to a vesting 
schedule, which provides that Unrestricted Shares vest over a five year 
period and Restricted Shares vest over a 10 year period, in each case 
provided that the management employee remains employed by the Company (and 
with Restricted Shares subject to further vesting requirements based on the 
Company's performance). Any unvested shares that are forfeited upon the 
termination of such employment are to be repurchased by the Company and 
resold to Mr. Leven or Mr. Aronson, as the case may be (depending on who 
owned the shares originally), at the Original Issue Price. In the event any 
of such shares are forfeited and reissued to Messrs. Leven or Aronson at the 
Original Issue Price, the Company will recognize compensation expense for the 
difference between the Original Issue Price and the market value of the stock 
on the date such shares are reoffered to Messrs. Leven and Aronson. Upon such 
resale, the shares will continue as Unrestricted Shares or Restricted Shares 
in the same manner as had they not been so forfeited. 
    

   
   Unrestricted Shares. Following the 1996 Amendment, there will be no 
restrictions on the Unrestricted Shares and such shares may not be 
repurchased from Messrs. Leven and Aronson and reissued to other members of 
management. 
    

   Restricted Shares. The Old Stock Purchase Agreements imposed, and the Old 
Stock Purchase Agreements as amended by the 1996 Amendment (the "Amended 
Stock Purchase Agreements") will impose, substantial risks of forfeiture on 
Restricted Shares. Prior to the 1996 Amendment, the Old Stock Purchase 
Agreements provided that, until such shares became "Earned Shares", there 
were substantial limitations on the holders' right to vote and to receive 
dividends with respect to such shares. For example, Messrs. Leven and Aronson 
and their permitted transferees were required to vote their Restricted Shares 
(other than those that become Earned Shares) in the same manner and the same 
proportions as the Original Investors (excluding Messrs. Leven and Aronson) 
voted their shares, and were generally not entitled to receive dividends with 
respect to Restricted Shares. Such limitations will be removed by the 1996 
Amendment, so that Messrs. Leven and Aronson will be entitled to vote all 
Restricted Shares (on a one vote per share basis), including Restricted 
Shares which have been reallocated to other members of management as provided 
above, prior to such shares being "earned" by the holders thereof, and to 
receive dividends thereon. See "--1996 Amendment". 

                                      47 
 

   
   Under both the Old Stock Purchase Agreements and the Amended Stock 
Purchase Agreements, Restricted Shares become Earned Shares upon the 
Company's attaining certain performance criteria. However, notwithstanding 
that they have been "earned", Earned Shares (other than the 13% of the 
pre-Offering outstanding Class A Common Stock that is deemed to have been 
earned by virtue of the 1996 Amendment) will be forfeited if the management 
holder of such shares (including either of Messrs. Leven or Aronson) resigns 
from his or her employment with the Company without "good reason" or is 
terminated for "cause" prior to the tenth anniversary of the date such shares 
were acquired by the holder thereof from the Company ("Termination 
Forfeiture"). See "--1996 Amendment". 
    

   The performance criteria that had to be achieved under the Old Stock 
Purchase Agreements in order for Restricted Shares to become Earned Shares 
were as follows: 

    (1) 1/26 of the Restricted Shares would become Earned Shares for every 
        $1,000,000 of annual "Adjusted EBITDA" of the Company (defined as 
        earnings before interest, taxes, depreciation, amortization and other 
        non-cash charges, adjusted to exclude one-time or non-recurring 
        expenses or credits), although no Restricted Shares would become 
        Earned Shares until Adjusted EBITDA for a fiscal year reached or 
        exceeded $3,000,000. 

    (2) The amount of Restricted Shares that could become Earned Shares was 
        based on the highest annual Adjusted EBITDA at any time and from time 
        to time. In all calculations, increments less than $1,000,000 were 
        ignored. For example, if Adjusted EBITDA in a fiscal year was 
        $3,000,000 to $3,999,999.99, then 3/26 of the Restricted Shares would 
        become Earned Shares; if, thereafter, Adjusted EBITDA for a fiscal 
        year was $10,100,000, then 10/26 (i.e., an additional 7/26) would 
        become Earned Shares. Accordingly, all of the Restricted Shares would 
        become Earned Shares only at such time as the Company had Adjusted 
        EBITDA of $26,000,000 or more in a fiscal year. 

    (3) Once Restricted Shares become Earned Shares, such shares are not 
        affected by a decline in annual Adjusted EBITDA in subsequent fiscal 
        years. However, once Adjusted EBITDA of $3,000,000 or more had been 
        attained, if the annual Adjusted EBITDA declined in a subsequent 
        fiscal year from the highest level at which Restricted Shares had 
        become Earned Shares, additional Restricted Shares would not become 
        Earned Shares until the average annual Adjusted EBITDA for the fiscal 
        years including and following the year of such decline in annual 
        Adjusted EBITDA was greater than the level of annual Adjusted EBITDA 
        at which Restricted Shares were last earned. 

   
   As of the date hereof, except pursuant to the 1996 Amendment, as described 
below, no Restricted Shares had become Earned Shares. Pursuant to the 1996 
Amendment, one-half (i.e., 13/26) of the Restricted Shares will be deemed to 
be Unrestricted Shares and will no longer be subject to the risk of 
Termination Forfeiture. 
    

   Under both the Old Stock Purchase Agreements and the Amended Stock 
Purchase Agreements, Earned Shares (other than the 13% referred to above that 
were deemed to have been earned by virtue of the 1996 Amendment) will be 
permanently vested (i.e., they will no longer be subject to Termination 
Forfeiture) on September 29, 2005. Any Restricted Shares that have not become 
Earned Shares by September 29, 2005 will be redeemed by the Company at the 
Original Issue Price and offered to the Original Investors (other than 
Messrs. Leven and Aronson) pro rata at the Original Issue Price based on 
their original holdings of Old Common Stock. 

   Under both the Old Stock Purchase Agreements and the Amended Stock 
Purchase Agreements, in the event that all or substantially all of the 
Company's stock or all or substantially all assets are transferred or sold, 
or upon a merger or other business combination, Earned Shares automatically 
become Unrestricted Shares. In addition, under both the Old Stock Purchase 
Agreements and the Amended Stock Purchase Agreements, any remaining 
Restricted Shares will automatically become Unrestricted Shares to the extent 
that value for the entire Company indicated by the gross sale price in such 
transaction results in an internal rate of return to the Original Investors 
of at least 40% on a compounded annual basis (after taking into account the 
amount and timing of all distributions and payments received by such Original 
Investors from the Company, after considering Unrestricted and Earned Shares 
then held by Messrs. Leven and Aronson, and after giving effect to Restricted 
Shares that become Unrestricted Shares as a result of such transaction). 

                                      48 
 

   
   1996 Amendment. The Company and Messrs. Leven and Aronson have agreed to 
amend their respective Old Stock Purchase Agreements, effective upon the 
completion of the Offering. The 1996 Amendment provides that (i) one-half of 
their Restricted Shares (representing approximately 11% of the Class A Common 
Stock outstanding before the Offering) will be deemed to be Unrestricted 
Shares, notwithstanding the fact that performance criteria relating to 
Adjusted EBITDA have not been met, (ii) their remaining Restricted Shares 
(which constitute, in the aggregate, approximately 9% of the Class A Common 
Stock outstanding before the Offering) will become Earned Shares at the rate 
of 1/13 of all of the remaining number of Restricted Shares (including the 
approximately 4% held by other members of management) for every $1,000,000 of 
annual Adjusted EBITDA, but only after Adjusted EBITDA for a fiscal year 
equals or exceeds $14,000,000, (iii) the Unrestricted Shares referred to in 
clause (i) above, will be vested and not subject to Termination Forfeiture, 
(iv) the Unrestricted Shares held by Messrs. Leven and Aronson and by Mr. 
Leven's wife, including the Unrestricted Shares referred to in clause (i) 
above, will be shares of Class B Common Stock (with ten votes per share), (v) 
the remaining Restricted Shares held by Messrs. Leven and Aronson will be 
Class A Common Stock (with one vote per share), including if and when such 
shares become Earned Shares, and will continue to be subject to Termination 
Forfeiture, (vi) Messrs. Leven and Aronson will have the right to vote their 
Restricted Shares and to receive dividends, if any, declared thereon before 
they become Earned Shares, (vii) no additional shares will be repurchased 
from Messrs. Leven and Aronson and reissued to other members of management 
and (viii) in calculating Adjusted EBITDA for any given year, there generally 
shall be subtracted 10% of the consideration paid by the Company in 
connection with any future acquisitions by the Company and/or its 
subsidiaries of another corporation or other entity.As part of the 1996 
Amendment, one-half of the Restricted Shares previously allocated to other 
members of management will also be deemed to be Unrestricted Shares. Such 
shares, representing approximately 2% of the Class A Common Stock outstanding 
before the Offering, will be voted by the management holders thereof 60% in 
the same manner that Mr. Leven votes his shares, and 40% in the same manner 
that Mr. Aronson votes his shares. As to any Restricted Shares still held by 
such management holders, 50% of such shares will be voted by the management 
holders thereof in the same manner that Mr. Leven votes his shares and 50% 
will be voted in the same manner Mr. Aronson votes his shares. 
    

   Current Ownership. The following table sets forth, as of August 1, 1996, 
the ownership of the Unrestricted Shares and Restricted Shares, as a 
percentage of the then outstanding Common Stock prior to the Offering, and 
adjusted to take into account the 1996 Amendment. 



                                Prior to the              As Adjusted for the 
                               1996 Amendment                1996 Amendment 
                       ----------------------------- ----------------------------- 
                         Unrestricted    Restricted    Unrestricted    Restricted     Total 
                       --------------- ------------- --------------- ------------- ---------- 
                                                                      
Michael A. Leven (1)        12.825%        10.969%        18.310%         5.480%     23.794% 
Neal K. Aronson              8.550         10.969         14.030          5.480      19.518 
Other Members of 
Management (2)               3.625          4.062          5.660          2.040       7.688 
                       --------------- ------------- --------------- ------------- ---------- 
                            25.000%        26.000%        38.000%        13.000%     51.000% 
                       =============== ============= =============== ============= ========== 


- ------------- 

(1) Includes shares transferred from Mr. Leven to members of his immediate 
    family in transactions permitted under his Old Stock Purchase Agreement. 

(2) Includes certain shares that were not included in the numbers referenced 
    in note 1 above and that have been reallocated to Jonathan Leven and 
    Robert Leven (employees of the Company and sons of Mr. Leven), as members 
    of the Company's management, in accordance with the terms of Mr. Leven's 
    Old Stock Purchase Agreement. 

See "Principal Stockholders" for details regarding the beneficial ownership 
of the foregoing shares, as adjusted for the Reclassification, the 1996 
Amendment and the Offering. 

                                      49 
 

                             SELLING STOCKHOLDERS 

   The following table sets forth certain information regarding (i) the 
beneficial ownership of Class A Common Stock by the Selling Stockholders as 
of October 1, 1996 (adjusted for the Reclassification), (ii) the number of 
shares of Class A Common Stock being offered hereby by each Selling 
Stockholder and (iii) their beneficial ownership of the Class A Common Stock 
after the Offering. Unless otherwise indicated, each Selling Stockholder 
listed below has sole voting and investment power with respect to the shares 
listed across from its name in the table. 

   No members of the Company's management or its Board of Directors will be 
selling shares pursuant to the Offering. 



