Arlington Law Group has assisted numerous clients in navigating the complex legal issues relating to opening and running a franchise. Although using an existing franchise model can often simplify several of the steps in starting a new business (e.g., the need to establish a recognizable brand and build customer loyalty), the franchise model also adds a few layers of unique legal complexity that need to be addressed early in the process.
Our experience working with both franchisees (the new business buying into the franchise model) and franchisors (the existing business selling the franchise model) allows us to help our clients avoid several pitfalls associated with contracting to become a franchisee.
Investigating the Franchisor
Unfortunately, many potential franchisees that we have spoken with have not spent enough time and energy conducting due diligence (research and investigation) regarding the proposed franchisor. Many clients assume that if a franchisor is selling their business model, it must be successful and well established. This is not always the case. When researching a franchisor on behalf of a prospective client, we quickly discovered that they would be opening the first location of the franchise in the United States. In fact, the parent company of the franchisor only had a few store locations abroad and these locations had only been operating for a handful of years. There was little certainty that this brand would be profitable anywhere, let alone catch on in the United States. Although this information was identified in the franchisor's disclosure documents, this fact had escaped our prospective client's attention, revealing that this individual had very limited knowledge about the franchised business that he intended to acquire.
A common problem that many franchisors have is that they are underfunded. If the franchisor has limited resources, it is greatly limited in its ability to provide adequate assistance to its new franchisees. One of the benefits of the franchise model is a strong franchisor that can provide assistance, guidance, training and advice to franchisees to ease the burden of starting a new business. If a franchisor is untested or underfunded, it can eliminate this benefit of the franchise model and make it significantly more difficult for a franchisee to maintain a successful franchise. Additionally, if a franchisor is underfunded, an economic downturn or unanticipated lawsuit could wipe out the franchisor entirely. Consequentially, it is important to determine the financial stability of a franchisor prior to acquiring a franchise.
Understanding the Franchise Agreement's Terms
The common expression "the devil is in the details" couldn't be more true than in a franchise agreement. Franchise agreements serve as the foundation of the entire franchisee-franchisor arrangement, from specifying the initial and ongoing franchise fees, to the franchisor and franchisee's rights and responsibilities to each other, to the ultimate termination of the franchisee-franchisor relationship. As a result, the terms set forth in the franchise agreement can often make or break a new franchisee.
Many of our clients carry the misconception that a franchise agreement is a “take it or leave it” document and gloss over its terms after deciding to proceed with the franchise. This assumption is also not always true. We have had success negotiating the terms of franchise agreements with several franchisors, especially newer and less established franchisors. By providing our clients a clear understanding of the implications in the key provisions of their franchise agreements, we allow our clients to determine which terms they want to try to negotiate with the franchisor. After our review highlights the onerous terms being imposed upon them, in some cases our clients have even decided they no longer want to invest in the franchise.
Pursuing a Multi-Pronged Initial Approach
Many clients approach the purchase of a franchise with a "checklist" style approach, knocking out step 1, then 2, then 3. However, this approach can backfire when trying to open a franchise. There is significant overlap and interaction among the various steps in starting a new franchised business. This overlap makes a "checklist" style approach disadvantageous. For example, if you negotiate and sign a franchise agreement before signing a commercial lease, you may have locked yourself into a number of franchisor requirements that are unacceptable and non-negotiable in the eyes of landlords in your area, such as granting the franchisor the right to enter the premises or to take over the leased location upon termination of the franchise agreement.
In addition, signing the franchise agreement likely commences your payment obligations to the franchisor, even though it may take you several more months before you find the right location, let alone negotiate and finalize the lease agreement, complete the build-out, hire employees and open for business.
The same sorts of problems occur if you reverse the order of the steps in your checklist. If you sign a lease agreement before locking down the terms of your franchise agreement and the negotiations with your intended franchisor breakdown, you could find yourself owing a monthly lease payment without having a business to open and generate revenues to cover your rent.
In order to avoid these potential catch-22s, it is important to fully understand the overall process of opening a franchise. Doing so allows these overlapping matters to be dealt with concurrently. Our extensive prior experience with setting-up franchised and non-franchised businesses allows us to better anticipate these interrelated matters and address them simultaneously, permitting our clients to implement a multi-pronged approach to establishing their franchise and avoiding these common pitfalls.
If you would like to discuss a potential or newly acquired franchise, please contact us for more information or to schedule an initial consultation.
