5 Factors to Consider Before Buying a Franchise
(Plus 7 Franchise Agreement Provisions that May be Negotiable)
If you are considering the purchase of a franchise then I am sure that there are many things that your are or should be evaluating and considering. Below are 5 critically important factors and issues that you should be considering and evaluating before you buy a franchise and before you sign a franchise agreement. There are many more than five‚ but the following is a start:
1. Due Diligence is Critical
Due diligence is all about evaluating your franchise investment before you pay a franchise fee and before uyou sign a franchise agreement. Look‚ you are about to make an extensive and multi-year commitment to a new business‚ so it is important that you conduct an in depth evaluation of both the franchisor and the potential franchise opportunity. Far too many franchisees just assume that if a franchise system has multiple units‚ a good product and good looking stores‚ that the franchise opportunity must be profitable. However “profitability” is not guaranteed and all franchises are not created equal. You must research and evaluate the franchisor‚ the franchise system and whether or not the franchise opportunity is a good fit for you. Of course‚ this all presumes that you have first found the right business for you and your personal goals.
2. Review and Evaluate the Franchisor’s FDD with a Qualified Professional
So‚ if you have identified a franchise that you are interested in then you have probably spoke to the franchisors sales staff and by now you should have received the franchisor’s Franchise Disclosure Document (“FDD”). Within the Franchisor’s FDD are legal disclosurs (those mandated by Federal law) that relate to important business and legal issues including: Information about the Franchisor‚ Information about the Franchised Business‚ Estimated Start-Up Costs‚ Upfront and continuing fees that you will be required to pay the franchisor‚ a list of franchisees and tables identifying the number of franchised usits that have been recently established and those that may have closed. The FDD must be provided to you by the franchisor at least 14 days prior to your execution of any franchise agreement or your payment of money. You need to consider the FDD as an important “life-line” that should be reviewed with an experienced franchise lawyer. At the core of this review must be an evaluation of your expectations and whether or not the legl rights set forth in the FDD accurately match your expectations. Dont rely on “verbal promises or statements” because if they are not in writing in the FDD then they are not real.
3. Contact Existing Franchisees
Existing franchisees – those that have already purchased‚ established and are operating the franchise that you are about to buy – represent one of the most important resources for you. These franchisees‚ potentially‚ represent your future and before signing a franchise agreement you need to politely contact them and discuss their experiences with the franchise system. You will want to ask questions about the franchisor support‚ the profitability of the business‚ franchisor advertising initiatives‚ what their approximate start-up costs were and their overall satisfaction with their investment decision. So‚ where do you get a list of franchisee’s to contact? In Item 20 of the Franchisor’s FDD. FDD Item 20 should contain a list of all franchisees‚ including their contact information‚ so use this as a starting point.
4. Know that Franchise Agreements are Indeed Negotiable
A common “myth” (one raised or claimed by many franchisors) is that franchise agreements are not negotiable. This is simply not true. That is‚ the vast majority of franchise agreements are in fact negotiable and franchisors are legally permitted to amend and modify their franchise agreements if the modification is due to a request by a franchisee who is acting to enhance his or her franchise rights. Look‚ not everything is negotiable but there are many reasonable franchisors out there and if you are also reasonable you may be able to negotiate some substantive franchise agreement changes that “enhance and clarify” your legal rights as a franchisee. Again‚while you can’t negotiate everything‚ some substantively important provisions that you should evaluate with your franchise lawyer and potentially negotiate‚ include:
- The scope of your protected territory and what the franchisor can and cannot do in your territory;
- Potential grace periods as to the accrual of your royalty obligations‚ including when they begin to accrue;
- Liquidated damages and limiting your liability if you terminate your franchise agreement due to poor performance;
- Your right to renew your franchise rights;
- Your right to transfer your franchise‚ including to family members for estate planning purposes;
- Your right to cure defaults claimed by the franchisor; and
- Potential rights of first refusal‚ allowing you to expand into new territories not yet sold by the franchisor.
5. Be Prepared: Sometimes You May Need to “Walk Away”
Look‚ I understand that starting a business and buying a franchise is an exciting process. This process represents an opportunity for change and to improve yourself and your economic prospects. But not every investment decision is the right one and sometimes‚ no matter how much you like or love a particular concept‚ you may need to “walk away”. So during the “due diligence” process you need to be “honest with yourself” and you must pay particular attention to any “red flags” that pop up‚ inconsistencies in the Franchisor’s information and concerns regarding the business model and potential for profitability.