                                   Beneficial Ownership 
                                           Prior                                  Beneficial Ownership 
                                      to the Offering                              After the Offering 
                                   --------------------                   ------------------------------------ 
                                                             Shares of 
                                      Shares                  Class A         Shares                     % 
                                    of Class A             Common Stock     of Class A        %      of Total 
              Name                 Common Stock      %      Being Sold     Common Stock    Equity  Voting Power 
- -------------------------------    ------------    ----   --------------  --------------   ------  ------------ 
                                                                                      
Ronald N. Beck                         48,350       *          15,797          32,553        *           * 
H. Pierre Eilian, M.D.                  9,670       *           3,195           6,475        *           * 
Jonathan D. Eilian                      9,670       *           3,195           6,475        *           * 
Nancy B. and Howard Feinglass          38,680       *           3,362          35,318        *           * 
Goolock Associates                    299,770       2.8%       65,130         234,640        1.9%        * 
Lotte Bravmann & Carol Bravmann 
   Berlin as Trustees FBO 
   Alyssa Michelle Berlin              49,955       *          14,347          35,608        *           * 
Lotte Bravmann & Carol Bravmann 
   Berlin as Trustees FBO 
   Elana Danielle Berlin               49,964       *          14,348          35,616        *           * 
Lotte Bravmann & Carol Bravmann 
   Berlin as Trustees FBO 
   Nicole Amy Berlin                   49,964       *          14,348          85,616        *           * 
Lotte Bravmann & Judith Kaufthal 
   as Trustees FBO 
   Jeremy J. Kaufthal                  49,964       *          14,348          35,616        *           * 
Lotte Bravmann & Judith Kaufthal 
   as Trustees FBO 
   Jonathan S. Kaufthal                49,964       *          14,348          35,616        *           * 
Lotte Bravmann & Judith Kaufthal 
   as Trustees FBO 
   Joshua M. Kaufthal                  49,955       *          14,348          37,382        *           * 
Marc Lasry                             38,680       *          12,637          37,318        *           * 
Leon Levy                             145,050       1.4%       39,110         105,940        *           * 
Microtopp Associates                  328,780       3.1%       71,304         257,476        2.0%        * 
David A. Mintz                         19,340       *           3,363          15,977        *           * 
Nash Grandchildren 1986 Trust         299,770       2.8%       86,957         212,813        1.7%        * 
Schwartz Microtel Investors, 
  L.L.C.                              336,266       3.1%      109,863         226,403        1.8%        * 
                                                              ------- 
  Total                                                       500,000 
                                                              ======= 


- ------------- 

* Represents less than 1% of the outstanding Common Stock, both in number and 
  in terms of voting power. 

                                      50 
 

                         DESCRIPTION OF CAPITAL STOCK 

   The following description of the Company's capital stock does not purport 
to be complete and is subject in all respects to applicable Delaware law and 
to the provisions of the Company's Charter and By-laws, as amended, copies of 
which have been filed as exhibits to the Registration Statement of which this 
Prospectus is a part. 

   The authorized capital stock of the Company consists of 35,000,000 shares 
of Common Stock, par value $0.01 per share, of which 30,000,000 shares have 
been designated as Class A Common Stock and 5,000,000 shares have been 
designated as Class B Common Stock, and 1,000,000 shares of Preferred Stock, 
par value $.01 per share (the "Preferred Stock"), of which up to 525,000 have 
been designated as Redeemable Preferred Stock. Immediately after the 
completion of the Offering, 9,872,490 shares of Class A Common Stock will be 
outstanding and 2,707,919 shares of Class B Common Stock will be outstanding. 
In addition, 450,000 shares of Class A Common Stock will be reserved for 
issuance under the Option Plans and 2,707,919 shares of Class A Common Stock 
will be reserved for issuance upon conversion of Class B Common Stock. 
Currently, 163,500 shares of Redeemable Preferred Stock are outstanding. 

Common Stock 

   Holders of the Class A Common Stock are entitled to one vote per share and 
holders of Class B Common Stock are entitled to ten votes per share on all 
matters to be voted upon by the stockholders. Holders of Class A Common Stock 
and Class B Common Stock do not have cumulative voting rights and, therefore, 
holders of shares possessing a majority of the voting power can elect all of 
the directors. In such event, the holders of the remaining shares will not be 
able to elect any directors. 

   Holders of Class A Common Stock and Class B Common Stock are entitled to 
share ratably such dividends as may be declared from time to time by the 
Board of Directors out of funds legally available therefor, subject to the 
terms of the Redeemable Preferred Stock and of agreements governing the 
Company's indebtedness. The Company does not anticipate paying cash dividends 
in the foreseeable future. See "Dividend Policy". In the event of the 
liquidation, dissolution or winding up of the Company, the holders of Class A 
Common Stock and Class B Common Stock are entitled to share ratably in all 
assets remaining after payment of liabilities and the liquidation preference 
and any accrued but unpaid dividends with respect to any then outstanding 
Preferred Stock. 

   In the event of any merger or consolidation of the Company with or into 
any other corporation pursuant to which shares of Class A Common Stock and 
Class B Common Stock are converted into other securities, cash or other 
property, shares of Class A Common Stock and shares of Class B Common Stock 
shall be converted into the identical consideration at the same rate per 
share, except that any voting securities into which Class B Common Stock 
shall be converted shall have ten times the voting power of any otherwise 
identical securities into which Class A Common Stock is converted, unless the 
holders of a majority of the shares of each such class shall have approved 
such merger or consolidation. 

   Shares of Class B Common Stock are convertible at the option of the holder 
into shares of Class A Common Stock on a share-for-share basis. In addition, 
shares of Class B Common Stock will automatically convert into shares of 
Class A Common Stock upon any transfer thereof, other than a transfer by a 
holder of Class B Common Stock to (i) an immediate family member of such 
holder or (ii) any trust or partnership of which all of the beneficiaries or 
partners, as the case may be, are such holder and/or immediate family members 
of such holder, so long as the transferee authorizes Mr. Leven or Mr. Aronson 
to vote such transferred shares. Holders of Class A Common Stock and Class B 
Common Stock have no preemptive or redemption rights and are not subject to 
further calls or assessments by the Company, except as otherwise provided in 
the Amended Stock Purchase Agreements. 

   
   The Class A Common Stock has been approved for quotation and trading on 
the National Market System of The Nasdaq Stock Market ("Nasdaq") upon 
completion of the Offering under the symbol "USFS". 
    

   The Transfer Agent and Registrar for the Class A Common Stock is Wachovia 
Bank of North Carolina, N.A. 

Preferred Stock 

   The Board of Directors has the authority, without any vote or action by 
the stockholders, to issue Preferred Stock in one or more series and to fix 
the designations, preferences, rights, qualifications, limitations and 
restrictions thereof, including the voting rights, dividend rights, dividend 
rate, conversion rights, terms of redemption (including sinking fund 
provisions), redemption price or prices, liquidation preferences and the 
number of shares constituting any series; 

                                      51 
 

provided, however, that the Board of Directors may not create a series of 
Preferred Stock with general voting rights or with the right to elect more 
than 50% of the Board under any circumstances without the approval of holders 
of 75% of the outstanding Class B Common Stock. 

   On September 29, 1995, pursuant to the "blank-check" authority vested in 
the Board by the Company's Charter, the Board of Directors adopted a 
resolution creating the Redeemable Preferred Stock, consisting of up to 
525,000 shares (which number may be decreased, but not increased, by the 
Board without a vote of the stockholders). By its terms, the Redeemable 
Preferred Stock ranks prior to the Common Stock and all other classes of the 
Company's capital stock with respect to dividend rights and rights upon the 
liquidation, dissolution or winding up of the Company. Shares of Redeemable 
Preferred Stock accrue dividends cumulatively in additional shares of 
Redeemable Preferred Stock at an annual rate of 10% on the $100 liquidation 
preference. The Company may redeem the Redeemable Preferred Stock in whole or 
in part at its discretion at any time and must redeem any outstanding shares 
of the Redeemable Preferred Stock on September 29, 2007 or within 10 business 
days of a Change of Control (as defined below) of the Company, at a 
redemption price per share equal to $100 plus all accrued but unpaid 
dividends thereon. A Change of Control is defined generally as (i) the sale 
or transfer of all or substantially all of the Company's assets to any person 
that is not an affiliate of the Company, (ii) the sale or transfer (whether 
by merger, consolidation or otherwise) of a majority of the Common Stock, in 
the aggregate to persons who (a) were not Original Investors, (b) are not 
employees of the Company or (c) are not members of the immediate family or of 
a trust or partnership for the benefit of any person described in clauses (a) 
or (b) above or an affiliate of any of the foregoing or (iii) the termination 
of employment for any reason by the Company (including by way of resignation) 
of Mr. Leven. In addition, the Company may, at any time, elect to require the 
holders of shares of Redeemable Preferred Stock to exchange all or part of 
their shares of Redeemable Preferred Stock for Subordinated Debentures due 
September 29, 2007 in the aggregate principal amount per share equal to $100 
plus all accrued but unpaid dividends thereon. Interest on the Subordinated 
Debentures is payable one-half in cash and one-half through the issuance of 
additional Subordinated Debentures. 

Certain Effects of Authorized but Unissued Stock 

   Authorized but unissued shares of Common Stock and Preferred Stock are 
available for future issuance without stockholder approval, except as may 
otherwise be required under Nasdaq rules. These additional shares may be 
utilized for a variety of corporate purposes, including future public 
offerings to raise additional capital, corporate acquisitions and employee 
benefit plans. 

   The existence of authorized but unissued and unreserved Common Stock and 
Preferred Stock may enable the Board of Directors to issue shares to persons 
friendly to current management, which could render more difficult or 
discourage an attempt to obtain control of the Company by means of a proxy 
contest, tender offer, merger, or otherwise, and thereby protect the 
continuity of the Company's management. 

Registration Rights 

   Pursuant to the terms of the Restated Stockholders' Agreement, the Company 
has granted the Original Investors piggyback and demand registration rights, 
which permit such persons to cause the Company to register their shares of 
Class A Common Stock (including shares of Class A Common Stock into which 
shares of Class B Common Stock are convertible) under the Securities Act in 
certain circumstances. The demand registration rights generally provide that, 
at any time after September 29, 2000, the holders of a majority of the shares 
of Class A Common Stock (including the shares of Class B Common Stock 
referred to above) registrable under such Agreement have the right to cause 
the Company to file one registration statement under the Securities Act 
covering all or part of such shares of Class A Common Stock (including the 
shares into which the shares of Class B Common Stock are convertible) and 
that the Company will use its best efforts to effect such registration. With 
respect to piggyback registration rights, at any time following such time 
that greater than 20% of the outstanding Common Stock has been registered 
under the Securities Act, the Company is required to notify the holders of 
Common Stock registrable under such Agreement that the Company intends to 
register some of its securities and, if requested by such holder, to include 
a portion of their shares of Common Stock in such registration ("piggyback 
shares"). The maximum number of shares of Class A Common Stock that may be 
included in such registration is determined by multiplying all of the 
piggyback shares by a fraction, the numerator of which is the number of 
shares being registered by the Company and the denominator of which is the 
number of shares to be outstanding after such registration (excluding the 
piggyback shares). The Company generally is obligated to bear the expenses, 
other than underwriting discounts, sales commissions and 

                                      52 
 

transfer taxes, if any, of the registration of such shares. Any exercise by 
the holders of such registration rights may hinder efforts by the Company to 
arrange future financings and may have an adverse impact on the market price 
of the Class A Common Stock. 

Delaware Law and Certain Charter and By-Law Provisions 

   The Company is a Delaware corporation and is subject to Section 203 of the 
Delaware General Corporation Law ("DGCL"). In general, Section 203 prevents 
an "interested stockholder" (defined generally as a person owning 15% or more 
of a corporation's outstanding voting stock) from engaging in a "business 
combination" (as defined in such section) with a Delaware corporation for 
three years following the date such person became an interested stockholder 
unless (i) before such person became an interested stockholder, the board of 
directors of the corporation approved the transaction in which the interested 
stockholder became an interested stockholder or approved the business 
combination; (ii) upon consummation of the transaction that resulted in the 
interested stockholder becoming an interested stockholder, the interested 
stockholder owns at least 85% of the voting stock of the corporation 
outstanding at the time the transaction commenced (excluding shares owned by 
persons who are both officers and directors of the corporation, and held by 
certain employee stock ownership plans) or (iii) following the transaction in 
which such person became an interested stockholder, the business combination 
is approved by the board of directors of the corporation and authorized at a 
meeting of stockholders by the affirmative vote of the holders of at least 
two-thirds of the outstanding voting stock of the corporation not owned by 
the interested stockholder. Messrs. Leven and Aronson are interested 
stockholders under the DGCL. However, since their acquisition of the 
Company's securities was approved in advance by the Company's Board of 
Directors, they would not be prohibited from engaging in a business 
combination with the Company. 

