New York Franchise Law Blog : Franchise Lawyer & Attorney Charles N. Internicola, Providing National Representation of Franchisees and Franchisors

When  evaluating the purchase of a franchise, prospective franchisees, frequently, question the purpose of a franchise fee and question: "what do I get in exchange for paying the franchise fee".  The following are some important factors that prospective franchisees should know about "franchise fees":

• A franchise fee is a one-time fee charged to franchisees when purchasing a franchise;

• Franchise fees are, typically, paid at the time of signing the franchise agreement;

• Franchise fees are, typically, non-refundable.  So, after signing your franchise agreement and paying the franchise fee if you later change your mind, chances are, that your fee will not be refunded;

• Franchise fees, almost always, do not entitle you to  assets or future services.  Franchise fees serve as the "price of admission" for joining the franchise system and "obtaining the rights" to become a franchisee;

• Franchise fees are typically non-negotiable.  However fee fee variations do occur when purchasing multi-unit opportunities.

• Franchise fees are legitimate fees (assuming that you have selected the right franchisor) designed to compensate the franchisor for the goodwill and systems that, presumably, the franchisor has developed and refined.

When evaluating a franchise opportunity consider that a franchise fee represents a legitimate expenditure designed to provide you with access to the franchisor's business systems, training and licensed marks.  The value of a franchise investment should not be judged based on the dollar amount of the franchise fee but rather the quality of the franchise system. Factors more important than the "amount of  the franchise fee" include: (a) the franchisors track record, (b) satisfaction of existing franchisees, (c) the quality of the franchisors training program, and (d) customer recognition of the franchisors goods or services. 

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For both franchisors and prospective franchisees alike, issues concerning "earnings claims", or the lack thereof, merit serious consideration and evaluation:

For Franchisors:

The decision making process starts with an initial determination as to whether or not the franchisor will include an earnings claims in its their FDD (Item 19).  The typical advantage to including an earning claim representation is to assist with franchise sales and, in certain circumstances, to limit future litigation exposure.  If a franchisor elects to include an earnings claim then the next level of inquiry resorts to assembling, documenting and properly structuring the information contained in Item 19.  If the franchisor elects to "not" include an earnings claim (a decision made by many franchisors) then the franchisor's primary task will require the establishment and enforcement of a compliance program designed to prevent  the inadvertent (or intentional) disclosure of "earnings" related information to prospective franchisees.

For Franchisees:

The evaluation of a franchisor's Item 19 earnings claims - or the lack thereof - represents a critical due diligence task for prospective franchisees.   If Item 19 disclosures are included, franchisees must evaluate the earnings information disclosed and whether or not such "claims" provide insight into the potential "profitability" of a franchise unit.  If earnings claims are "not" included then franchisees must be certain that they do not rely on any oral "earnings" statements or representations made the franchisors sales staff - that is franchisors are not permitted to make earnings claims or representations unless they are contained in writing in FDD Item 19.

Some basic - but critical - information to be aware of when considering "earnings claims":

• Not Required by Law.  Earnings claims are "not" required by law.  However, if a franchisor, in connection with the offer or sale of a franchise, wishes to disclose an earnings claim or any earnings based information, such information must be disclosed in Item 19 of the franchisor's FDD.

• Not Prohibited by Law.  In many franchise sales settings franchisees are advised (typically by a franchisors sales agent) that "by law" the franchisor "is not permitted to make an "earnings claim" .  The intended implication of such statement, sometimes, is for the prospective franchisee to assume that "the earnings are great and that the franchisor would be glad to disclose them but cant because of the franchise laws".  Prospective franchisees need to know that this is not the case and that a franchisor's decision as to whether or not to include an Item 19 earnings claim is an optional decision.  For many legitimate reasons many franchisors elect to "not "include earnings claims representations, however, this decision is optional.

• Must have a Reasonable Basis.  When drafting and preparing an earnings claim, franchisor's and their legal counsel must ensure that the franchisor possesses a "reasonable basis" for the earnings claim.  Faced with this ambiguous legal standard, franchisors must ensure that the earnings claim is based on representative and current information that is documented in writing. Factors that should be included in this disclosure include the basis for the earnings claim, whether or not the claim is based on actual franchisee data and variations within the data pool.  

When it comes to "earnings claims" that are many more factors to consider.  When drafting Item 19 disclosures, sometimes, the process is more art than science.  However when approached properly and diligently, earnings claims will serve as an important information and legal tool benefitting both franchisors and franchisees.

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There are many reasons why, for many, the purchase of a franchise makes sense. However, buying a franchise may not be right for you. I was, again, reminded of this "obvious and basic fact" during a conference call today with a client considering a substantial investment in a multi-unit franchise. The investment was sizable and, quite frankly, there was plenty of opportunity in the deal.  After a substantial legal review (where everything looked good and substantial negotiating points were achieved) he decided that "becoming a franchisee was not right for him" -  so he walked away from the deal. 

I think the right decision was made.  Not for any particular legal reason, but, because sometimes, becoming a franchisee is just not right.  When your "gut" tells you its not right - then walk away. The reverse, however, should not be applied.  That is,  if, your "gut" tells you that a potential franchise opportunity "is right for you", then your next step is not to just sign a franchise agreement but, rather, to engage in a thorough "due diligence" evaluation to ensure that you are acting on solid information.

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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. 

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In the current economic climate there are many news reports discussing franchise failure and the harsh economic realities faced by some well intentioned and hard working franchisees.  These articles typically feature a struggling franchisee and then proceed with a discussion as to the economic difficulties that the franchisee is experiencing.  When reading many of these articles - especially the portion where the franchisees express what he or she believes is causing the failure in the franchised business - I am concerned that many franchisees (including prospective franchisees reading the article) may be missing some critical points.

