Consequences of a Failed Franchise

For existing franchisees and individuals considering the purchase of a franchise‚ an extremely instructive – but unfortunate – discussion appeared on the question and answer section of CNNMoney’s Small Business website. In the article‚ “Escaping a franchise deal gone bad,” the franchisee of a children’s entertainment franchise inquired about her legal options following what appears to have been the unsuccessful launch of her business. In the article‚ the franchisee mentions a couple of important factors/issues that all prospective and current franchisees should consider.

Issue I – Insure that You Possess Adequate Capital Before Committing to a Franchise

In the article the franchisee mentions that to open the franchise‚ she needed $250‚000.00 in capital. She attributes a portion of her failure to her inability to raise adequate capital. However‚ this franchisee readily admits that she did not “attempt” to raise capital until after paying her franchise fee and signing the franchise agreement.

• How this Issue Should be Approached by Prospective Franchisees – Do not commit to a franchise agreement or pay a franchise fee until you are certain that you will have access to adequate capital. If this cannot be determined until you sign a franchise agreement then speak with your attorney about making the franchise agreement (and the payment or refund-ability of your franchise fee) conditional and subject to obtaining a specified amount of financing.

Issue II – Be Cautious with “Light or Express” Versions of a Full Service Franchise Concept

Although specifics are lacking in the article‚ the franchisee mentions that since she did not possess the recommended level of capital‚ she was permitted by the franchisor to open a “smaller version of the franchise”.

• How this Issue Should be Approached by Prospective Franchisees – Do not consider a “light” version of any full-service franchise concept unless the “light version” has been tested and successful in the marketplace. In other words‚ don’t become a Ginnie pig in an experiment where your life savings and financial stability is at stake. Also‚ be cautious of any franchisor who is willing to modify the established capital criteria and requirements.

Issue III – Be Cautious of Post-Termination Restrictive Covenants and Obligations

The franchisee mentions that she is looking to get her money back and set up her own‚ non-franchised‚ competing business.

• How this Issue Should be Approached by Prospective Franchisees – Initially it is critical to recognize that‚ as a franchisee‚ your obligations (including your non-compete) will‚ in most instances under most franchise agreements‚ exist for a set duration commencing from the date of termination of your franchise. This is a critical and important protection necessary for franchisors to preserve the integrity of their franchise system. For the prospective franchisee you must recognize – before signing a franchise agreement – that once you become a franchisee‚ your future actions will be restricted. Always obtain a clear understanding as to the scope and extent of these restrictions.

For current franchisees who find themselves in a similar situation‚ the article offers some good advice from Ed Teixeira of franchiseknowhow and attorney Robin Day Glenn. For prospective franchisees‚ the critical factor remains “look before you leap” – consult with an experienced franchise lawyer and do your homework.

By Charles Internicola December 8, 2014