   In addition, certain provisions of the Company's Charter and By-laws 
summarized in the following paragraphs will become operative prior to or 
simultaneously with the completion of the Offering and may be deemed to have 
an anti-takeover effect and may delay, defer or prevent an attempt to obtain 
control of the Company by means of a proxy contest, tender offer, merger or 
other transaction that a stockholder might consider in its best interest, 
including those attempts that might result in a premium over the market price 
for the shares held by stockholders. 

   Special Meeting of Stockholders. The Charter provides that special 
meetings of stockholders of the Company may be called only by the Board of 
Directors, the Chairman of the Board of Directors or the Chief Executive 
Officer. This provision will make it more difficult for stockholders to take 
actions opposed by the Board of Directors. This provision may not be amended 
or repealed without the approval of holders of at least 75% of the 
outstanding voting power of the Company. This provision of the Charter may 
not be amended or repealed without the approval of holders of at least 75% of 
the outstanding voting power of the Company. 

   Stockholder Action by Written Consent. The Charter provides that no action 
required or permitted to be taken at any annual or special meeting of the 
stockholders of the Company may be taken without a meeting, and the power of 
stockholders of the Company to consent in writing, without a meeting, to the 
taking of any action is specifically denied. This provision may not be 
amended or repealed without the approval of holders of at least 75% of the 
outstanding voting power of the Company. This provision of the Charter may 
not be amended or repealed without the approval of holders of at least 75% of 
the outstanding voting power of the Company. 

   Prohibition on Issuance of Voting Preferred Stock. The Charter provides 
that the Board of Directors cannot create a series of Preferred Stock with 
general voting rights or with the right to elect more than 50% of the Board 
under any circumstances without the approval of holders of 75% of the 
outstanding Class B Common Stock. This provision may not be amended or 
repealed without the approval of holders of at least 75% of the outstanding 
voting power of the Company. 

   Advance Notice Requirements for Stockholder Proposals and Director 
Nominations. The By-laws provide that stockholders seeking to bring business 
before an annual meeting of stockholders, or to nominate candidates for 
election as directors at an annual or special meeting of stockholders, must 
provide timely notice thereof in writing. To be timely, a stockholder's 
notice must be delivered to or mailed and received at the principal executive 
offices of the Company not less than 70 days nor more than 90 days prior to 
the meeting; provided, however, that in the event that the date of the annual 
meeting is advanced by more than 20 days or delayed by more than 70 days from 
such anniversary date, notice by the stockholder to be timely must be 
received no earlier than the close of business on the ninetieth day prior to 
such annual meeting and not later than the close of business on the later of 
the seventieth day prior to such annual meeting or the tenth day following 
the day on which public announcement of the date of 

                                      53 
 

such meeting is first made. The By-laws also specify certain requirements for 
a stockholder's notice to be in proper written form. These provisions may 
preclude some stockholders from bringing matters before the stockholders at 
an annual or special meeting or from making nominations for directors at an 
annual or special meeting. 

   Termination of Employment Agreements. The By-laws provide that approval of 
75% of the Board of Directors is required to terminate the employment 
agreements of Messrs. Leven or Aronson. 

Limitation of Liability and Indemnification Agreements 

   The Charter provides that to the fullest extent permitted by the DGCL, a 
director of the Company shall not be liable to the Company or its 
stockholders for monetary damages for breach of fiduciary duty as a director. 
Under current Delaware law, liability of a director may not be limited (i) 
for any breach of the director's duty of loyalty to the Company or its 
stockholders, (ii) for acts or omissions not in good faith or that involve 
intentional misconduct or a knowing violation of law, (iii) in respect of 
certain unlawful dividend payments or stock redemptions or repurchases and 
(iv) for any transaction from which the director derives an improper personal 
benefit. The effect of the provision of the Charter is to eliminate the 
rights of the Company and its stockholders (through stockholders' derivative 
suits on behalf of the Company) to recover monetary damages against a 
director for breach of the fiduciary duty of care as a director (including 
breaches resulting from negligent or grossly negligent behavior) except in 
the situations described in clauses (i) through (iv) above. This provision 
does not limit or eliminate the rights of the Company or any stockholder to 
seek nonmonetary relief such as an injunction or rescission in the event of a 
breach of a director's duty of care. In addition, the Charter provides that 
the Company shall indemnify its directors, officers, employees and agents to 
the extent not prohibited by Delaware law. 

   In addition, prior to the completion of the Offering, the Company intends 
to enter into agreements (the "Indemnification Agreements") with each of the 
directors of the Company pursuant to which the Company will agree to 
indemnify each such director against claims, liabilities, damages, expenses, 
losses, costs, penalties or amounts paid in settlement (collectively, 
"Losses") incurred by such director and arising out of his capacity as a 
director, executive officer, employee and/or agent of the Company to the 
maximum extent permitted by applicable law. In addition, such director or 
officer shall be entitled to an advance of expenses to the maximum extent 
authorized or permitted by law to meet the obligations indemnified against. 
The Indemnification Agreements also obligate the Company to purchase and 
maintain insurance for the benefit and on behalf of its directors insuring 
against all liabilities that may be incurred by such director in or arising 
out of his capacity as a director, officer, employee and/or agent of the 
Company. 

   To the extent that the Board of Directors or the stockholders of the 
Company may in the future wish to limit or repeal the ability of the Company 
to indemnify directors, such repeal or limitation may not be effective as to 
directors who are currently parties to the Indemnification Agreements, 
because their rights to full protection are contractually assured by the 
Indemnification Agreements. It is anticipated that similar contracts may be 
entered into, from time to time, with future directors and with executive 
officers of the Company. 

                                      54 
 

                                 UNDERWRITING 

   Subject to the terms and conditions of the Underwriting Agreement, each of 
the Underwriters named below, and each of the Underwriters for whom Schroder 
Wertheim & Co. Incorporated and Montgomery Securities are acting as 
representatives (the "Representatives"), has severally agreed to purchase 
from the Company and the Selling Stockholders an aggregate of 2,325,000 
shares of Class A Common Stock at the Price to Public less the underwriting 
discounts and commissions set forth on the cover page of this Prospectus, in 
the amounts set forth below opposite their respective names. 



                                                Number of 
                                                Shares of 
Underwriter                               Class A Common Stock 
- -----------                               -------------------- 
                                             
Schroder Wertheim & Co. Incorporated 
Montgomery Securities 

                                                --------- 
Total                                           2,325,000 
                                                ========= 


   The Underwriting Agreement provides that the Underwriters' obligation to 
pay for and accept delivery of the shares of Class A Common Stock offered 
hereby is subject to certain conditions precedent and that the Underwriters 
will be obligated to purchase all such shares, excluding shares covered by 
the over-allotment option, if any are purchased. The Underwriters have 
informed the Company and the Selling Stockholders that no sales of Class A 
Common Stock will be confirmed to discretionary accounts. 

   The Company and the Selling Stockholders have been advised by the 
Underwriters that they propose initially to offer the Class A Common Stock to 
the public at the public offering price set forth on the cover page of this 
Prospectus and to certain dealers at such price, less a concession not in 
excess of $       per share. The Underwriters may allow and such dealers may 
reallow a concession not in excess of $       per share to certain other 
brokers and dealers. After the Offering, the public offering price, the 
concession and reallowances to dealers and other selling terms may be changed 
by the Underwriters. 

   
   At the request of the Company, the Underwriters have reserved shares of 
Class A Common Stock for sale, at the public offering price, to directors, 
officers and employees of the Company and certain other persons. Such 
directors, officers, employees and other persons will purchase, in the 
aggregate, less than 10% of the Class A Common Stock offered in the Offering. 
The number of shares available for sale to the general public will be reduced 
to the extent such persons purchase such reserved shares. Any reserved shares 
not so purchased will be offered by the Underwriters to the general public on 
the same terms as the other shares offered hereby. 
    

   The Company and the Selling Stockholders have granted to the Underwriters 
an option exercisable for 30 days after the date of this Prospectus to 
purchase up to an aggregate of 348,750 additional shares of Class A Common 
Stock to cover overallotments, if any, at the same price per share to be paid 
by the Underwriters for the other shares of Class A Common Stock offered 
hereby. If the Underwriters purchase any such additional shares pursuant to 
the overallotment option, each Underwriter will be committed, subject to 
certain conditions, to purchase a number of the additional shares of Class A 
Common Stock proportionate to such Underwriter's initial commitment. 

   The Company, its directors and executive officers, and certain other 
stockholders have agreed with the Representatives, for a period of 180 days 
after the date of this Prospectus, not to issue, sell, offer to sell, grant 
any options for the sale of, or otherwise dispose of any shares of Class A 
Common Stock or Class B Common Stock or any rights to purchase shares of the 
same (other than stock issued or options granted pursuant to the Company's 
stock incentive plans), without the prior written consent of the 
Representatives. See "Shares Eligible for Future Sale." 

   The Company and the Selling Stockholders have agreed to indemnify the 
Underwriters against certain liabilities that may be incurred in connection 
with the sale of the Class A Common Stock, including liabilities arising 
under the Securities Act, and to contribute to payments that the Underwriters 
may be required to make with respect thereto. 

   Prior to the Offering, there has been no public market for the Class A 
Common Stock. The initial public offering price for the Class A Common Stock 
will be determined by negotiation among the Company, the Selling Stockholders 

                                      55 
 

and the Representatives. Among other factors considered in determining the 
Price to Public will be prevailing market and economic conditions, projected 
revenues and earnings of the Company, the state of the Company's business 
operations, an assessment of the Company's management, and consideration of 
the above factors in relation to market valuation of companies in related 
businesses and other factors deemed relevant. There can be no assurance, 
however, that the prices at which the Class A Common Stock will sell in the 
public market after the Offering will not be lower than the Price to Public. 

                        SHARES ELIGIBLE FOR FUTURE SALE

   Upon completion of the Offering, 9,872,490 shares of Class A Common Stock 
will be outstanding and 2,707,919 shares of Class B Common Stock will be 
outstanding. Of these shares, the 2,325,000 shares of Class A Common Stock 
sold in the Offering will be freely tradeable by persons other than 
"affiliates" of the Company, without restriction under the Securities Act. 
Further, 8,047,490 shares of Class A Common Stock and all 2,706,557 shares of 
Class B Common Stock will be "restricted" securities within the meaning of 
Rule 144 and may not be sold in the absence of registration under the 
Securities Act unless an exemption from registration is available, including 
the exemptions contained in Rule 144. However, approximately 9,425,000 shares 
of Class A Common Stock (including 2,707,919 shares of Class A Common Stock 
into which the Class B Common Stock is convertible) will be eligible for sale 
under Rule 144 beginning on September 29, 1997 (subject to certain volume and 
other restrictions prescribed by Rule 144). As defined in Rule 144, an 
"affiliate" of an issuer is a person that directly, or indirectly through one 
or more intermediaries, controls, or is controlled by, or is under common 
control with, such issuer. 

   In general, under Rule 144 as currently in effect, a person (or persons 
whose shares are aggregated), including an "affiliate" as that term is 
defined below, who has paid for shares is entitled, beginning two years from 
the later of the date of acquisition of the shares from the Company or from 
an affiliate of the Company, to sell within any three- month period up to 
that number of shares that does not exceed the greater of 1% of the then 
outstanding shares or the average weekly trading volume of the then 
outstanding shares during the four calendar weeks preceding each such sale. A 
person (or persons whose shares are aggregated) who is not deemed an 
affiliate of the Company and who has paid for his shares is entitled, 
beginning three years from the later of the date of the acquisition from the 
Company or from an affiliate of the Company, to sell such shares under Rule 
144(k) without regard to the volume limitations described above. Affiliates 
continue to be subject to such volume limitations after the three-year 
holding period. 