In Eilene Zimmerman's CNNMoney.com article, "Trench Warfare in the Franchise Field", Rita's franchisee Tish Reisman discusses some of the difficult circumstances that she is currently experiencing.  While it certainly appears that Ms. Reisman is a hard working and well intentioned individual, I am concerned that the points she raises (as to the possible causes for her business losses) may be off the mark.  In the article Ms. Reisman, raises the following points that she attributes to her losses:

(a) Encroachment:  "A competing Rita's opened five miles away";

(b) Time Consuming Promotions:  "A corporate marketing campaign required her to stand in front of Wal-Mart and Kmart stores handing out coupons, sucking up time and resources she couldn't spare";

(c) Product Introductions:  "Rita's requires her to sell every new flavor it introduces for 24 days - even if it tanks"

While the issues raised by Ms. Reisman are certainly issues of concern, are they the actual cause of the "franchise failure" that she seems to be experiencing?  Here are some of my thoughts:

• Encroachment - Encroachment is an extremely serious issue for franchisees and indeed a major contributor to franchisee failure and diminished profits / losses.  However, in Ms. Reisman's case we are advised that the competing Rita's franchisee is located 5 miles away.  When dealing with the "local nature" of ices and similar quick serve products is this really an encroachment issue?  Five miles sounds quite reasonable and could actually serve as a benefit to Ms. Reisman in terms of economies of scale that may be created through possible joint marketing efforts and brand penetration.  While encroachment is a serious issue for all franchisees, I am not certain that this is a significant factor for Ms. Reisman.

• Time Consuming Promotion - I am not sure if I buy this issue at all as a contributing factor.  Having a franchisor interested in market promotion is a good thing and, quite frankly, Ms. Reisman could have paid some teenagers to hand out coupons - as opposed to doing it herself.  

• Product Innovation - many times franchisees complain, and rightfully so, that the franchisor is not actively engaged in product innovation and development.  So, here to, I would not criticize Rita's for its constant product introduction.  However, to the extent that franchisee's are experiencing higher levels of waste (due to poor sales of new products) there should certainly be a royalty adjustment for the franchisee.  This is certainly an issue for Ms. Reisman, but, again is this a substantial contributor to her unprofitability?

While Ms. Reisman may be experiencing other issues not addressed in the article, I can not  help but believe that she needs to be addressing and evaluating some serious additional factors.  For both Ms. Reisman and any individual considering a franchise investment, here are some other factors that I would be considering:

• Debt Service - The issue of debt service is not mentioned in the article but could be playing a substantial factor in the economics experienced by Ms. Reisman.  Did Ms. Reisman borrow money to establish her Rita's franchise and, if so, how much?  Too many times prospective franchisees do not consider the substantial impact that debt service will have on their bottom line.  Is Ms. Reisman over levereged? 

• Expectations - When purchasing her Rita's franchise what were Ms. Reisman's expectations about profitability.  My only point here is that when evaluating something as a success or failure , a lot depends on your expectations.  Did Ms. Reisman have the right expectation when she purchased her franchise?  Did she base her expectations on solid "due diligence" involving discussions with existing franchisees, a thorough evaluation of the FDD and her legal obligations?

There are many other factors that are of extreme relevance to understanding the unfortunate circumstances that Ms. Reisman is facing.  It is not enough to simply blame the franchisor and, quite frankly, Ms. Reisman needs to thoroughly assess her current circumstances and implement some immediate corrective measures.  Unfortunately, if Ms. Reisman's  due diligence or expectations were off, going forward, the Rita's franchise may not be the correct business for herself and her family.  

UPDATE:

In a comment Paul Segreto of Franchise Essentials links to his excellent and "honest" post "Fear and Consequence of Failure: A True Story".  If you are a franchisee definitely read what Paul has to say as I believe that the advice he offices speaks from experience.  If you are a struggling franchisee consider what Paul has to say - especially the part of considering an exit strategy.

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This afternoon in consulting with a client who had recently signed a franchise agreement involving a substantial commitment of capital, I was reminded about the importance of maintaining "realistic" expectations when buying a franchise. When discussing his expectations about his franchise purchase and the business that he will be developing, he was extremely "realistic" as to his expectations and the work ahead of him.  That is: 

(a) He diligently evaluated the "franchise opportunity" that he was investing in and thoroughly understood that, as with many businesses, it would be a number of months and possibly years (hopefully not) before he achieved a level of profitability and acceptable return on his franchise investment; and

(b) He understood that the success of his franchise rested on the hard work, marketing and business development that he (and his family) would bring to this new business. Significantly, his approach is not one of "lets wait and see" what business comes through the door.

The most important lesson that I was reminded of by my client - a lesson that future franchisees and franchisors may also put to use - is that getting your expectations "right" is critical.  When considering a business opportunity and setting your "expectations", franchisors and franchisees should consider:

• Profitability will Take Some Time -   Profitability is not guaranteed and, depending on your particular franchise opportunity, may take 8 days (unlikely), 8 months or 8 years (hopefully not).  That is, you must plan ahead and account for the extremely realistic fact that you in selling a franchise or purchasing a franchise you must properly communicate and/or understand that reserve capital will be critical.  Evaluate the opportunity thoroughly and ensure that you have developed the correct expectation about the future profitability of your business.

• Franchisors Can't (and Shouldn't) do Everything - Buying a franchise does not mean you just pay money and then sit back and wait for business to "walk through the doors".  You must be actively engaged in the marketing and "development" of your business.  Look to your franchisor as your "partner" and not your "caretaker".  Franchisors, be selective about the franchisees that you approve - look for franchisees that will contribute to the development of your franchise system. 

Get your expectations right.

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When  purchasing an "existing business" (whether a franchised or independent operation) prospective purchasers are faced with the critically important task of conducting a "due diligence" evaluation/investigation of the business under consideration.  While there are many steps to the "due diligence" process and while many of these steps are the same whether the business is a "franchised operation" or an "independent location", one critically important distinction and factor that should not be overlooked and must be evaluated by the prospective purchaser of an existing franchise is:

"whether or not there is value in the franchise system?".

