Important ConsiderationsOn August 27, 2021 by Susan
in Buying a Franchise
I review a lot of franchise disclosure documents (FDDs) for prospective franchisees in various franchise systems. Because I have also drafted FDDs for various franchise systems, I can advise prospective franchisees what is typical in a franchise agreement. It’s important for prospective franchisees to understand that certain provisions go to the heart of the franchise system and, therefore, are not negotiable. I can also pragmatically advise prospective franchisees what provisions may be negotiable, depending upon the prospective franchisee’s leverage.
It is also important for a prospective franchisee to do thorough due diligence on the franchisor, the franchise system and the franchise concept. Although virtually all franchise agreements are overwhelmingly one-sided, optimally the franchise agreement will be stored in a file cabinet (in the cloud, of course) and it won’t hurt you. If, however, the franchisor has the wrong attitude towards its franchise system, is not competent to operate a franchise system or is undercapitalized, the franchise agreement could be used to a franchisee’s serious detriment. Similarly, if the franchisee has the wrong attitude about being a franchisee, is not competent to operate the franchised business or is undercapitalized, the franchise agreement could be used to his serious detriment. Of course, if the franchise concept is not a good one, or the space is saturated, that could be problematic as well.
In addition to doing thorough due diligence, prospective franchisees should be aware of what franchising is and how franchise systems typically operate. Among the things you should be aware of are the following:
- The franchisor has the contractual right to decide what products and services you sell or provide. You don’t have the right to decide not to sell any of the required services You also don’t have the right to sell additional unauthorized services.
- The franchisor may change the products and services over time, as the franchise system evolves, without your consent – regardless of additional risk or cost to you. (The franchise agreement may contain certain caps on costs resulting from equipment or trade dress modifications, though.)
- The franchisor has no fiduciary duty to you. The franchisor typically makes decisions that benefit the franchise system as a whole, not any particular franchisee.
- A franchise is a long-term commitment, generally at least five years, but typically 10 years. If your franchise isn’t successful, or if it’s not a good fit for you, you are nevertheless obligated for the term of the franchise agreement. Optimally, you would be able to have another person take over your franchised business by selling it with the franchisor’s consent. If not and you just shut down our franchised business, you could be obligated to continue paying royalties, advertising contributions and/or other franchise fees through the end of the franchise agreement term.
- Despite signing the franchise agreement as a limited liability company or corporation, you will be required to sign a personal guaranty. Therefore, a franchisor can recover unpaid royalties, advertising contributions and other franchise fees from you personally (and attach your personal assets) if your limited liability company or corporation does not have adequate assets.
Operating the right franchised business with the right franchisor can be an avenue to success, if you’re the right franchisee. It’s important to do your due diligence, understand what you’re getting into and make an informed decision before you decide to move forward, though.
Susan E. Wells
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