   The Company, its officers and directors and certain of its other current 
stockholders, who collectively hold 2,818,725 shares of Class A Common Stock 
and 2,707,919 shares of Class B Common Stock, have agreed that they will not 
dispose of any shares of Class A Common Stock or Class B Common Stock, or any 
securities convertible or exchangeable for shares of Class A Common Stock, 
for a period of 180 days after the date of this Prospectus without the 
written consent of the Representatives of the Underwriters. After the 
Offering, certain holders of shares of Common Stock will be entitled to have 
shares included in certain registration statements filed by the Company. See 
"Description of Common Stock--Registration Rights". 

   
   Following the Offering, the Company intends to file a registration 
statement on Form S-8 under the Securities Act to register 450,000 shares of 
Class A Common Stock issuable upon the exercise of stock options granted 
under the Option Plans. Shares of Class A Common Stock issued upon the 
exercise of stock options after the effective date of such registration 
statement generally will be available for sale in the open market. 
Immediately following the Offering, however, no options to purchase Class A 
Common Stock will be exercisable under the Option Plans. 
    


                     VALIDITY OF THE CLASS A COMMON STOCK 

   The validity of the shares of Class A Common Stock offered hereby will be 
passed upon for the Company by Paul, Weiss, Rifkind, Wharton & Garrison, New 
York, New York, and for the Underwriters by Sullivan & Cromwell, New York, 
New York. 

                                   EXPERTS 

   The Consolidated Financial Statements included in this Prospectus and the 
Registration Statement have been audited by Deloitte & Touche LLP, 
independent auditors, as stated in their report appearing herein, and are 
included in reliance upon the report of such firm given upon their authority 
as experts in accounting and auditing. 

                                      56 
 

                             AVAILABLE INFORMATION

   The Company has filed with the Securities and Exchange Commission (the 
"Commission") a registration statement on Form S-1 (herein, together with all 
amendments and exhibits, referred to as the "Registration Statement") under 
the Securities Act. This Prospectus does not contain all of the information 
set forth in the Registration Statement, certain parts of which are omitted 
in accordance with the rules and regulations of the Commission. For further 
information, reference is hereby made to the Registration Statement. 
Statements contained in this Prospectus as to the contents of any contract or 
other document are not necessarily complete, and in each such instance 
reference is made to the copy of such contract or document filed as an 
exhibit to the Registration Statement, each such statement being qualified in 
all respects by such reference. As a result of the Offering, the Company will 
become subject to the informational requirements of the Exchange Act, and in 
accordance therewith will file reports, proxy statements and other 
information with the Commission. The Registration Statement, as well as all 
periodic reports and other information filed by the Company pursuant to the 
Exchange Act, may be inspected and copied at the public reference facilities 
maintained by the Commission at 450 Fifth Street N.W., Washington, D.C. 
20549, and at the regional offices of the Commission located at 7 World Trade 
Center, 7th Floor, New York, New York 10048 and Citicorp Center, 500 Madison 
Street, Suite 1400, Chicago, Illinois 60661. Copies of such materials may be 
obtained from the World Wide Web site that the Commission maintains at 
http://www.sec.gov. and from the Public Reference Section of the Commission, 
450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. 

                                      57 
 

                         U.S. FRANCHISE SYSTEMS, INC. 
                               AND SUBSIDIARIES 

                            INDEX TO CONSOLIDATED 
                             FINANCIAL STATEMENTS 



                                                                                  Page 
                                                                                  ----- 
                                                                                
INDEPENDENT AUDITORS' REPORT                                                       F-2 

CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1995 AND 
  JUNE 30, 1996 AND FOR THE PERIOD FROM AUGUST 28, 1995 (INCEPTION) 
  TO DECEMBER 31, 1995 AND FOR THE SIX MONTHS ENDED JUNE 30, 1996: 

Consolidated Statements of Financial Position                                      F-3 

Consolidated Statements of Operations                                              F-4 

Consolidated Statements of Stockholders' Deficit                                   F-5 

Consolidated Statements of Cash Flows                                              F-6 

Notes to Consolidated Financial Statements                                         F-7 


                                     F-1 
 

                         INDEPENDENT AUDITORS' REPORT 

Board of Directors 
and Stockholders of U.S. Franchise Systems, Inc.: 

   We have audited the accompanying consolidated statements of financial 
position of U.S. Franchise Systems, Inc. and subsidiaries (the "Company") as 
of December 31, 1995 and June 30, 1996 and the related consolidated 
statements of operations, stockholders' deficit, and cash flows for the 
periods from August 28, 1995 (inception) to December 31, 1995 and the six 
months ended June 30, 1996. These financial statements are the responsibility 
of the Company's management. Our responsibility is to express an opinion on 
these financial statements based on our audits. 

   We conducted our audits in accordance with generally accepted auditing 
standards. Those standards require that we plan and perform the audit to 
obtain reasonable assurance about whether the financial statements are free 
of material misstatement. An audit includes examining, on a test basis, 
evidence supporting the amounts and disclosures in the financial statements. 
An audit also includes assessing the accounting principles used and 
significant estimates made by management, as well as evaluating the overall 
financial statement presentation. We believe that our audits provide a 
reasonable basis for our opinion. 

   In our opinion, such consolidated financial statements present fairly, in 
all material respects, the financial position of the Company at December 31, 
1995 and June 30, 1996 and the results of its operations and its cash flows 
for the periods from August 28, 1995 (inception) to December 31, 1995 and the 
six months ended June 30, 1996, in conformity with generally accepted 
accounting principles. 

Deloitte & Touche LLP 

   
August 9, 1996 
(October 23, 1996 as to Note 11) 
    

                                     F-2 




                         U.S. FRANCHISE SYSTEMS, INC. 
                               AND SUBSIDIARIES 

                CONSOLIDATED STATEMENTS OF FINANCIAL POSITION 



                                                                              December 31,       June 30, 
                                                                                  1995             1996 
                                                                              ------------     ------------ 
                                                                                         
                                  Assets 
CURRENT ASSETS: 
  Cash and temporary cash investments                                          $13,893,000     $12,732,000 
  Accounts receivable                                                                              122,000 
  Deposits                                                                          87,000          87,000 
  Prepaid expenses                                                                 399,000         349,000 
                                                                              ------------     ----------- 
   Total current assets                                                         14,379,000      13,290,000 
PROMISSORY NOTES RECEIVABLE                                                                        416,000 
EQUIPMENT--Net                                                                     134,000         389,000 
FRANCHISE RIGHTS                                                                 3,371,000       3,369,000 
DEFERRED COMMISSIONS                                                                41,000       1,282,000 
OTHER ASSETS                                                                       147,000         281,000 
                                                                              ------------     ----------- 
                                                                               $18,072,000     $19,027,000 
                                                                              ============     =========== 
                 Liabilities and Stockholders' Deficit 
CURRENT LIABILITIES: 
  Accounts payable                                                             $   201,000     $   375,000 
  Commissions payable                                                               22,000         572,000 
  Deferred application fees                                                        120,000       2,842,000 
  Accrued expenses                                                                  65,000         376,000 
  Royalties due to HSA Properties                                                                  390,000 
  Due to Hudson Hotels Corporation                                                 706,000         706,000 
                                                                              ------------     ----------- 
   Total current liabilities                                                     1,114,000       5,261,000 
DUE TO HUDSON HOTELS CORPORATION                                                   731,000         731,000 
                                                                              ------------     ----------- 
   Total liabilities                                                             1,845,000       5,992,000 
                                                                              ------------     ----------- 
REDEEMABLE STOCK: 
  Preferred shares, par value $0.01 per share; authorized 525,000 
    shares; issued and outstanding 163,500 shares; cumulative, 
    exchangeable (entitled in redemption to $16,759,000 and $17,597,000 
    at December 31, 1995 and June 30, 1996, respectively)                       16,759,000      17,597,000 
                                                                              ------------     ----------- 
  Common shares, par value $0.01 per share; issued and outstanding 
    3,186,294 Class A shares (see Note 11) entitled in redemption 
    (under certain conditions) to $330,000 at December 31, 1995 and 
    June 30, 1996                                                                  330,000         330,000 
                                                                              ------------     ----------- 
COMMITMENTS AND CONTINGENCIES 
STOCKHOLDERS' DEFICIT: 
  Common shares, par value $0.01 per share; authorized 30,000,000 
    shares of Class A Common Stock and 5,000,000 shares of Class B 
    Common Stock; issued and outstanding 4,861,196 Class A shares and 
    2,707,919 Class B shares (see Note 11)                                          78,000          78,000 
  Capital in excess of par                                                         228,000 
  Accumulated deficit                                                           (1,168,000)     (4,970,000) 
                                                                              ------------     ----------- 
   Total stockholders' deficit                                                    (862,000)     (4,892,000) 
                                                                              ------------     ----------- 
                                                                               $18,072,000     $19,027,000 
                                                                              ============     =========== 


               See notes to consolidated financial statements. 

                                     F-3 
 

                         U.S. FRANCHISE SYSTEMS, INC. 
                               AND SUBSIDIARIES 

                    CONSOLIDATED STATEMENTS OF OPERATIONS 



                                                       Period From 
                                                     August 28, 1995    Six Months 
                                                     (Inception) to        Ended 
                                                      December 31,       June 30, 
                                                          1995             1996 
                                                     ---------------   ------------ 
                                                                  
REVENUES                                               $     --         $   395,000 
                                                      --------------      ---------- 
EXPENSES: 
 Marketing and reservations                                 13,000          490,000 
 Other franchise sales and advertising                     550,000        1,263,000 
 Corporate salaries, wages, and benefits                   423,000          993,000 
 Other general and administrative                          215,000          835,000 
 Depreciation and amortization                             126,000          268,000 
                                                      --------------      ---------- 
                                                         1,327,000        3,849,000 
                                                      --------------      ---------- 
LOSS FROM OPERATIONS                                     1,327,000        3,454,000 
OTHER INCOME (EXPENSE): 
 Interest income                                           195,000          331,000 
 Interest expense                                          (36,000)         (72,000) 
                                                      --------------      ---------- 
NET LOSS                                               $ 1,168,000      $ 3,195,000 
                                                      ==============      ========== 
LOSS APPLICABLE TO COMMON STOCKHOLDERS                 $ 1,645,000      $ 4,033,000 
                                                      ==============      ========== 
WEIGHTED AVERAGE NUMBER OF COMMON SHARES 
 OUTSTANDING                                            10,755,409       10,755,409 
                                                      ==============      ========== 
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS PER 
  SHARE                                                $      0.15      $      0.38 
                                                      ==============      ========== 


               See notes to consolidated financial statements. 

                                     F-4 
 

                         U.S. FRANCHISE SYSTEMS, INC. 
                               AND SUBSIDIARIES 

               CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT 
         PERIOD FROM AUGUST 28, 1995 (INCEPTION) TO DECEMBER 31, 1995 
                    AND THE SIX MONTHS ENDED JUNE 30, 1996 



                                        Common Stock         Capital in                         Total 
                                   ----------------------     Excess of     Accumulated      Stockholders' 
                                     Shares       Amount         Par          Deficit          Deficit 
                                   -----------   --------     ----------    ------------     ------------- 
                                                                              
BALANCE--August 28, 1995                   --    $   --       $   --        $     --         $     -- 
 Issuance of capital stock          7,569,115      78,000      705,000                           783,000 
 Undeclared dividends on 
  redeemable preferred stock                                  (477,000)                         (477,000) 
 Net loss                                                                    (1,168,000)      (1,168,000) 
                                   ----------    --------     --------      -----------       ---------- 
BALANCE--December 31, 1995          7,569,115      78,000      228,000       (1,168,000)        (862,000) 
 Redemption of capital stock       (1,149,502)    (11,000)    (108,000)                         (119,000) 
 Issuance of capital stock          1,149,502      11,000      111,000                           122,000 
 Undeclared dividends on 
  redeemable preferred stock                                  (231,000)        (607,000)        (838,000) 
 Net loss                                                                    (3,195,000)      (3,195,000) 
                                   ----------    --------     --------      -----------      ----------- 
BALANCE--June 30, 1996              7,569,115    $ 78,000     $   --        $(4,970,000)     $(4,892,000) 
                                   ==========    ========     ========      ===========      =========== 


               See notes to consolidated financial statements. 