That is, as a purchaser, you must evaluate and determine what added value (i.e., profits and cash flow), if any, that you will be afforded by purchasing and operating a "franchised business" (and becoming a franchisee) as compared to a competing but "non-franchised" independent operation. When making this "assessment" you must recognize that there is tremendous variation and value between franchises - that is, some franchise systems add real value and advantages while some poorly run "franchise systems" simply drain the profitability of its franchisees.  When making this assessment, some of the factors that you should consider, include:

• Higher Sales Do Not Necessarily Equate to Higher Profits.  As a franchisee one substantial obligation that you will be undertaking will include the payment of "royalties" to the franchisor.  Since royalties are typically based on a percentage of your "gross sales" the franchised business that you are evaluating will most likely have higher operating costs than the non-franchised business.

• Not all Franchise Systems are Equal.  Some "franchise systems" are simply poorly run and ill conceived business operations that afford little, if any, value to its franchisees.   So, don't just "assume" that the franchise business that you are considering will be properly supported by the franchisor - ask questions, speak to other franchisees and evaluate the benefits of the franchise system that you are buying into.

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Recently on satellite radio I listened to a radio advertisement, allegedly, by a national franchisor promoting the resale of what I believe to be previously closed franchise locations. The franchisor is allegedly Quiznos and this morning I checked out their website relating to their promotion and sale of opportunities relating to the "re-opening" of closed Quiznos locations. Basically, the website is promoting and offering prospective franchisees the opportunity to acquire rights to own or operate closed Quiznos locations.  Presented as a "low start-up cost" opportunity, the website operator makes the following "promotional" statments about this Quiznos "re-open" opportunity:

Own a Big Brand without a Big Investment.

Jump into a proven business system for as little as $12,500 down.

Own your own business in as little as 90 days.

Quinos has a limited inventory of stores available through this program.

 While I readily admit that I have not reviewed  Quiznos disclosure documents respecting this alleged  "reopen opportunity", here is my take on this advertisement and potential opportunity:

• Understand Why the "Closed Location" Originally Failed.   Franchise failure resulting in closed stores  may be attributed to many factors and may not necessarily be attributed to the the Franchisor, i.e., failure could be attributed to a deficient and non-performing franchisee. However, when a franchisor possesses an "inventory of closed stores" and is looking to resell these opportunities you must question whether or not the closed stores (and especially the particular store that you are considering) may be attributed to failings or deficiencies on the part of the franchisor, the franchise system or the business location, i.e., Is the continuing royalty too high? Is the food cost too high? Is the rent reasonable? Is the advertising program insufficient? Does the location generate enough traffic?  You must understand what contributed the original "store closing" and insure that the facts and legal obligations that you are undertaking are different.  That is, learn from the mistakes of others.

• Your Investment Goes Far Beyond your Initial Out of Pocket Expense.  When buying a franchise your investment goes far beyond  "out of pocket" expenses.  Although this opportunity is presented as one with limited start up costs, you must also consider the loan obligations that you will be agreeing to and assuming.  While your "out of pocket" may be nominal you could be acquiring substantial debt obligations.  Also, always remember that your time has value and in and of itself represents a substantial investment - especially if your store is not generating a profit.

• Don't Just "Jump In". I think that you probably know this already, but we all need to be reminded of this critical point.  So, "don't, do not just jump in".  Due diligence is key.

Disclaimer: Michael Webster of BizOp makes a great comment about this  alleged Quiznos website and the possibility that it may not be directly affiliated with Quiznos. Michael's comment is instructive for prospective franchisees and a reminder as to why prospective franchisees must engage in a detailed due diligence process.  Thanks Michael.

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Recently I received some interesting and insightful comments from an  individual commenting on issues involving franchisee rights.  Her main point of contention appears to be the disparity of bargaining power and legal rights between franchisors and franchisees.  While this is certainly an issue of concern, I believe that her comments may be giving a "free pass" to franchisees who don't take the time to conduct the appropriate pre-purchase franchise due diligence.  The following are some of the commentators insightful points:

On Franchise Agreement Liquidated Damages:

Isn't it true that most franchisees don't understand that the "optional" liquidated damages terms in the contract are premeditated to give the franchisor the advantage when the franchisee fails to thrive? The failure fee is hidden within the contract from the view of franchisees.

Do attorneys point this "failure fee" out to their clients?

My Take on this Serious Issue:  As I have previously discussed, "liquidated damage" provisions in franchise agreements - especially those that kick-in when a franchisee "closes his or her doors" have the potential to inflict serious financial harm on a franchisee who already may have lost a substantial investment.  However, these provisions may be negotiated by franchise attorneys and are exactly the types of "legal issues" that a franchisee should be discussing with a franchise attorney before signing a franchise agreement. Liquidated damage clauses can be negotiated.

On Franchisees Reading and Negotiating their Franchise Agreement:

While it may be true that franchise agreements may be legally negotiated with the franchisor by individual prospective franchisees, isn't it true that most of the mature franchisors don't or won't negotiate changes and will acknowledge that pre-sale, their contracts are not negotiable. Don't they acknowledge this to the courts, when asked?

My Take on this Serious Issue: Franchise agreements are negotiable and even "mature" franchisors are willing to make reasonable modifications.  However, even if we assume that a particular franchisor will not make changes why would a prospective franchisee invest his or her livelihood in a franchise and sign a franchise agreement without first reviewing, understanding and evaluating each and every right and obligation contained in the franchise agreement.  Look,  there are many times where I believe that franchisees need an advocate but franchisees cannot  get a "free pass" when they neglect to conduct even the most basic due diligence.  

In the end, you do not have to sign a franchise agreement and, sometimes, even with successful franchise systems, not signing the agreement might be the best course of action for you. No one is forcing you to sign the agreement.  Likewise you must know that no matter how many other franchisees may have signed the franchise agreement you - personally - must understand and evaluate what you are signing.  Your livelihood depends on it.

For franchisors, a policy that permits limited but targeted franchise agreement modifications may actually strengthen the enforceability of your franchise agreements when faced with litigation. 

My thanks to Ms. Cross for some really insightful comments.

