How to Decipher Your Franchise Agreement
September 19, 2017 11:00 AM
It is finally happening. You are making your dreams come true and becoming your own boss by buying into a franchise, but before you get too excited make sure you know exactly what you are getting into.
A franchise agreement is a legally binding agreement between you and the franchisor. It lays out the terms and conditions of what will be expected by both parties. You will be asked to sign a franchise agreement when you officially become a franchisee.
In general the franchise agreement will include an overview of the relationship between you and the franchisor as well as the duration of the agreement. It should also state clearly what fees you will be expected to pay to the franchisor. There will be both initial fees and ongoing fees as well. In the agreement the franchisor will dictate what territory you have and what their standards are for site selection and development. Any training and support including advertising and marketing the franchisor will offer you will also be laid out in the agreement.
The Financial Disclosure Document
Probably the most important document you will have to review is the financial disclosure document (FDD).
These are the items you should pay extra attention to:
Item 3: Litigation. This section will include all current and past criminal and civil litigation for the franchisor, both those against them and those they are pursuing. Consider it a red flag if you see a bunch of lawsuits from franchisees against the franchisor or if there is a pending class action by consumers.
Item 4: Bankruptcy. In this section will be listed any bankruptcies that the franchisor or its management is going through.
Item 5: Initial fees. Here is where you will see exactly what you will be expected to pay to initially to open up your franchise unit. Two things to keep in mind is that sometimes these fees are negotiable so talk to the franchisor if you are interested in haggling. Second if the fees are listed as a range, ask if your fees will be on the lower or higher end.
Item 6: Other fees. This section will include other fees or payments you will be required to pay. Keep in mind that not all fees are listed here so make sure you do your research so you are prepared for any unexpected costs.
Item 7: Initial investment. These costs can vary so be sure to talk to other franchisees who are more experienced and find out how much money they needed to put up front before their business became profitable and how much of a salary they were able to draw in their first couple of years.
Item 11: Franchisor’s obligations. This is the part of the document which should outline what services you can expect from the franchisor like site selection, training, marketing/advertising, and developmental and operational assistance. Watch the language used in this section so it is clear what they are required to provide you and what they “might” offer you.
Item 12: Territory. Here is where you will see if you have any exclusive rights to any territory. Keep in mind that when you renew your contract these rights may change. Stay away from franchisors who don’t offer you any territory protection at all.
Item 13: Trademarks. Any pertinent information about the franchisor’s trademarks and trade names will be included here.
Item 14: Patents, copyrights and proprietary information. Read this section for clear instructions on how you can use the patents and copyrights.
Item 17: Renewal, termination, transfer and dispute resolution. This section will lay out clearly what your rights are as a franchisee and what rights you are giving up to the franchisor to be part of their program. Misunderstandings about this can cause major problems down the pike later so make sure you have a clear understanding.
Item 18: Public Figures. If any celebrities or public figures are a part of the brand, their names and how much they are paid will be in this section.
Item 19: Financial performance. Not all franchisors will provide information about their financial performance. If they do not lay it out here ask them one on one or reach out to a few of their current franchisees for some of this information.
Item 20: Franchisee information. Pay attention to how many units the franchisor has taken back and resold. A high number could indicate a high turnover. If contact information is provided for franchisees who have left the system, then see if you can reach out to them and pick their brain about the pros and cons of the franchisor.
Item 21: Financial statements. The franchisor should provide you with copies of financial statements for the last three years. Make sure to have an accountant who specializes in franchising to look them over for you. Remember that a franchisor with a troubling financial outlook will spell trouble for you if they continue to have problems.
Item 22: Contracts. Check to make sure that any contracts listed in this section are attached to the FDD. Don’t forget to go through each of them very carefully before making any final decisions.
Make sure that all the information in the FDD are consistent with the information in the final franchise agreement. If there are a lot of discrepancies, then you should raise your concern to the franchisor.
Hiring a Team to Back You Up
To protect your interests you should make sure you have a lawyer who is an expert at franchise agreements review all the documents for you and a franchise consultant to help you navigate the whole process of becoming a franchisee.
If you decide to hire a franchise consultant, make sure you research exactly what services a particular consultant can provide. Not every franchise consultant offers the same services. Common services include assistance with legal documentation as well as the development of all operations and training documentation and strategic planning to grow your franchise business.
When hiring a financial consultation, there are certain qualifications you should look for to make sure that you select the right person to assist you. You certainly want someone who has experience working the franchise industry. It could be as a franchisee themselves or as a key member of a franchisor’s leadership team. They should also have a good reputation in the industry and be willing and able to give you the undivided attention you need.