                                     F-5 
 

                         U.S. FRANCHISE SYSTEMS, INC. 
                               AND SUBSIDIARIES 

                    CONSOLIDATED STATEMENTS OF CASH FLOWS 



                                                                                  Period From        Six Months 
                                                                                August 28, 1995         Ended 
                                                                                (Inception) to        June 30, 
                                                                                 December 31, 
                                                                                     1995               1996 
                                                                                ---------------    -------------- 
                                                                                               
OPERATING ACTIVITIES: 
 Net loss                                                                         $(1,168,000)       $(3,195,000) 
 Adjustments to reconcile net loss to net cash used in operating activities: 
  Depreciation and amortization                                                       126,000            268,000 
  Increase in accounts receivable, prepaid expenses and deposits                     (699,000)          (189,000) 
  Increase in promissory notes receivable                                                               (416,000) 
  Increase in deferred commissions                                                    (41,000)        (1,241,000) 
  Increase in other assets                                                                              (150,000) 
  Increase in accounts payable and accrued expenses                                   266,000            485,000 
  Increase in commissions payable                                                      22,000            550,000 
  Increase in deferred application fees                                               120,000          2,722,000 
  Increase in royalties due to HSA Properties                                                            390,000 
                                                                                 ------------        ----------- 
  Net cash used in operating activities                                            (1,374,000)          (776,000) 
                                                                                 ------------        ----------- 
INVESTING ACTIVITIES: 
 Acquisition of equipment                                                            (137,000)          (271,000) 
 Acquisition of franchise rights                                                   (1,991,000)          (117,000) 
                                                                                 ------------        ----------- 
  Net cash used in investing activities                                            (2,128,000)          (388,000) 
                                                                                 ------------        ----------- 
FINANCING ACTIVITIES: 
 Issuance of redeemable preferred stock (net of $67,000 issuance cost)             16,283,000 
 Issuance of capital stock                                                          1,112,000            122,000 
 Redemption of capital stock                                                                            (119,000) 
                                                                                 ------------        ----------- 
  Net cash provided by financing activities                                        17,395,000              3,000 
                                                                                 ------------        ----------- 
NET INCREASE (DECREASE) IN CASH AND TEMPORARY 
 CASH INVESTMENTS                                                                  13,893,000         (1,161,000) 
CASH AND TEMPORARY CASH INVESTMENTS--Beginning of period                                   --         13,893,000 
                                                                                 ------------        ----------- 
CASH AND TEMPORARY CASH INVESTMENTS--End of period                                $13,893,000        $12,732,000 
                                                                                 ============        =========== 
NONCASH ACTIVITIES: 
 Undeclared dividends accrued on redeemable preferred stock                       $   477,000        $   838,000 
                                                                                 ============        =========== 
Portion of purchase price due to Hudson Hotels Corporation 
  in future years, discounted at 10%                                              $ 1,437,000        $        -- 
                                                                                 ============        =========== 


               See notes to consolidated financial statements. 

                                     F-6 
 

                         U.S. FRANCHISE SYSTEMS, INC. 
                               AND SUBSIDIARIES 

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
                AS OF DECEMBER 31, 1995 AND JUNE 30, 1996 AND 
               FOR THE PERIOD FROM AUGUST 28, 1995 (INCEPTION) 
                 TO DECEMBER 31, 1995 AND FOR THE SIX MONTHS 
                             ENDED JUNE 30, 1996 

1. BASIS OF PRESENTATION AND ORGANIZATION 

   U.S. Franchise Systems, Inc. (the "Company") was incorporated under the 
laws of the State of Delaware on August 28, 1995 to acquire, market, and 
license distinct franchise brands principally within the United States. The 
consolidated financial statements include the accounts of the Company and its 
wholly owned subsidiaries: Microtel Inns and Suites Franchising, Inc. (and 
its wholly owned subsidiary Microtel International, Inc.); Hawthorn Suites 
Franchising, Inc. ("HSF"); and US Funding Corp. ("US Funding"). The 
consolidated financial statements also include the accounts of the marketing 
and reservation funds of the Microtel and Hawthorn hotel systems. All 
significant intercompany balances and transactions have been eliminated in 
consolidation. 

Microtel Inns and Suites Franchising, Inc. 

   On October 5, 1995, the Company entered into an agreement (the "Microtel 
Agreement") with Hudson Hotels Corporation ("Hudson") to acquire the 
exclusive worldwide franchising rights and operating assets of the Microtel 
hotel system (the "Microtel Acquisition") for $3,037,000. The Company paid 
$1,600,000 at closing and agreed to pay $1,437,000 (see Note 6) over the next 
three years with interest at 10%. The Company also agreed to pay $700,000 for 
consulting services, $400,000 of which was paid at closing, with the 
remainder payable over two years. As part of the Microtel Agreement, the 
Company received warrants to purchase 100,000 common shares of Hudson through 
September 1, 2000 at an exercise price of $8.375 per share. The Microtel 
Agreement requires the Company to pay a royalty for the right to use, and 
license others to use, certain trademarks, service marks, and trade names 
(the "Microtel Proprietary Marks") associated with the Microtel hotel system 
(see Note 10). This acquisition was accounted for as a purchase of franchise 
rights. 

   The Company did not acquire physical facilities, employee base, sales 
force, production techniques or an existing customer base in conjunction with 
the acquisition of the worldwide franchising rights. 

   Pursuant to a Trademark, Service Mark, and System License Agreement (the 
"Microtel License Agreement"), the Company granted to Microtel Inns and 
Suites Franchising, Inc. the exclusive right to use, and to license others to 
use, the Microtel Proprietary Marks and Microtel hotel system in connection 
with the operation of hotels under the Microtel hotel system. 

Hawthorn Suites Franchising, Inc. 

   On March 27, 1996, the Company entered into an agreement with HSA 
Properties, L.L.C. ("HSA") to acquire the exclusive worldwide franchising 
rights with respect to the Hawthorn hotel system (the "Hawthorn Agreement"). 
The Company made no payment to HSA at closing but agreed to remit to HSA a 
portion of the royalties the Company actually receives from future Hawthorn 
franchisees. 

   The Company did not acquire physical facilities, employee base, sales 
force, production techniques or an existing customer base in conjunction with 
the acquisition of the worldwide franchising rights. 

   Pursuant to a Trademark, Service Mark, and System License Agreement which 
expires in April 1998 (the "Hawthorn License Agreement"), the Company granted 
to HSF, its wholly owned subsidiary, the exclusive right to use, and to 
license others to use, the Hawthorn proprietary marks in connection with the 
Hawthorn hotel system (see Note 10). 

Marketing and Reservation Funds 

   The Company collects reservation and marketing fees from its franchisees 
and uses such funds at its discretion to develop, support and enhance the 
reservation systems and marketing programs of the Microtel and Hawthorn hotel 
systems. The related revenues and expenses are reported gross in the 
accompanying financial statements. 

                                     F-7 
 

                         U.S. FRANCHISE SYSTEMS, INC. 
                               AND SUBSIDIARIES 

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 
                AS OF DECEMBER 31, 1995 AND JUNE 30, 1996 AND 
               FOR THE PERIOD FROM AUGUST 28, 1995 (INCEPTION) 
                 TO DECEMBER 31, 1995 AND FOR THE SIX MONTHS 
                             ENDED JUNE 30, 1996 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 

   Application Fee Revenue and Related Costs--Initial franchise fee revenue 
consists of application fees received by the Company's subsidiaries from 
prospective franchisees. Such fees are recognized in income when the 
underlying hotels open for business. Related franchise sales commissions are 
also deferred until the underlying hotels open for business, at which time 
such costs are charged to expense. 

   Cash and Temporary Cash Investments--The Company considers its investments 
with an original maturity of three months or less to be cash equivalents. 
Included in "cash and temporary cash investments" are the following: 



                                      December 31, 1995       June 30, 1996 
                                      -----------------       ------------- 
                                                         
Cash in bank deposit accounts            $   518,000           $ 1,792,000 
Money market funds                        13,375,000            10,940,000 
                                         -----------           ----------- 
                                         $13,893,000           $12,732,000 
                                         ===========           =========== 


   Franchise Rights--Franchise rights represent the cost of acquiring such 
rights and are amortized on a straight-line basis over 15 years. Accumulated 
amortization was $57,000 at December 31, 1995 and $176,000 at June 30, 1996. 

   Impairment of Long-Lived Assets--The Company has adopted Statement of 
Financial Accounting Standards No. 121, "Accounting for the Impairment of 
Long-Lived Assets and Long-Lived Assets to Be Disposed of" ("SFAS 121"), as 
of January 1, 1996. The adoption of SFAS 121 in 1996 did not have a material 
effect on the financial condition or operations of the Company. Long-lived 
assets, principally intangibles, are evaluated annually and written down to 
fair value when management believes that the unamortized balance cannot be 
recovered through future undiscounted cash flows. 

   Income Taxes--The Company has adopted the provisions of Statement of 
Financial Accounting Standards No. 109, "Accounting for Income Taxes," which 
requires the use of the asset and liability approach in accounting for income 
taxes. 

   Stock Plans--The Company has elected to account for stock plans in 
accordance with SFAS No. 123, "Accounting for Stock-Based Compensation." 
Accordingly, compensation expense will likely result from the award of stock 
options, restricted stock and similar awards to employees. 

   Per Share Amounts--Per share amounts are determined by dividing loss 
applicable to common stockholders by weighted average shares outstanding. 
Weighted average shares include redeemable common shares outstanding. Loss 
applicable to common stockholders represents net loss adjusted for accrued 
dividends on the redeemable preferred stock. 

   All references in the financial statements to the number of shares and per 
share amounts of the Company's common stock have been retroactively restated 
to reflect the increased number of common shares outstanding resulting from a 
stock split (See Note 11). 

   Management Estimates--The preparation of financial statements in 
conformity with generally accepted accounting principles requires management 
to make estimates and assumptions that affect the reported amounts of assets 
and liabilities and disclosure of contingent assets and liabilities at the 
date of the financial statements and the reported amounts of revenues and 
expenses during the reporting period. Actual results could differ from those 
estimates. 

                                     F-8 
 

                         U.S. FRANCHISE SYSTEMS, INC. 
                               AND SUBSIDIARIES 

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 
                AS OF DECEMBER 31, 1995 AND JUNE 30, 1996 AND 
               FOR THE PERIOD FROM AUGUST 28, 1995 (INCEPTION) 
                 TO DECEMBER 31, 1995 AND FOR THE SIX MONTHS 
                             ENDED JUNE 30, 1996 

3. REDEEMABLE PREFERRED STOCK 

   The cumulative redeemable exchangeable preferred stock (the "redeemable 
preferred stock") earns cumulative dividends at an annual dividend rate of 
10%, payable in additional shares of redeemable preferred stock when 
declared. The redeemable preferred stock is, at the Company's option, 
redeemable or exchangeable into 10% subordinated debentures due September 29, 
2007 at $100 per share plus accrued and unpaid dividends (the "Liquidation 
Value") at any time before September 29, 2007. If issued, 50% of the interest 
due on the debentures may be paid partially in kind by the issuance of 
additional debentures at the option of the Company, with the balance of 
interest payable in cash. On September 29, 2007, the redeemable preferred 
stock is required to be redeemed at the Liquidation Value. 

4. EQUIPMENT 

   Equipment is recorded at historical cost and consisted of the following: 



                                        December 31,    June 30, 
                                            1995          1996 
                                            ----          ---- 
                                                  
Furniture and fixtures                    $ 25,000      $ 56,000 
Computer equipment and software             16,000        69,000 
Office equipment                            21,000        32,000 
Architectural plans and renderings          75,000       251,000 
                                          --------      -------- 
                                           137,000       408,000 
Accumulated depreciation                    (3,000)      (19,000) 
                                          --------      -------- 
                                          $134,000      $389,000 
                                          ========      ======== 


   Architectural plans and renderings are depreciated on a straight-line 
basis over a period of 15 years. Computer software is depreciated on a 
straight-line basis over a period of 3 years. Computer equipment is 
depreciated using the 200% declining-balance method over a period of 5 years. 
The remaining fixed assets are depreciated using the 200% declining-balance 
method over a period of 7 years. 