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In certain "franchise sales settings" franchisees are sometimes led to believe that modifications cannot be legally made to their franchise agreement.  That is, to induce a franchisee to sign the franchise agreement - without the benefit of any negotiations or review by a franchise attorney - the franchisee is led to believe that the franchise agreement is a "standard agreement" (signed by everyone) and that legally the franchisor is not allowed to make any changes.  The implication: you might as well just sign the agreement and not waste time or money since "we can't change the franchise agreement even if we wanted to".  

Sadly this misstatement / "myth" leads to a false sense of security and sometimes some big mistakes by prospective franchisees.  To be clear:

• Franchise agreements are negotiable;
• It is not illegal for a franchisor to modify its franchise agreement; and
• It is extremely common for franchisees to negotiate certain aspects of the franchise agreement.

Understanding these facts keep in mind that the extent to which a franchisor may be willing to negotiate the terms of its agreement varies depending on the negotiating power of the parties - one major factor includes the financial resources of the franchisee.  Also, certain core provisions of a franchise agreement - such as the royalty rate, methods of operation and use of proprietary products - usually are not and should not be subject to change.  

Some of the critically important franchise agreement terms that you should be evaluating and potentially negotiating, include:

• Scope of your protected territory;
• Grace periods regarding the commencement of royalty obligations;
• Liquidated damages and liability for early termination;
• Renewal rights;
• Transfer rights; 
• Cure periods for alleged defaults; and
• Potential "rights of first refusal".

Depending on your circumstances and concerns there are many other issues that, as a prospective franchisee, you should be considering.  However, it is critical that, as a prospective franchisee, you recognize that you have the "right" to negotiate the terms of your franchise agreement.  This "right" must be taken seriously.

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Recently, in my article "Avoid the Hype when Buying a Franchise: Focus on Specifics and Not Overall Industry Trends"  I discussed what I believe to be the improper and harmful methods for promoting franchise sales, i.e.,  generic statements and promises that may lead to inaccurate and unrealistic expectations by a franchisee.  These statements are bad for both franchisors and franchisees and my advice, basically, was to disregard and avoid this type of promotion.

This afternoon after speaking with a client about a franchise that he was evaluating - a franchise that he explained would provide him with a great "return" -  I took a look at the franchisor's website and, there it was, the pitch:

[_________________] is a proven franchise system with low start-up costs and high returns.

While I readily admit that I am a franchise lawyer and not an accountant, if I were a prospective franchisee or even legal counsel to the franchisor making this pitch, I would have the following questions:

• How High of a Return?  2%,  5%, 10%...?;

• A "Return" Based on What? Start-up costs, overall investment?  

• Is the Return Measured / Based on Gross Sales or Net Income? Before Royalties or after Royalties? Before debt service or after debt service? and;

• What type of return should I expect?

The reality is that this franchisor probably does not (and cannot - without subjecting itself to potential litigation exposure) offer an answer to these questions and even if it did there would (I hope) be an extensive number of disclaimers.  For the prospective franchisee recognize that franchisors cannot guarantee success (that is not their job), so before you make an investment decision based on "vague" statements about "profits" and "returns", start asking questions.

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Driving into the office this morning I listened to a radio commercial that I found to be repulsive . The commercial was not political, did not contain any profane language and, quite possibly, did not contain any false statements.  Nevertheless, the information conveyed in this commercial (really just a bunch of self-serving platitudes) could do harm to the unprepared.  

So what was this commercial about?  The sale of franchises for a national mall based / strip-center consumer video game franchise.  You see, the commercial was not promoting the operations of their retail stores or franchisee operations but rather the sale of "franchise opportunities".  Since I don't have the actual text of the commercial (I am basing this post on my memory of 5 minutes ago) I will not disclose the name of the franchise.

What Do I think is So Wrong about this Commercial? the fact that rather than promoting existing franchisee sales and informing consumers about the advantages of their stores (compared to competitors) they offered a generic pitch about buying their franchise.  Their "franchise sales" pitch followed the following formula:

• Make a generic statement about "becomming your own boss";
• Offer generic information about  "industry growth trends"; and
• Imply, with even more generic information, that you - as a franchisee - can benefit from this opportunity by utilizing their "proven and powerful" systems.

Basically, alot of hype and platitudes - many words but little, if any, information.  

Points for Prospective Franchisees: (1) Just buying a franchise does not make you your own boss; (2) Just because an overall "industry" is growing and profitable does not mean that as a "retail franchisee" your business will also be profitable; (3) Before buying a franchise give serious thought about what makes them "unique" and the "added value" that they bring to the table.  Most importantly, when you hear a franchisor brag about "proven and powerful systems" ask specific questions about those "systems" and what makes them "proven" and "powerful".  Don't wait until after you pay a franchise fee and invest in build-out.

Some of the many internet resources to consider include: The Franchise King, Franchise Essentials, Blue MauMau, Franchise Pick, WSJ Small Business. 

Points for Franchisors:  Advertising franchise sales is no a bad thing and, in fact, may be a key component to overall system development and growth. However, the ads should be based on the unique and fundamental characteristics of your particular system and the advantages that you offer.  If these "unique characteristics" are not readily identifiable then you are doing something wrong and you should be focusing on true "system development" and not unit sales.  Significantly, the witnessed success of existing franchisees is the best source of growth for a franchise system.

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If you are considering the purchase of a franchise it is critical to recognize that your "investment" goes beyond - well beyond - initial franchise fees and startup expenses. While franchise fees and start-up expenses (such as equipment purchases and "build-out") are critical expenses that must be evaluated, they only tell half the story.  That is, when signing a franchise agreement you will be committing yourself to a serious of legal obligations that will involve the commitment of your time, future financial resources and legal obligations for many years to come.  

So when evaluating the "cost" of a franchise, in addition to franchise fees and initial start-up costs, give some serious consideration to:

(a) Reserve Capital. Additional funds that you may be required to invest in your business/franchise during periods of unprofitability and negative cash flow.  As with any business you may very well encounter periods of unprofitability and losses.  When faced with losses and cash flow shortages you will be required to invest additional assets and resources to sustain the operations of your franchise;

(b) Your Time. The extensive time that your will be devoting to operating and managing your new franchise.  Your time is valuable and when operating your franchise you will be foregoing income and opportunities from other sources of employment.  Although obvious, this expense / opportunity cost is commonly overlooked. If your franchised business does not work out remember that your losses include missed opportunity costs and income that you would have otherwise earned. 

