Buying a franchise may seem like a good way to get started operating a business. Business franchise opportunities can offer prospective buyers an established business with a widely recognized name and a successful business model.
But before signing a franchise agreement, it is a good idea to have it reviewed by an attorney who practices in the area of franchise law. Franchise contracts tend to favor the franchisor rather than the franchisee. Franchise buyers may be able to negotiate more favorable terms to better protect themselves and their businesses.
Getting legal advice regarding the following questions can help potential franchise buyers identify issues within the franchise agreement or even the franchise itself so that they can make an informed decision about whether to buy a franchised business.
Does the Franchise Disclosure Document Raise any Red Flags?
Federal law requires all franchisors to provide prospective franchisees with a Franchise Disclosure Document (FDD). The FDD contains 23 questions that are designed to provide a prospective franchisee with all of the information relevant to making a sound buying decision.
The document gives the franchisor’s history – including whether there has been involvement in litigation or bankruptcy. It discloses the costs associated with starting and operating the business. It also specifies the territory in which the business can operate.
The FDD includes provisions about the renewal of the franchise agreement as well as how it can be terminated or transferred. It usually gives information about financial performance and how disputes are to be resolved.
When reviewing the information, there are certain circumstances that may indicate further investigation is necessary to determine if there could be a problem. The following circumstances could be red flags about the franchise:
Churn Rate
The churn rate is how often a franchise has changed hands. A franchise with a high churn rate is a concern as it might mean the location has not been profitable, or there are other problems that make the franchise undesirable. This is something to ask the franchisor and any of the previous franchise owners if possible.
Litigation History
If a franchise has a litigation history, there needs to be further investigation to find out the reasons for the litigation and whether the issues being litigated are similar. If franchisees are suing the franchisor, it could mean there are problems with the franchisor’s performance. If the franchisor has sued franchisees, it might mean franchisees are having problems making timely payments.
Limitations on Damages
Franchisors often insert provisions into franchise agreements that specify what amounts are to be paid as damages in the event of a breach by the franchisee. These provisions should be reasonable considering the investment made by the franchisee and not unfairly penalizing.
What Do I Need to Know About the Franchise Territory?
The franchise territory is an important consideration when buying a franchise business. More competition within a franchise territory will likely mean less business for the franchisee.
The FDD must disclose whether the franchisor is granting the franchisee a specific territory. It must further disclose whether the territory granted is to be exclusive to the franchisee. A territory is considered exclusive if the franchisor agrees not to establish any company-owned or other franchised businesses within the territory. If territory exclusivity is conditioned on performance by the franchise, those conditions must be specifically stated.
If a territory is not exclusive, it must be expressly stated, and the extent and methods of competition must be disclosed. Franchisors must also set forth the options available to the franchisee to expand business within the territory.
Are Restrictive Provisions in a Franchise Agreement Non-negotiable?
Franchise agreements dictate what franchisees can and cannot do both during the franchise period and after the franchise terminates. Non-compete provisions are common in franchise agreements and prohibit the franchisee from operating a competing business during the term of the franchise and for a period thereafter.
To be enforceable in Texas, a non-compete provision must be reasonable as to the activities restricted, the geographic area of restriction, and the length of time the restriction applies. If a non-compete clause in a franchise agreement is overly broad, it may be possible to negotiate a more reasonable alternative.
In the near future, non-compete provisions may no longer be a big concern in business contracts. The Federal Trade Commission (FTC) has proposed a new rule that would ban non-compete clauses in most situations and would void existing non-compete clauses. A final vote on the rule by the FTC is expected in 2024.
Are My Renewal Rights Protected?
Franchise agreements are only valid for a designated period of years. At the end of the period, there will usually be an option to renew the agreement. While this may not seem like something to worry about when deciding to purchase a franchise, it is far better to try and negotiate favorable renewal terms at the outset rather than at some future point.
Initial franchise periods are commonly 10 or 20 years. A franchisee may be given the opportunity to renew the agreement one or more times. However, the renewal option is often contingent on compliance with specific conditions in the franchise agreement. Those conditions need to be reviewed with the future in mind to determine if they are reasonable assuming a successful franchise.
If The Franchise Is Successful, Can I Sell It for A Profit?
Most franchise agreements will say that there is no right to sell a franchise without the consent of the franchisor. The franchisor will usually specify the conditions under which consent to sell will be given. Those conditions may include the following:
- Purchaser must meet franchisor minimum standards
- Costs for investigation and training must be paid
- The current franchisee must be in compliance with the franchise agreement
The franchisor will often retain the right to match any purchase offer received by the franchisee. This provision can deter potential buyers from becoming interested in a franchise. A Houston franchise attorney will have some ideas as to how such a provision can be worded so as not to frustrate a franchisee’s future ability to sell the franchise.
Will The Franchisor Insist on A Personal Guarantee?
A franchisor requires a franchisee to personally guarantee any losses the franchisor might experience due to a breach of the franchise agreement. A personal guarantee is the franchisor’s attempt to protect their financial interests.
Franchisees need to read a personal guarantee carefully, as it may be unnecessarily broad. A franchisee will want to guarantee only what is minimally necessary and negotiate to limit or remove as much as possible.
Can A Franchisee Terminate the Franchise Agreement?
Franchise agreements contain a list of reasons why a franchisor may terminate a franchise agreement but do not give any termination rights to franchisees. Nevertheless, a franchisee may terminate a franchise agreement in the following situations:
- The franchisor breaches the franchise agreement
- The franchisor misrepresented information that the franchisee relied on in buying the franchise
- The franchisor becomes insolvent
Before you buy a franchise, make sure the opportunity has the best chance for success and your rights are protected. Schedule a consultation with a Houston franchise attorney at Feldman & Feldman in Houston.