5. LEASES 

   The Company leases certain equipment and office space used in its 
operations. Rental expense under operating leases was $41,000 for the period 
from August 28, 1995 to December 31, 1995 and $111,000 for the six months 
ended June 30, 1996. The future minimum rental commitments under 
noncancelable operating leases at June 30, 1996 were as follows: 



                          
1996                         $131,000 
1997                          259,000 
1998                          203,000 
1999                          207,000 
2000                          146,000 
                             -------- 
Total minimum payments       $946,000 
                             ======== 


                                     F-9 
 

                         U.S. FRANCHISE SYSTEMS, INC. 
                               AND SUBSIDIARIES 

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 
                AS OF DECEMBER 31, 1995 AND JUNE 30, 1996 AND 
               FOR THE PERIOD FROM AUGUST 28, 1995 (INCEPTION) 
                 TO DECEMBER 31, 1995 AND FOR THE SIX MONTHS 
                             ENDED JUNE 30, 1996 

6. DUE TO HUDSON HOTELS CORPORATION 

   The Company is required to pay Hudson $1,437,000 ($1,700,000 discounted at 
a rate of 10%), which represents the balance due for the assets of the 
Microtel hotel system (see Note 1), payable on October 5, annually, as 
follows: 



                       
1996                      $  706,000 
1997                         277,000 
1998                         454,000 
                          ---------- 
                           1,437,000 
Less current portion        (706,000) 
                          ---------- 
                          $  731,000 
                          ========== 


7. PREPAID EXPENSES 

   Pursuant to the Microtel Agreement, Hudson is required, for a period of 
three years, to consult with and assist in establishing the Company as an 
operating entity in the business of selling and administering franchises 
utilizing the Microtel hotel system. An initial payment in the amount of 
$400,000 was made to Hudson in October 1995 and recorded as a prepaid 
expense. The Company is obligated to pay an additional $150,000 in each of 
1996 and 1997 in connection with such consulting arrangements. Such amounts 
are being amortized over the term of the Microtel Agreement. Amortization 
expense of $58,000 and $117,000 was charged to expense for the period ended 
December 31, 1995 and for the six months ended June 30, 1996, respectively. 

8. STOCK PURCHASED BY EMPLOYEES 

   On October 5, 1995, as part of the initial capitalization of the Company, 
two of its officers (the "Original Management Investors") purchased 5,485,259 
shares of common stock (51% of the total issued) pursuant to "Stock Purchase 
Agreements" for an aggregate purchase price of $567,245 or $.1034 per share. 
Of such shares, 2,688,850 were unrestricted (the "Unrestricted Shares") and 
the remaining shares were restricted (the "Restricted Shares") as to voting 
rights and the ability to receive dividends as well as being subject to a 
ten-year vesting and an earnings test. Included in the shares issued pursuant 
to the Stock Purchase Agreements were Unrestricted Shares representing 5% of 
the then outstanding common stock and Restricted Shares representing 6% of 
the then outstanding common stock (the "Transferable Shares"), which could be 
redeemed from the Original Management Investors by the Company at $.1034 per 
share and reissued to other members of the Company's management at the 
discretion of the Stock Reallocation Committee of the Board of Directors. 

   
   In February 1996, the Company redeemed 826,833 of the Transferable Shares 
from the Original Management Investors at $.1034 per share and resold such 
shares to other members of management at the estimated fair value at that 
time of $.1034 per share. In April 1996, the Company redeemed 322,669 
Transferable Shares from other management at $.1034 per share and 
subsequently resold such shares to other management at the estimated fair 
value at that time of $.1137 per share. 

   All Transferable Shares are subject to a vesting schedule, so that 
unrestricted Transferable Shares vest over a five-year period and restricted 
Transferable Shares vest over a ten-year period, in each case provided that 
the management employee who purchased the shares remains employed by the 
Company. Any Transferable Shares which are forfeited will be repurchased by 
the Company and will be reoffered to the Original Management Investors at 
$.1034 per share. Compensation expense will be recorded to the extent the 
fair value of the reoffered shares exceeds $.1034. 

   Restricted Shares are earned using a formula based upon increases in the 
Company's earnings before interest, taxes, and depreciation. Earned shares 
would generally be forfeited if the holder's employment ceases before 
September 29, 2005. Any Restricted Shares that have not been earned by 
September 29, 2005 will be redeemed 
    

                                     F-10 
 

   
                         U.S. FRANCHISE SYSTEMS, INC. 
                               AND SUBSIDIARIES 

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 
                AS OF DECEMBER 31, 1995 AND JUNE 30, 1996 AND 
               FOR THE PERIOD FROM AUGUST 28, 1995 (INCEPTION) 
                 TO DECEMBER 31, 1995 AND FOR THE SIX MONTHS 
                             ENDED JUNE 30, 1996 

8. STOCK PURCHASED BY EMPLOYEES (Continued) (Continued) 
    

   
by the Company and reissued to the original stockholders of the Company 
(other than the Original Management Investors) pro rata based on their 
original holdings of common stock. Restricted Shares held by the Original 
Management Investors and all Transferable Shares held by other members of 
management have been classified as redeemable common stock in the balance 
sheet because they are redeemable by the Company in certain circumstances for 
reasons not under the Company's control. 
    

   
   In the event that substantially all of the Company's stock or assets are 
transferred or sold, or upon a business combination, earned shares 
automatically become unrestricted. In addition, any remaining Restricted 
Shares at the time of a merger or sale of the Company become unrestricted to 
the extent that the then value of the Company results in an internal rate of 
return to the original stockholders of the Company of 40% compounded 
annually. 
    

   
   The Company accounts for stock plans under the provisions of FASB 
Statement 123, "Accounting for Stock--Based Compensation." As the fair value 
of the stock purchased by officers and other employees described above 
approximated the purchase price, no compensation has been recorded. The Stock 
Purchase Agreements were amended in 1996 (see Note 11). 
    

9. INCOME TAXES 

   Deferred income taxes in the accompanying consolidated statement of 
financial position includes the following amounts of deferred tax assets and 
liabilities: 



                                     December 31,       June 30, 
                                         1995             1996 
                                         ----             ---- 
                                                 
Deferred tax liability                                 $ (487,000) 
Deferred tax asset                      441,000         2,125,000 
Valuation allowance                    (441,000)       (1,638,000) 
                                       --------        ---------- 
Net deferred income taxes              $     --        $       -- 
                                       ========        ========== 


   The deferred tax liability results primarily from the deferral of 
franchise sales commissions for financial reporting purposes. The deferred 
tax asset results from tax net operating loss carryforwards and the deferral 
of initial franchise fees for financial reporting purposes. 

   For income tax purposes, as of June 30, 1996, the Company had accumulated 
net operating loss carryforwards of $2,792,000 which expire through the year 
2011. 

   The following is a reconciliation of the statutory rate to the effective 
rate of the Company: 



                                                December 31,     June 30, 
                                                   1995           1996 
                                                   ----           ---- 
                                                           
Statutory federal rate                              34.0%         34.0% 
Statutory state rate less federal effect             4.0           4.0 
Other                                                 --          (1.0) 
Change in valuation allowance                      (38.0)        (37.0) 
                                                   -----         ----- 
Effective tax rate                                    --%           --% 
                                                   -----         ----- 


                                     F-11 
 

   
                         U.S. FRANCHISE SYSTEMS, INC. 
                               AND SUBSIDIARIES 

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 
                AS OF DECEMBER 31, 1995 AND JUNE 30, 1996 AND 
               FOR THE PERIOD FROM AUGUST 28, 1995 (INCEPTION) 
                 TO DECEMBER 31, 1995 AND FOR THE SIX MONTHS 
                             ENDED JUNE 30, 1996 

10. COMMITMENTS 
    

   The Company, as part of the Microtel Agreement, is required to fulfill 
certain obligations under such Agreement. These include the following: 

   To execute franchise agreements and to have open or under development the 
following number of Microtel hotels each December annually: 



                       Number 
Year                 of Hotels 
- ----                 --------- 
                     
1997                     50 
1998                    100 
1999                    175 
2000                    250 


   The above development schedule is considered to have been complied with 
unless such schedule is not met for two consecutive years. If 75% of the 
development level has been met, a fee of $1,000,000 may be paid and upon such 
payment, the Company will be deemed to be in compliance with such schedule. 

   Hudson will retain the right to receive franchise application fees and all 
franchise royalty payments under existing agreements at October 5, 1995 or 
under agreements for which franchise applications had been received as of 
October 5, 1995, except for the reservation and marketing fees, which are 
retained by the Company. 

   As part of the Microtel Acquisition, Hudson retained the right to 
franchise and to receive royalties on 60 franchises either issued or which 
may be issued in the future to Hudson, its affiliates and certain other 
persons. For each new franchise other than the 60 issued or which may be 
issued to Hudson, its affiliates and such other persons, the Company is 
required to remit to Hudson a continuing monthly royalty equal to 1.0% of the 
revenues subject to royalties on the first 100 properties opened by the 
Company, 0.75% for the next 150 properties, and 0.5% for each new property 
after the first 250 properties. 

   If any of the above obligations are not met, including the payment of 
amounts due to Hudson (see Note 6), all of the rights to the Microtel system 
may, at Hudson's discretion, revert back to Hudson. In the event Hudson 
exercises its right to the Microtel system, the Company, through Microtel 
Inns and Suites Franchising, Inc., will retain the rights to any franchise 
royalty payments due under franchises granted by the Company and its 
subsidiary, less certain processing fees due to Hudson. 

   The Company, as part of the Hawthorn Agreement, is required to fulfill 
certain obligations under such agreement. These include the following: 

   To execute qualified franchise agreements, as defined in the Hawthorn 
Agreement, for the operation of the following number of Hawthorn hotels (the 
"Termination Standard") on June 27, annually: 



                     Number of 
Year                  Hotels 
- ----                 --------- 
                     
1997                     10 
1998                     20 
1999                     40 
2000                     60 
2001                     80 
2002                    100 


                                     F-12 
 

                         U.S. FRANCHISE SYSTEMS, INC. 
                               AND SUBSIDIARIES 

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 
                AS OF DECEMBER 31, 1995 AND JUNE 30, 1996 AND 
               FOR THE PERIOD FROM AUGUST 28, 1995 (INCEPTION) 
                 TO DECEMBER 31, 1995 AND FOR THE SIX MONTHS 
                             ENDED JUNE 30, 1996 

10. COMMITMENTS (Continued) 

   
   If the above franchising schedule is not met, HSA has the right to 
terminate the Hawthorn Agreement, at which time the Company would lose its 
right to franchise the Hawthorn brand. The Company will retain the rights to 
a percentage of the franchise royalty payments received from new franchises 
in existence as of the effective date of the termination based on the level 
of achievement of the Termination Standard. 
    

   For franchises open or under construction or with respect to which 
franchise agreements had been executed as of March 27, 1996, the date on 
which the Company acquired the rights to franchise the Hawthorn brand (the 
"Existing Hawthorn Hotels"), the Company is required to remit to HSA a 
continuing royalty of 100% of franchise royalty and termination fees 
received. 