(c) Post-Termination Restrictive Covenants and Fees. As a franchisee in most instances you will be committing yourself to long-term obligations and restrictive covenants.  These covenants and obligations have a cost, especially when they restrict what you can and cannot do if you elect to shut down your franchise.   This is of special concern to current business owners with established reputations within a community who - for legitimate reasons - decide to become a franchisee of a national company.  

For Example - If you are a carpenter with a long established reputation within a community and you elect to purchase and become a franchisee of a national "repair" or "handyman" franchise what happens if your franchise relationship does not work out and you cancel your franchise agreement?  Will you be precluded from operating your own repair business - a business that you operated many years before becoming a franchisee?  The answer is that it all depends on the restrictive covenants contained in your franchise agreement - covenants and obligations that you should review and discuss in detail with your franchise lawyer "before" signing a franchise agreement.

So when considering the "cost" of your franchise investment you must go beyond "out of pocket" expenses and fees and evaluate the substantive impact of the long-term legal obligations that you will be committing to.

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If you are researching the benefits of franchising, buying a franchise or starting a franchise, chances are that you have come across articles and promotional materials discussing the benefits of a "proven franchise system".  That is, prospective franchisees are advised that if they become a franchisee of  a particular franchise they will benefit from a "proven system".  While this vague term is used often and claimed by almost all franchisors, not every franchisor possesses legitimate systems and not every franchise system is "proven".

So, what is a "proven franchise system"?  While this question is subject to a broad range of interpretation, the following is some fundamental information about "systems" and "franchise systems" that must be considered by prospective franchisees and franchisors:

• "Systems" - are simply the procedures and tasks undertaken by business owners and managers in connection with the day-to-day operations of a business.  Every aspect of a business including, advertising, financial controls, production of goods, employee management and customer service can all be boiled down to a set of procedures and "systems".  Not every business is successful and not every "system" is effective or beneficial.

• Franchise Systems - are the procedures and tasks itemized and detailed by a franchisor (typically disclosed and detailed in the franchisor's operations manual) in connection with the operation of a franchised business.  A franchisors business systems typically include tasks and procedures focused on (a) Marketing, (b) Customer Service, (c) Employee Training, (d) Production of products and (e) Methods for delivering services.

• Proven Franchise Systems - Are the "franchise systems" that have been "previously" implemented (presumably by the franchisor and other franchisees) and have been demonstrated to result in successful and profitable operations of the franchised business.

Considerations for Prospective Franchisees:  

Effective and legitimate "systems" are critical for the successful operation of a franchised business. Don't just assume that a franchisor's "systems" are "proven" or "effective".  Ask the franchisor's representatives detailed questions about what makes their "systems" unique, effective and profitable and recognize that the "proven" nature of a start-up franchisor's "systems, in most cases, may be extremely limited.

Considerations for Prospective Franchisors:

Successful franchise systems depend on successful franchisees.  The mere act of preparing franchise disclosure documents and registering disclosure documents does not create a franchise. Strong franchises require thought out and tested business "systems" and procedures that have been tested and proven successful.  During the start-up franchising stage controlled growth (with limited franchise sales) may be necessary to will permit the necessary monitoring and refinement of your business systems. 

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For the first time franchise or business purchaser "due diligence" is critical.  Although the term "due diligence" may sound odd or out of place, it simply refers to the "pre-purchase / pre-investment investigation" that you undertake before signing a franchise agreement  or business purchase agreement.  In his article "What is Due Diligence in Business Acquisitions" Ney Grant provides an excellent overview of this process.  In my book I describe a purchasers "due diligence" obligations, as follows:

A prospective purchaser must approach "due diligence" as a constant and continuing information gathering and evaluation process respecting each and every aspect of the prospective business and the business purchase transaction.

As the prospective purchaser of a franchise "due diligence" investigation should not be viewed as a mere formality but rather an important "life line" standing between you and the possibility of making a bad decision.  Keep in mind that that a good decision and a good due diligence evaluation may lead you to the conclusion that the franchise that you believed to be "perfect" and a "great opportunity" may not be right for you. Unfortunately the decision is not an easy one to make and, as a franchise lawyer, I advise my clients that you must check your emotion at the door and be prepared, if necessary, to "walk away from a deal".  From my clients perspective sometimes the best deals are the ones that never happen.

As a future entrepreneur there will be many opportunities available to you - take your time and make sure that you select the one that fits you and offers you an opportunity for success. If you are considering the purchase of a franchise and considering the steps that should be undertaken in the "due diligence" process, I strongly recommend that you review our due diligence articles.

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Recently I came across an article written by an attorney discussing the benefits of buying a franchise in the current economic climate.  The assertion raised in the article (an assertion that I completely disagree with) was that now is a good time to invest in a franchise because "in today's economic climate many franchisor's are willing to negotiate and discount their franchise fee".

If you are buying a franchise because of a "discounted franchise fee" you are making a mistake - a big mistake.  Why? the decision to purchase and invest in a franchise requires a  detailed evaluation of the franchisor and the quality of the franchise system.  "Discounted" franchise fees or a franchisor's willingness to negotiate its franchise fee should not be viewed as an "incentive" to purchase a franchise but rather a "red flag" to question the franchisor's  commitment to the long term stability of its franchise system.  Franchise fees represent a significant source of short-term revenue for franchisors.  As a franchise system expands adding "discounted franchisees" a franchisors ability to support its expanding franchise base and business systems may be severely diluted.  

In today's economic climate dedicated franchisors focused on the long-term success of its franchisees should not be focused on short-term revenues (generated through the sale of discounted franchises) but rather the continuing development of quality training programs and business systems.  Discounted franchise fees are typically accompanied by the addition of unqualified franchisees and the dilution of the overall franchise system.

