Common legal pitfalls for first time franchisees and how to avoid them.
Buying into a franchise can be a great opportunity to begin running a profitable business based on a proven business model with support from the franchisor. But despite the benefits of being part of a franchise, there can be some unexpected issues further down the line if you enter the agreement unprepared.
Buying into a franchise can be a great opportunity to begin running a profitable business based on a proven business model with support from the franchisor. But despite the benefits of being part of a franchise, there can be some unexpected issues further down the line if you enter the agreement unprepared.Most franchisors use their standard franchise agreement and state that it is non-negotiable. Therefore, many franchisees sign the agreement without first taking legal advice since it is viewed as a pointless legal cost. This can lead to unforeseen legal problems out of which disputes can arise.
Seeking independent legal advice prior signing the franchise agreement will allow you to fully understand your legal position clearly. This will allow you to properly evaluate whether the franchise is a good investment or not.
There are certain key areas of which you will want to have a comprehensive understanding. Also, you may wish to explore whether some of the terms can be negotiated before you put pen to paper:
Costs
With any investment, it is essential to know the ins and outs of the costs, it is no different for a franchise agreement.
There will usually be a franchise fee and royalty payments to be paid to the franchisor. However, the royalty payments may not be calculated on profits but rather than annual turnover. So, if you make a loss you will still be expected to pay.
It is also worth checking whether there will be any additional costs required, such as for training, equipment or marketing.
Therefore, before you sign the franchise agreement it is important to have an idea as to the total amount you will need to invest in order to set up the business. It could be a nasty surprise to only budget for the franchise fee and be lumped with a much greater bill!
Restrictions
The franchisee agreement will often contain several restrictions on what the franchisee can and can’t do. This is to be expected since a franchisor will want to protect their franchise, but it is important to know what these restrictions are in order to avoid possible penalties.
A common restriction imposed is on carrying on another business while you are running franchise business. If you are someone who runs several businesses, this would be a term that you would want to know about and potentially renegotiate.
Another common restriction is on opening a business that will compete with the franchise after the franchise agreement has ended. It will be important to know about this term before terminating the franchise agreement or investing in another business as it is one that could lead to a lengthy dispute.
Termination
Often the franchise agreement will allow the franchisor to terminate the agreement if there is a breach. Therefore, it is important to know what will constitute a breach in order to prevent losing your investment in the franchise.
Equally, there may not be an option for a franchisee to terminate the agreement, even if the business is failing. This could leave you locked into running an unprofitable business for several more years, especially if you are not able to sell the business on.
Renewing
Most franchise agreements last five years and if at the end of that period you have worked hard to build a profitable business it would be disappointing for the franchisor refuse to renew the agreement, or to only renew it at a greatly increased price.
Many franchisees assume that when the agreement reaches its conclusion the franchisor is obliged to renew the previous agreement. However, this is not usually the case. Often franchise agreements will not put an obligation on the franchisor to renew the agreement or if it does it could be on the terms of the currently drafted franchise agreement, which could have changed dramatically over the previous five years.
It is important to check, before the agreement is signed, whether the franchisee has the right to renew the agreement otherwise five years of hard work could be wasted.
For more information and advice on franchise businesses, contact Tebbitts & Co on 01270 211567 or email info@tebbitts.co.uk to arrange a free ½ hour consultation.
Article by John Hillerby