   For each new franchise (i.e., other than Existing Hawthorn Hotels) the 
Company is required to remit to HSA a continuing royalty ranging from 25.3% 
to 67.3% (based on the number of hotel rooms) of franchise royalty fees 
collected. The Company owns a 1% interest in HSA which entitles the Company 
to receive 1% of the gross revenues received by HSA from the Company with 
respect to all new franchises. Royalties due to HSA on new Hawthorn hotels 
are subject to increase if the royalties required to be paid under franchise 
agreements are less than 4% of gross room revenues or if the number of 
qualified franchise agreements for new Hawthorn hotels on new franchises is 
less than the following: 



                            Number of 
    Date                      Hotels 
    ----                      ------ 
                            
June 27, 1997                   20 
December 27, 1997               30 
June 27, 1998                   40 
June 27, 1999                   65 
June 27, 2000                   90 
June 27, 2001                  115 
June 27, 2002                  140 
 

   The Company is required to employ at least 15 persons devoted to the sales 
and promotion of the Hawthorn and Microtel brands and is required to spend 
not less than $100,000 on marketing during 1996 and 1997 promoting the 
Hawthorn brand. 

   The Company is required to reimburse HSA for amounts previously advanced 
by HSA to a reservation and advertising fund in connection with the Existing 
Hawthorn Hotels in an amount not to exceed $179,000. 

   Under the Hawthorn Acquisition Agreement, the Company and its affiliates 
are generally restricted until June 27, 1998 from franchising any lodging 
brands other than (i) Hawthorn brand hotels, (ii) Microtel brand hotels, and 
(iii) other limited-service non-suite hotels with an average daily rate of 
$49 and under. Until June 27, 1997, the Company generally must also refrain 
from franchising any brands outside of the lodging industry. 

11. SUBSEQUENT EVENTS 

   
   On October 11, 1996, the stockholders approved the creation of two classes 
of common stock: Class A Common Stock, par value $.01 per share and Class B 
Common Stock, par value $.01 per share, and to split and reclassify each 
share of its existing common stock, par value $.10 per share, into 9.67 
shares of Class A Common Stock. In connection with the reclassification, 
certain members of management and related stockholders holding 2,707,919 
shares of Class A Common Stock will exchange such shares for the same number 
of shares of Class B Common Stock. Shares of Class A Common Stock and Class B 
Common Stock will be identical in all respects except that (i) holders of 
Class B Common Stock shall be entitled to ten votes per share and holders of 
Class A Common Stock will be entitled to one vote per share and (ii) the 
Class B Common Stock will be convertible into Class A Common 
    


                                     F-13 
 

                         U.S. FRANCHISE SYSTEMS, INC. 
                               AND SUBSIDIARIES 

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 
                AS OF DECEMBER 31, 1995 AND JUNE 30, 1996 AND 
               FOR THE PERIOD FROM AUGUST 28, 1995 (INCEPTION) 
                 TO DECEMBER 31, 1995 AND FOR THE SIX MONTHS 
                             ENDED JUNE 30, 1996 

11. SUBSEQUENT EVENTS (Continued) 

   
Stock at the option of the holder and, with limited exceptions, upon the 
transfer thereof. Following the reclassification, there will be 30 million 
shares of Class A Common Stock and 5 million shares of Class B Common Stock 
authorized for issuance. All references in the financial statements to the 
number of shares and per share amounts of the Company's common stock have 
been retroactively restated to reflect the increased number of common shares 
outstanding. 
    

   In addition, prior to and contingent upon the completion of the proposed 
public offering, the Stock Purchase Agreements described in Note 8 were 
amended to revise the vesting requirements with respect to 50% of the 
Restricted Shares (approximately 13% of the Common Stock outstanding before 
the offering). Such shares will be deemed to be earned and vested shares 
notwithstanding the fact that performance criteria have not been met by the 
Company. Remaining Restricted Shares will be Class A Common Stock when earned 
under the Agreements. No effect has been given in the historical financial 
statements for the change in vesting requirements. 

   
   On October 11, 1996, the Company's stockholders approved two stock option 
plans, one for officers, employees, consultants and advisors of the Company 
(the "Employee Plan") and one for its non-employee directors (the "Directors 
Plan" and together with the Employee Plan, the "Option Plans"). The Employee 
Plan authorizes the grant of awards to eligible participants of a maximum of 
325,000 shares of the Company's Class A Common Stock, subject to terms, 
including exercise price and timing of exercise, which are determinable by 
the Board of Directors. The Directors Plan provides for the issuance of 2,000 
shares of Class A Common Stock each year to each non-employee director. 
Options vest and become exercisable under the Directors Plan one year from 
the date of grant. Immediately prior to the proposed public offering, the 
Board of Directors intends to award options to purchase a total of 10,000 
shares of Class A Common Stock to its five non-employee directors and to 
award to eligible participants under the Employee Plan options to purchase 
168,100 shares of Class A Common Stock at the public offering price. The 
options issued under the Employee Plan will vest over a four year period and 
will expire 10 years from the date of grant. Compensation expense will be 
recorded in accordance with FASB Statement 123, "Accounting for Stock Based 
Compensation" for the fair value of the options awarded under the Option 
Plans. 
    


                                     F-14 
 

================================================================================

No dealer, salesman or other individual has been authorized to give any 
information or to make any representations not contained in this Prospectus 
in connection with the Offering covered by this Prospectus. If given or made, 
such information or representations must not be relied upon as having been 
authorized by the Company or the Underwriters. This Prospectus does not 
constitute an offer to sell, or a solicitation of an offer to buy, the Class 
A Common Stock in any jurisdiction where, or to any person to whom, it is 
unlawful to make such offer or solicitation. Neither the delivery of this 
Prospectus nor any sale made hereunder shall, under any circumstances, create 
any implication that there has not been any change in the facts set forth in 
this Prospectus or affairs of the Company since the date hereof. 

                                ------------- 

                              TABLE OF CONTENTS 



                                                          Page 
                                                          ---- 
                                                       
Prospectus Summary                                          3 
Risk Factors                                                9 
Use of Proceeds                                            15 
Dividend Policy                                            15 
Capitalization                                             16 
Dilution                                                   17 
Selected Financial Data                                    18 
Management's Discussion and Analysis of Financial 
  Condition and Results of Operations                      19 
Business                                                   22 
Management                                                 36 
Certain Relationships and Related Transactions             42 
Principal Stockholders                                     44 
Selling Stockholders                                       50 
Description of Capital Stock                               51 
Underwriting                                               55 
Shares Eligible for Future Sale                            56 
Validity of Class A Common Stock                           56 
Experts                                                    56 
Available Information                                      57 
Index to Consolidated Financial Statements                F-1 

                                ------------- 

   Until              , 1996 (25 days after the commencement of the 
Offering), all dealers effecting transactions in the Class A Common Stock, 
whether or not participating in this distribution, may be required to deliver 
a Prospectus. This is in addition to the obligation of dealers to deliver a 
Prospectus when acting as Underwriters and with respect to their unsold 
allotments or subscriptions. 
- ---=============================================================================

                               2,325,000 Shares 

                             [US FRANCHISE LOGO] 

                                U.S. Franchise 
                                Systems, Inc. 

                             Class A Common Stock 
                              ($0.01 par value) 

                           Schroder Wertheim & Co. 
                            Montgomery Securities 

   
                                    , 1996 

================================================================================
    

 

                                    PART II

                    INFORMATION NOT REQUIRED IN PROSPECTUS 

Item 13. Other Expenses of Issuance and Distribution 

   The following table sets forth all expenses, other than underwriting 
discounts and commissions, in connection with the issuance and distribution 
of the securities registered hereby. All the amounts shown are estimates, 
except for the Securities and Exchange Commission registration fee, the NASD 
filing fee and the Nasdaq National Market listing fee. All of the following 
fees and expenses will be paid by the Company. 



                                                                      
Securities and Exchange Commission registration fee                     $ 12,377.66 
NASD filing fee                                                            4,243.25 
Nasdaq National Market listing fee                                        43,280.00 
Printing and engraving expenses                                          110,000.00 
Legal fees and expenses                                                  400,000.00 
Accounting fees and expenses                                             300,000.00 
Blue Sky fees and expenses (including counsel fees and expenses)          20,000.00 
Transfer Agent and Registrar fees and expenses                             4,000.00 
Miscellaneous                                                             50,000.00 
                                                                        ----------- 
  Total                                                                 $943,900.91 
                                                                        =========== 


   
Item 14. Indemnification of Directors and Officers 
    

   Section 145(a) of the General Corporation Law of the State of Delaware 
provides that a Delaware corporation may indemnify any person who was or is a 
party or is threatened to be made a party to any threatened, pending or 
completed action, suit or proceeding, whether civil, criminal, administrative 
or investigative (other than an action by or in the right of the corporation) 
by reason of the fact that he is or was a director, officer, employee or 
agent of the corporation or is or was serving at the request of the 
corporation as a director, officer, employee or agent of another corporation 
or enterprise, against expenses, judgments, fines and amounts paid in 
settlement actually and reasonably incurred by him in connection with such 
action, suit or proceeding if he acted in good faith and in a manner he 
reasonably believed to be in or not opposed to the best interests of the 
corporation, and, with respect to any criminal action or proceeding, had no 
cause to believe his conduct was unlawful. 

   Section 145(b) provides that a Delaware corporation may indemnify any 
person who was or is a party or is threatened to be made a party to any 
threatened, pending or completed action or suit by or in the right of the 
corporation to procure a judgment in its favor by reason of the fact that 
such person acted in any of the capacities set forth above, against expenses 
actually and reasonably incurred by him in connection with the defense or 
settlement of such action or suit if he acted under similar standards, except 
that no indemnification may be made in respect of any claim, issue or matter 
as to which such person shall have been adjudged to be liable to the 
corporation unless and only to the extent that the court in which such action 
or suit was brought shall determine that despite the adjudication of 
liability, such person is fairly and reasonably entitled to be indemnified 
for such expenses which the court shall deem proper. 

   Section 145 further provides that to the extent a director or officer of a 
corporation has been successful in the defense of any action, suit or 
proceeding referred to in subsections (a) and (b) or in the defense of any 
claim, issue, or matter therein, he shall be indemnified against expenses 
actually and reasonably incurred by him in connection therewith; that 
indemnification provided for by Section 145 shall not be deemed exclusive of 
any other rights to which the indemnified party may be entitled; and that the 
corporation may purchase and maintain insurance on behalf of a director or 
officer of the corporation against any liability asserted against him or 
incurred by him in any such capacity or arising out of his status as such 
whether or not the corporation would have the power to indemnify him against 
such liabilities under such Section 145. 

   Section 102(b)(7) of the General Corporation Law provides that a 
corporation in its original certificate of incorporation or an amendment 
thereto validly approved by stockholders may eliminate or limit personal 
liability of 

                                     II-1 

 
members of its board of directors or governing body for breach of a 
director's fiduciary duty. However, no such provision may eliminate or limit 
the liability of a director for breaching his duty of loyalty, failing to act 
in good faith, engaging in intentional misconduct or knowingly violating a 
law, paying a dividend or approving a stock repurchase which was illegal, or 
obtaining an improper personal benefit. A provision of this type has no 
effect on the availability of equitable remedies, such as injunction or 
rescission, for breach of fiduciary duty. The Company's Charter contains such 
a provision. 

   The Company's Charter further provides that the Company shall indemnify 
its officers and directors and, to the extent authorized by the Board of 
Directors, employees and agents of the Company, to the fullest extent 
permitted by and in the manner permissible under the laws of the State of 
Delaware. 

   In addition, prior to the completion of the Offering, the Company intends 
to enter into agreements (the "Indemnification Agreements") with each of the 
directors of the Company pursuant to which the Company will agree to 
indemnify each director against claims, liabilities, damages, expenses, 
losses, costs, penalties or amounts paid in settlement (collectively, 
"Losses") incurred by such director and arising out of his capacity as a 
director, officer, employee and/or agent of the Company to the maximum extent 
permitted by applicable law. In addition, each director shall be entitled to 
an advance of expenses to the maximum extent authorized or permitted by law 
to meet the obligations indemnified against. The Indemnification Agreements 
also obligate the Company to purchase and maintain insurance for the benefit 
and on behalf of each of its directors insuring such director in or arising 
out of his capacity as a director, officer, employee and/or agent of the 
Company. 

Item 15. Recent Sales of Unregistered Securities 

   During the past three years, the Company has issued the following 
securities, none of which have been registered under the Securities Act. 