So if you are considering the purchase of a franchise don't be swayed by any alleged discounts or bargains.  Focus on a due diligence process that places an emphasis on a franchisor's commitment to its "business systems" and the overall profitability of its franchisees.  Keep in mind that your overall "franchise investment" goes well beyond an initial franchise fee.

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The purchase of a franchise represents a substantial investment that will have longstanding implications for both you and your family.  Prior to selecting a franchise and deciding to move forward, you must engage in an active "due diligence" evaluation of the franchise system and determine if its is right for you.  As discussed in "Contact Existing Franchisees before Signing a Franchise Agreement" existing franchisees are excellent sources of information when evaluating a potential franchise investment.  Three "initial" questions that you should be asking existing franchisees, include:

1.  Were you Satisfied with the Franchisor's "Pre-Opening" Training and Support?  One of the advantages of purchasing a franchise, in theory, should be the support and training provided by the franchisor.  The training and support that you receive prior to opening your franchise will be critical to launching a successful franchise. If current franchisees are not satisfied with the pre-opening training and support provided buy the franchisor, seriously question whether this is the right franchise for you and speak to your franchisor lawyer about adding specific training guuarantees to your franchise agreement should you decide to go forward.

2.  Are you Satisfied with the Franchisor's "On-Going" Training and Support?  While many franchisees open their business to a successful launch and impressive sales, on-going support is crucial.  A good franchise system is characterized by constant communication and support between the franchisor and its franchisees.  If current franchisees are not satisfied with the on-going support offered to them, again, you must question whether or not this is the right franchise for you.  Certainly raise this issue with the franchisor's sales people and your lawyer.

3.  Do the Numbers Make Sense? In other words, after paying royalties, advertising fees, product costs and operating expenses does the business earn a profit?  This is an apparent and critical question that too many prospective franchisees fail to consider and evaluate. When focusing on this issues ask as many questions as possible and speak to as many franchisees as you can.  Gather information and then discuss this issue with both your business accountant and franchise lawyer.

In addition to these initial questions you should have many others focused based on the particular franchise that you are considering.  I suggest that you write down a list of your expectations and then - prior to signing any franchise agreement - seek out and obtain as much information as possible to determine whether or not the franchise that you are considering is right for you.  Your decision should also be based on a candid discussion with your franchise lawyer and a thorough evaluation of the franchisor's disclosure documents.

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When purchasing a business or franchise, your lease agreement will serve as one of the most influential factors in determining the profitability of your new business.  In states such as New York and New Jersey where rents are higher, paying particular attention to your rent factor is critical.

When the business that you are purchasing is a franchise, some additional lease agreement "due diligence" factors that you should consider, include:

• Is the Lease a Sublease. Whether or not the lease for the business premises is transferred to you directly (as the purchaser of the business and the new franchisee) or if the lease is held by the franchisor (as the direct tenant) and then to you, indirectly, as a subtenant. This is important because in instances where the franchisor has direct control of the lease, it is possible – if you breach or terminate the franchise agreement – for the franchisor to attempt to “step in” and take over the operations of the business that you are purchasing. Again, this concern only comes about in instances where you breach the terms of the franchise agreement;

• Is there a Lease Management Fee. Whether or not the franchisor charges a monthly lease management fee. This applies mostly in instances involving the franchisor’s sublease of the business location and constitutes, typically, an administrative monthly fee charged to you by the franchisor for being identified as the direct tenant on the lease;

• Restricted Lease Use Clause. Whether or not the leased business location may be converted to a non-franchised business location in the event of a termination of the franchise agreement; and

• Protected Territory. Whether or not the franchise agreement includes a protected territory (i.e., a specified geographic radius or map located within a certain proximity to the business location) within which the franchisor will not sell any additional franchises.

Your lease will serve as one of the most critical business assets that you will be acquiring, so you must get the terms right.  If the business that you are purchasing is a car wash or gas station in New York, Long Island or New Jersey your lease agreement due diligence must also include an assessment of the property for potential environmental conditions.

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In an earlier post I discussed the critical importance of obtaining an environmental assessment prior to purchasing a car wash or gas station.  In a recent transaction (where I represented a client purchasing a gas station business on "leased property") an issue was raised as to whether or not an environmental assessment is necessary when (a) the property is leased - and thereby not owned by the business purchaser, (b) the landlord agrees to be responsible for any pre-existing land contamination, and (c) the landlord maintains an environmental contamination insurance policy.

Basically, the question that has been raised is: "if I am buying the gas station business only (not the land) and the landlord is responsible for past contamination, do I still need to obtain Phase One Environmental Site Assessment?  

Answer: Yes, because even if the landlord is responsible for past contamination (i.e. the landlord will pay for the cost of remediation) as a business purchaser you nevertheless want to avoid contaminated property since any future remediation will require that you shut down your newly purchased business during the "clean up" process.  So even if the landlord or the landlord's insurance company is paying for the remediation costs, you will nevertheless lose thousands of dollars since you will be required to close your business during this process.  Another reason why you will require an environmental assessment is to determine a baseline as to the condition of the property prior taking over the station's operations - this will be critical to avoid future conflicts with your new landlord who may claim that you caused contamination that may have existed long before you.

For a brief but helpful review of insurance options that you should consider for a gas station business, Solomon Williams has written a helpful article on this topic.  As to why insurance is "vital" to your gas station business, Mr. Williams, offers the following summary:

Opening a gas station requires certain insurance policies. These policies need to cover everything from employee protection to public liability insurance as well as environmental and storage tank insurance. If you sell groceries or other items as well as gas then you should also include the necessary insurance for this type of business. The easiest option is to find an insurance company that will tailor a single insurance package to meet your needs.

However, while insurances will serve as a critical component to the overall success of your business, when purchasing a gas station you will nevertheless need an environmental assessment.

