5 Things to Know before Buying a Franchise
Below are five steps / factors / issues that you should be considering and evaluating before investing in a franchise. There are many more than five, but the following is a start.
(1) Due Diligence is Critical – If you are considering the purchase of a franchise it is critical 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 franchisees, good looking stores and trade dress, 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.
(2) Thoroughly Examine the Franchisor’s FDD with a Qualified Professional – If you have already contacted a franchise company to inquire about your potential purchase of a franchise opportunity, chances are that you have been handed, mailed or emailed an extensive document referred to as an “FDD”. FDD stands for “franchise disclosure document” and is the legally mandated disclosure document that a franchisor must provide to you at least 14 days prior to your execution of any agreements or your payment of any money. The FDD is an important document that will serve as a significant resource to enable you to more thoroughly examine the franchise opportunity that you may be considering. The FDD will contain information about the franchisors management team, the franchisors “estimate” of the start-up costs that you should expect to incur and the royalties and on-going fees that you will be required to pay. FDD’s are important and before investing in a franchise you should hire an experienced franchise lawyer to review this document.
(3) Contact Existing Franchisees – One of the biggest resources that a prospective franchisee should consider is the opinion and experiences of existing franchisees. When evaluating a franchise opportunity, take some time to politely contact existing franchisees (choose a franchisee in another state or someone that you will not be in competition with), let the existing franchisee know that you are considering the purchase of a franchise and that you would appreciate it if they would speak with you about their experiences and satisfaction with the franchisor and the franchise system. Don’t just contact franchisees recommended by the franchisor – seek out the advice of as many independent franchisees as possible. Item “20” of the FDD titled “Outlets and Franchisee Information” should include a list of the existing franchisees and their contact information, so use the FDD as your starting point to identify franchisees that you should contact.
(4) Understand that Franchise Agreements are Negotiable – When a franchise opportunity is presented to a prospective franchisee, many times, the prospective franchisee is advised that the franchise agreement is “not negotiable”. Some franchisors and their sales staff may even take this approach a step further and advise that even if they wanted to change the franchise agreement that it would be illegal for them to do so. However, before you simply sign a franchise agreement and pay a franchise fee, you must understand that franchise agreements are indeed negotiable. It is not illegal for a franchisor to negotiate the terms of your franchise agreement. While you must be reasonable with your expectations about the franchise agreement terms that a franchisor may or may not be willing to negotiate, review the franchise agreement with your franchise lawyer and develop an approach to address and negotiate some strategic points that may enhance your rights as a franchisee. Some of the critically important franchise agreement terms that you should be evaluating with your franchise lawyer and potentially negotiating, include:
(a) Scope of your protected territory;
(b) Grace periods regarding the commencement of royalty obligations;
(c) Liquidated damages and liability for early termination;
(d) Renewal rights;
(e) Transfer rights;
(f) Cure periods for alleged defaults; and
(g) Potential "rights of first refusal".
(5) Sometimes the Best Decision may Be to “Walk Away” - It is critical that you remain “honest with yourself” during your due diligence investigation and the consulting with your franchise lawyer. That is, the franchise that you once believed to be a great opportunity (one that you were previously excited about and told your family you were purchasing) may turn out not to be what you expected. Sometimes in the excitement of this entrepreneurial venture you may be inclined to discount or overlook warning signs that should serve as a red flag. Understand that walking away from a franchise transaction, sometimes, may be the best business decision.
Charles,
Another fine post. I do however, disagree with your statement that franchise agreements are negotiable.
To keep uniformity, should they be?
The Franchise King®
I think you can keep the uniformity with tweaks to agreements. I'd be charging a franchisee for this as it would be outside the standard franchise package.
At the beginning we developed our agreement with franchisees and approached the agreement as the basis for a win:win agreement with every clause benefiting both parties.
Most visible franchisors do not negotiate their contracts of sale of the franchise rights and the business plan but do preserve their right within the contract to change the terms of the contract, with the agreement of the franchisee, after the contract is signed.
Unfortunately, the "uniform" and "standard" take-it-or-leave-it franchise agreements involve very few promises by the franchisors to the franchisees and the franchisees sign these onerous contracts in which they are required to make promises to pay royalties for ten years or more (whether they are successful or not) because they believe that this is the only way they can access the success and profits implied and promised OUTSIDE of the contract but disclaimed within the actual written contract.
Charles Internicola honestly points out that franchisees are sometimes carried away by unrealistic expectations and that upon investigation "the best decision may be to walk away." Once the onerous contract long-term contract is signed, it is too late and it is sink or swim time. I like Charles Internicola because he doesn't paint pretty pictures for prospective franchisees and warns about putting too much at risk.
Unfortunately, franchises are sold as if they are always successful for the new owners because the brutal truth of the failure of "startup" small businesses must be hidden from view of prospective buyers of franchises in order to promote business activity in the economy.
Joel, I agree that uniformity is critical. However, not every franchise system and FDD is as "thought out" and drafted as they should be. My thought is that in certain circumstances - with certain types of franchisors - modifications may be necessary.