   On September 29, 1995, as part of the initial capitalization of the 
Company, the Company issued a total of 1,112,245 shares of Old Common Stock 
to the Original Investors, for an aggregate purchase price of $1,112,245 or 
$1.00 per share. The offer and sale of such securities was made pursuant to 
the exemption provided by Section 4(2) of the Securities Act. 

   On September 29, 1995, simultaneously with the issuances of Old Common 
Stock described above, the Company also issued a total of 163,500 shares of 
Redeemable Preferred Stock to the Original Investors, for an aggregate 
consideration of $16,350,000 or $100 per share. The offer and sale of such 
securities was made pursuant to the exemption provided by Section 4(2) of the 
Securities Act. 

   
   In addition, since September 29, 1995 the Company has from time to time 
issued shares of Old Common Stock to members of management. Specifically, on 
February 7, 1996 (the "February Transaction"), Messrs. Leven and Aronson sold 
a total of 85,505 shares of Old Common Stock to the Company for $85,505 or 
$1.00 per share. The Company in turn immediately reissued these 85,505 shares 
to other members of the Company's management at the same price of $1.00 per 
share. In April 1996 (the "April Transaction"), the Company redeemed 33,368 
shares of Old Common Stock from certain management holders at $1.00 per 
share. The Company subsequently reissued these 33,368 shares to members of 
the Company's management at a price of $1.10 per share. The April Transaction 
occurred at $1.10 per share instead of $1.00 per share due to the increase in 
the value of the Company from February 7, 1996 resulting from the beginning 
of the Company's franchise sales activities and the execution of the Hawthorn 
Acquisition Agreement. See "Principal Stockholders--Management's Shares of 
Common Stock". 
    


Item 16. Exhibits and Financial Statement Schedules 

   (a) Exhibits. 



            
Exhibit 
 Number        Description 
- -------        ----------------------------------------------------------------------------------------------------------------- 
 1.1           Form of Underwriting Agreement 
 3.1**         Amended and Restated Certificate of Incorporation of U.S. Franchise Systems, Inc. 
 3.2**         Amended and Restated Bylaws of U.S. Franchise Systems, Inc. 

                                     II-2 

 
 4.1**         Specimen Common Stock Certificate of U.S. Franchise Systems, Inc. 
 5.1           Opinion of Paul, Weiss, Rifkind, Wharton & Garrison. 
10.1**         Form of License Agreement for Microtels. 
10.2**         Form of License Agreement for Hawthorn Suites hotels. 
10.3**         Joint Venture Agreement between Microtel Franchise and Development Corporation and U.S. Franchise Systems, Inc., 
               dated as of September 7, 1995. The Registrant agrees to furnish a copy of any omitted schedule supplementally 
               to the Commission upon request. 
10.4**         Master Franchise Agreement between HSA Properties, L.L.C. and U.S. Franchise Systems, Inc., dated as of March 
               27, 1996. The Registrant agrees to furnish a copy of any omitted schedule supplementally to the Commission upon 
               request. 
10.5**         Amended and Restated Stockholders' Agreement, dated as of September 29, 1995, as amended on October 11, 1996, 
               among the Company and the Original Investors. 
10.6           Amended and Restated Employee Stock Purchase Agreement between U.S. Franchise Systems, Inc. and Michael A. Leven, 
               entered into as of September 29, 1995, as amended effective simultaneously with the closing of the Offering. 
10.7           Amended and Restated Employee Stock Purchase Agreement between U.S. Franchise Systems, Inc. and Neal K. Aronson, 
               entered into as of September 29, 1995, as amended effective simultaneously with the closing of the Offering. 
10.8**         Employment Agreement by and between U.S. Franchise Systems, Inc. and Michael A. Leven, dated as of October 1, 
               1995. 
10.9**         Employment Agreement by and between U.S. Franchise Systems, Inc. and Neal K. Aronson, dated as of October 1, 
               1995. 
10.10          Voting Agreement between Michael A. Leven and Andrea Leven, to be entered into simultaneously with the closing 
               of the Offering. 
10.11          Voting Agreement between Michael A. Leven and Neal K. Aronson, to be entered into simultaneously with the closing 
               of the Offering. 
10.12**        Office Lease Agreement between Hallwood Real Estate Investors Fund XV and U.S. Franchise Systems, Inc., dated 
               September 25, 1995. 
10.13**        First Amendment to Office Lease between Hallwood 95, L.P. and U.S. Franchise Systems, Inc., dated May 20, 1996. 
10.14          U.S. Franchise Systems, Inc. 1996 Stock Option Plan. 
10.15          U.S. Franchise Systems, Inc. 1996 Stock Option Plan for Non-Employee Directors. 
10.16**        Term Sheet, dated May 14, 1996, between the Company and NACC regarding the Franchisee Financing Facility. 
21.1**         List of Subsidiaries of U.S. Franchise Systems, Inc. 
23.1           Consent of Paul, Weiss, Rifkind, Wharton & Garrison (contained in the opinion filed as Exhibit 5.1 hereto). 
23.2           Consent of Deloitte & Touche LLP. 
23.3**         Consent of Dean S. Adler. 
23.4**         Consent of Jeffrey A. Sonnenfeld. 
24.1**         Power of Attorney from officers and directors (contained on signature page). 
27.1**         Financial Data Schedule. 


- ------------- 
** Previously Filed. 

(b)            Financial Statement Schedules. none required. 

Item 17. Undertakings 

   Insofar as indemnification for liabilities arising under the Securities 
Act may be permitted to directors, officers and controlling persons of the 
registrant pursuant to the provisions described under Item 15 above, or 
otherwise, the registrant has been advised that in the opinion of the 
Securities and Exchange Commission, such indemnification is against public 
policy as expressed in the Securities Act and is, therefore, unenforceable. 
In the event that a claim for indemnification for such liabilities (other 
than the payment by the registrant of expenses incurred or paid by a 
director, officer or controlling person of the registrant in the successful 
defense of any action, suit or proceeding) is 

                                     II-3 

 
asserted by such director, officer or controlling person in connection with 
the securities being registered, the registrant will, unless in the opinion 
of its counsel the matter has been settled by controlling precedent, submit 
to a court of appropriate jurisdiction the question whether such 
indemnification by it is against public policy as expressed in the Securities 
Act and will be governed by the final adjudication of such issue. 

   The undersigned registrant hereby undertakes: 

     (1) For purposes of determining any liability under the Securities Act 
   of 1933, the information omitted from the form of prospectus filed as part 
   of this Registration Statement in reliance upon Rule 430A and contained in 
   a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or 
   (4) or 497(h) under the Securities Act shall be deemed to be part of this 
   Registration Statement as of the time it was declared effective. 

     (2) For the purpose of determining any liability under the Securities 
   Act of 1933, each post-effective amendment that contains a form of 
   prospectus shall be deemed to be a new registration statement relating to 
   the securities offered therein, and the offering of such securities at 
   that time shall be deemed to be the initial bona fide offering thereof. 

     (3) To provide to the Underwriters at the closing specified in the 
   underwriting agreements certificates in such denominations and registered 
   in such names as required by the Underwriters to permit prompt delivery to 
   each purchaser. 

                                     II-4 

 
SIGNATURES 

   
   Pursuant to the requirements of the Securities Act of 1933, as amended, 
the registrant has duly caused this registration statement to be signed on 
its behalf by the undersigned, thereunto duly authorized, in the City of 
Atlanta, State of Georgia, on October 21, 1996. 
    

                                      By: /s/ Michael A. Leven 
                                           ----------------------------------- 
                                          Michael A. Leven 
                                          Chairman, President and 
                                          Chief Executive Officer 

   
   Pursuant to the requirements of the Securities Act of 1933, as amended, 
this registration statement has been signed by the following persons on 
October 21, 1996 in the capacities indicated. 
    




         Signatures                   Title or Capacities 
- ----------------------------    -------------------------------- 
                             
              *                 Chairman, President, Chief 
 ---------------------------    Executive Officer and 
       Michael A. Leven         Director (Principal Executive 
                                Officer) 

              * 
 --------------------------- 
         Irwin Chafetz          Director 

              * 
 --------------------------- 
     Richard D. Goldstein       Director 

              * 
 --------------------------- 
       Barry Sternlicht         Director 

By /s/   Neal K. Aronson        Executive Vice President, 
    -------------------------   Chief Financial Officer and 
         Neal K. Aronson        Director (Principal Financial 
         Attorney-in-Fact       and Accounting Officer) 


                                     II-5 


                               INDEX TO EXHIBITS



Exhibit 
 Number        Description                                                                                           Page 
- -------        -------------------------------------------------------------------------------------------------     ---- 
                                                                                                               
 1.1           Form of Underwriting Agreement 
 3.1**         Amended and Restated Certificate of Incorporation of U.S. Franchise Systems, Inc. 
 3.2**         Amended and Restated Bylaws of U.S. Franchise Systems, Inc. 
 4.1**         Specimen Common Stock Certificate of U.S. Franchise Systems, Inc. 
 5.1           Opinion of Paul, Weiss, Rifkind, Wharton & Garrison. 
10.1**         Form of License Agreement for Microtels. 
10.2**         Form of License Agreement for Hawthorn Suites hotels. 
10.3**         Joint Venture Agreement between Microtel Franchise and Development Corporation and U.S. Franchise 
               Systems, Inc., dated as of September 7, 1995. The Registrant agrees to furnish a copy of any 
               omitted schedule supplementally to the Commission upon request. 
10.4**         Master Franchise Agreement between HSA Properties, L.L.C. and U.S. Franchise Systems, Inc., 
               dated as of March 27, 1996. The Registrant agrees to furnish a copy of any omitted schedule 
               supplementally to the Commission upon request. 
10.5**         Amended and Restated Stockholders' Agreement, dated as of September 29, 1995, as amended on 
               October 11, 1996, among the Company and the Original Investors. 
10.6           Amended and Restated Employee Stock Purchase Agreement between U.S. Franchise Systems, Inc. 
               and Michael A. Leven, entered into as of September 29, 1995, as amended effective simultaneously 
               with the closing of the Offering. 
10.7           Amended and Restated Employee Stock Purchase Agreement between U.S. Franchise Systems, Inc. 
               and Neal K. Aronson, entered into as of September 29, 1995, as amended effective simultaneously 
               with the closing of the Offering. 
10.8**         Employment Agreement by and between U.S. Franchise Systems, Inc. and Michael A. Leven, dated 
               as of October 1, 1995. 
10.9**         Employment Agreement by and between U.S. Franchise Systems, Inc. and Neal K. Aronson, dated 
               as of October 1, 1995. 
10.10          Voting Agreement between Michael A. Leven and Andrea Leven, to be entered into simultaneously 
               with the closing of the Offering. 
10.11          Voting Agreement between Michael A. Leven and Neal K. Aronson, to be entered into simultaneously 
               with the closing of the Offering. 
10.12**        Office Lease Agreement between Hallwood Real Estate Investors Fund XV and U.S. Franchise Systems, 
               Inc., dated September 25, 1995. 
10.13**        First Amendment to Office Lease between Hallwood 95, L.P. and U.S. Franchise Systems, Inc., 
               dated May 20, 1996. 
10.14          U.S. Franchise Systems, Inc. 1996 Stock Option Plan. 
10.15          U.S. Franchise Systems, Inc. 1996 Stock Option Plan for Non-Employee Directors. 
10.16**        Term Sheet, dated May 14, 1996, between the Company and NACC regarding the Franchisee Financing 
               Facility. 
21.1**         List of Subsidiaries of U.S. Franchise Systems, Inc. 
23.1           Consent of Paul, Weiss, Rifkind, Wharton & Garrison (contained in the opinion filed as Exhibit 
               5.1 hereto). 
23.2           Consent of Deloitte & Touche LLP. 
23.3**         Consent of Dean S. Adler. 
23.4**         Consent of Jeffrey A. Sonnenfeld. 
24.1**         Power of Attorney from officers and directors (contained on signature page). 
27.1**         Financial Data Schedule. 


   
- ------------- 

** Previously Filed.