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When purchasing a business or franchise, in most instances, one of the primary assets that you will be acquiring is the "lease" to the existing business location / store that you are "buying".   A few of the many obvious reasons as to why your lease agreement will be crucial, include:

• Profitability - The monthly rent and "additional rent" will directly impact your profits;

• Permitted Use of the Business Premises - The lease "use clause" will restrict the the products / services that you will be permitted to sell / offer - including your ability to expand your products / services in the future.  For example, if you are leasing a gas stations, does your lease permit you to add a car wash or convenience store in the future? If you operate a soup franchise does your lease permit the addition of ice cream or similar products that a franchisor may require for product diversification?

• Assignability - The lease agreement will specify and determine your future right to sell your business and assign your lease to a third party purchaser.

Recognizing the obvious importance of the "lease assignment", as a purchaser, at the outset of your proposed purchase transaction, it is critical that you communicate with the landlord and obtain the landlord's written consent to your purchase transaction and the expected operations of your business.  The landlord’s consent must be identified as an express contingency specified in your purchase agreement and, among other things:

(a) be in writing;

(b) be signed by the landlord;

(c) acknowledge the landlord’s approval of the assignment;

(d) expressly acknowledge that the lease is in “full force and effect” with no outstanding defaults by the seller; and

(e) acknowledge the amount of the tenant’s security deposit.

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In the face of a recession has come a renewed interest and focus on franchising and franchise opportunities. Faced with the uncertainty of "corporate life" and layoffs rendering hard working and educated individuals without employment, a spotlight has been placed on franchise ownership and the resources available to prospective franchisees.

So what do We Learn From Viewing Franchising through the Prism of a Recession?

• No Business is Recession Proof - Including a Franchise: In her timely and informative article "When Career Turns Down, Franchising is Option" career columnist Eve Tahmincioglu correctly recognizes that purchasing a franchise is definitely an option that "out-of-work individuals with money" should consider.  However, Ms. Tahmincioglu cites to Small Business Administration statistics and cautions would be franchisees that a franchise business (like any business) is not recession proof.  So what does this mean?  Nothing is guaranteed and do lots of research - explained in the next point below.

• Selecting the Right Franchise Requires Research: In an earlier post I urge (strongly) that before you purchase a franchise contact existing franchisees and ask them about their experiences.  This point is critical, however, in terms of the "information gathering process", the internet has helped franchise purchasers level the playing field.  In his article "Blogs Provide Insight to Would Be Franchisees" Wall Street Journal columnist Richard Gibson provides prospective franchisees with critical advice and, most significantly, an analysis of Blogs that offer business purchasers with great information and advice . So if you are considering the purchase of a business or franchise read Richard Gibson's article and check out the blogs, which include:

Blue Maumau, Franchise Pundit, Franchise Chat, Rush on Business, Unhappy Franchisee.  Other great franchise blogs include: The Franchise King, Franchise Pick, Franchise Essentials.

•  If You are Buying a Franchise "Only" because You Lost Your Job - Don't Do It: With the many rewards that come with entrepreneurship and owning your own business or franchise come many difficult questions, obligations and choices.  While your current employment status (or lack thereof) may be "one of many" valid reasons to buy a franchise it should not be the only reason - otherwise, you may make a bad situation worse. In my article "Can (or even Should)  you Buy a Business or Franchise to Replace a Lost Job?" I have attempted to address this issue and identify some of the additional factors that should be considered.

Although the "current" economic climate is difficult, there are, nevertheless, many opportunities for those looking to make a leap into the world of entrepreneurship.  However, before doing this, take advantage of the valuable information offered on the web by the franchise and business community.

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Due diligence is essential to all business purchase transactions. However, when the business transaction involves the lease or purchase of property that may be contaminated (such as a gas station, "quick lube" and car wash), your due diligence must expand to include the additional task of obtaining an environmental study.

So where do you start?

• Add an Environmental Contingency Clause to your Contracts - Make sure that your purchase agreements (such as your asset purchase agreement, lease agreement and/or real property purchase agreement) include an "environmental contingency" clause  permitting you to order and obtain an environmental assessment and study of the property.  If contamination is found, the contingency clause should be drafted in a way that permits you to back-out of the transaction and, importantly, get your deposit refunded.

• Obtain a Phase I Site Assessment - Obtaining an "environmental assessment" is not a complex process.  This assessment, performed by a licensed professional is typically known as a “Phase I Environmental Site Assessment”. This initial assessment will review the history of the property and provide you with preliminary findings as to possible contamination. Depending on the results of the “Phase I” study additional studies may be required.

Keep in mind that when purchasing a business such as a gas station, "quick lube" and even car wash, typically, you will be leasing land or purchasing property that may have a long history of "industrial type" activity that may be contaminated.   Once you purchase the business - even if you did not cause the contamination - you could be stuck with a big problem created long-ago. Environmental assessments are readily available, affordable (relative to the investment of your life savings) and should never be ignored.

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(Great, a lawyer answering a question about whether you need to hire a lawyer)

Answer? Yes - but not right away.  

The competent advice and guidance of a franchise lawyer will serve as a valuable tool (one of the many "tools" that are required) to be utilized on your road to entrepreneurship and the purchase of a franchise.  The advice provided by your franchise lawyer should be based on practical experience and involve a detailed review of the proposed franchise agreement and franchise disclosure document (FDD) and be followed by negotiatios with the franchisor.  However, while hiring a franchise lawyer is critical, it should not be your first step.

So what do I mean by "not right away"?  The process of buying a business is not a "sprint" (at least it should not be) but rather an "endurance event" that will require you to seriously evaluate your individual needs, business skills and expectations.  Once you have made this assessment, you will be faced with the challenging task of finding a business that is both profitable and right for who you are and your skill sets.  This is no easy task and will require that you do significant research (tons of resources available on the web), communicate with other business owners, communicate with existing franchisees (to do this, see "Contact Existing Franchisees before Signing a Franchise Agreement") and, possibly, seek out the advice of franchise professionals.  Don't just pick or get stuck on one particular franchise model or limit your research to the information provided to you by the franchisor's salesperson.  Remember, first and foremost, what matters most to a successful franchise investment are "profits" that will be  measured by your ability to take home money to your family each and every month.  So question everything.  If the franchise sells soup, then question how you will earn "profits" in the summer.  If the franchise sells ice cream, understand how "profits" are generated in the winter.  If the franchise appears to draw long lines or generate large revenues, then question what percentage of  those long lines and revenues are converted into "profits". 

Once you have completed your own internal analysis and "business review" , thats when the legal advice and analysis becomes critical.  The franchise agreement that you will sign will serve as the blueprint and road map for your business for many years to come.  As such, there are many, many critical issues that you must address with your franchise lawyer.  Some of the many issues that you must discuss and evaluate, include:

• The franchise fee that will be charged;
• The continuing royalty that you will be paying on a monthly or weekly basis;
• Advertising fund fees that you may or may not be required to contribute to;
• Approved vendors and suppliers of the supplies and products critical to your business;
• The protected territory that you may or may not be granted;
• Buildout and lease obligations that you will be required to undertake;
• Many, many other issues.

In many instances, (contrary to statements by a franchise sales person that their franchise agreement is "non-negotiable") your franchise lawyer will be able to negotiate and implement modifications to your franchise agreement that will have a substantive impact on your franchise investment and increase the odds for your success.  In today's economic climate, my experience has been that franchisor's are more willing than ever to negotiate with new franchisees.  Even things like deferring "royalties" for a number of months.  

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This is a question that I get often from my clients.  However, since lawyers are not the most qualified professionals to answer this question  (compared to a business appraiser or specialized consultant) I am not the most qualified to answer this question.  That said, business valuation is key and must be discussed with your lawyer prior to committing to a purchase agreement. While I am emphasizing the obvious, this issue comes up daily and in many transactions purchasers become "attached" to the idea of becoming a business owner and entrepreneur and let their guard down as to valuation.  So while your lawyer can not value your business, you must be taking every step to do so - preferably with the assistance of a qualified business account and certified business appraiser.  All of this should be coordinated with your business and franchise lawyer whose job is to ensure that you (and your contract deposit) are legally protected during this review period / due diligence.  

Some important factors that a prospective business / franchise purchaser should consider:

• Due Diligence is critical - always insure that you thoroughly review the finances (tax returns, royalty reports, purchase order receipts and register receipts) of the business that you are purchasing to verify the earning claims of the seller.

• Conduct on Site Due Diligence - Don't stop at a "paper review", spend time "on-site" interacting with customers and sampling/measuring daily sales.  This is not asking too much and the attorneys can structure confidentiality agreements to protect the seller and encourage him or her to provide you with access.

• Include a Due Diligence Contingency Clause - If your financial review/due diligence cannot be completed prior to signing the business purchase or franchise agreement , then ensure that your agreement includes a "due diligence contingency clause" enabling you to complete your review and back out of the agreement if necessary.

• Coordinate Communications - Ensure that your attorney, accountant/valuation professional speak and coordinate their activities. 

• Remember that Profits (not gross sales) are Key - This is an obvious point but one that should be emphasized again and again.  The most important factor to you will be how much money you get to take home to your family on a weekly or monthly basis and not the gross sales of your business and how much you paid the franchisor in royalties.  So don't get enamored with gross sales, pay attention to the recurring expenses of the business.

Essentially, leave no stone unturned.  By the way there are a multitude of valuable resources out their, always be circumspect, but check them out, i.e., www.franchisepick.com, www.thefranchiseking.com, www.unhappyfranchisee.com.

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For existing franchisees and individuals considering the purchase of a franchise,anextremely 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.

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You have identified a franchise concept that you are extremely interested in.  You have met with the franchisor’s sales staff, completed an application and are impressed, so far, by what you see. However, before taking that next step, before paying a franchise fee or signing a franchise agreement, contact existing franchisees to get the “inside track”. 

Where do you get existing franchisee information?  In the franchisor’s disclosure  document (also known as the “FDD” and formally known as a Uniform Franchise  Offering Circular) that must be provided to you by the franchisor at least 14  calendar days prior to you signing a franchise agreement or paying any fee to  the franchisor.  The FDD is an extensive document and, quite frankly, one of the few “life-lines”  that will be available to help you make a true assessment of the franchise opportunity that you are considering. The legally mandated information contained in the FDD, and thereby disclosed to you as a prospective franchisee, is extensive, extremely relevant and should be reviewed with both a franchise lawyer and business accountant.  However, sticking to the point of this article, that is obtaining information from existing franchisees, please know the following:

• Item “20” titled “Outlets and Franchisee Information” should contain extensive information about (a) existing franchisees - including their names, addresses and contact information, (b) the number of franchise outlets in operation (at least as of the date of the FDD), (c) the number of franchise outlets that are expected to open within the next fiscal year, and (d) the number of franchise outlets that were closed, sold or terminated in the last fiscal year;

• Contact existing franchisees (not just the “star” – multi-unit franchisees who the franchisor suggests you speak with) and politely ask them about their experiences as a franchisee, the support given to them, the quality of the product (or service) and, if possible, the cash flow and profitability of the business;

• Pay particular attention to the number of franchise outlets closed, terminated or sold during the past year.  If there are a significant number (relative to total overall outlets) of closed, terminated and/or sold outlets, proceed with caution and ask lots of questions. Please keep in mind that while it may be inevitable to have a few closed outlets due to a “franchisee’s mismanagement or lack of effort”, look out for a pattern of closings, terminations and outlet sales and do not just accept an explanation blaming a closed outlet on a franchisee’s lack of effort.  In many cases, a closed outlet may be a function of neglect by both the franchisor (in terms of support and product development) and the franchisee; and 

• If the franchisor is projecting a significant increase in the number of projected outlet openings (a projection that should be included in Section 20 of the FDD) question whether or not the franchisor possesses the managerial staff and infrastructure to properly support all of these new outlets.  

When purchasing a franchise, there is a lot to consider and, inevitability – like every entrepreneur, you are bound to make mistakes. However, by contacting existing (and terminated) franchisees you can learn from some of their mistakes and cut down on your own.

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