How to Protect Yourself when Buying into a Franchise
You’re already taking a huge risk with buying into a franchise, so it’s important to limit that risk as much as possible. Of course, there are certain risks that are unavoidable, such as the real chance that your franchise tanks. The success of your franchise largely depends on your efforts. However, here are some practical tips that we’ve come up with after helping hundreds of franchisees make the decision to buy into a franchise.
Tip #1: Create an Entity Before Signing a Franchise Agreement
When John Smith signs a contract, John Smith is personally liable. When John Smith forms Smith Holdings, LLC and signs a contract as Smith Holdings, LLC, he is generally not liable for contractual obligations as the limited liability company he formed is the actual party to the contract. This scenario applies directly to franchising. Before you sign your Franchise Agreement, form a business entity such as a corporation or a limited liability company and sign the Franchise Agreement as that entity.
Entering into your Franchise Agreement as an entity can significantly limit your personal liability. However, you are still personally liable for any personal guaranty that you sign. Most franchisors require franchisees to sign a personal guarantee. Nevertheless, if someone slips and falls in your shop or office, they most likely won’t be able to take your house and the clothes off your back if you have an entity in place. Trust us – just form an entity. We can form entities for franchisee clients in as little as 1-2 days so they can still sign their Franchise Agreement on time.
Tip #2: Attend Discovery Day and Ask a lot of Questions
There’s no doubt that you should familiarize yourself with the franchise you are buying into. Most franchisors offer “Discovery Day.” They invite you to spend a day or more at a corporate-owned location or one of their top franchisee’s locations. Take advantage of this opportunity to ask a ton of questions. When you see something that doesn’t quite make sense to you, ask why they do that.
If you are at a franchisee’s location, candidly ask them questions about their relationship with the franchisor, their revenue, their expenses, and what they think of the franchise. While that may seem awkward, they were once in your shoes, deciding whether to spend upwards of hundreds of thousands of dollars to take a risk on a franchise. In our experience, other franchisees are more than happy to give an insider’s perspective on a franchise.
You will most likely be required to sign a confidentiality or non-disclosure agreement prior to attending Discovery Day. That’s totally normal. The franchisor wants to protect their secret methods and operations in the event you don’t sign. Nevertheless, make sure you read and understand the terms you’re agreeing to.
Tip #3: Negotiate the Terms of Your Franchise Agreement
The terms of your Franchise Agreement are sometimes negotiable. Most specifics, such as the length of your term, initial franchise fee, and the franchisor’s remedies and termination rights are pretty set in stone. However, franchisors want more franchisees. They are selling you on their franchise, and they will sometimes negotiate to close the deal. In the past, we’ve successfully negotiated tiered royalties, rights of first refusal on neighboring territories, and lower or eliminated renewal fees among other things.
The key to successfully negotiating is thinking long-term. The franchisor most likely won’t cut you a break on the initial franchise fee. However, if you express your interest in a long relationship with the franchisor, they are usually open to locking in a renewal fee or transfer fee as opposed to the usual terms, which bind you to the “current” price at the time of renewal. We also encourage franchisees to negotiate the size of their territory as well as a right of first refusal on adjacent or local territories.
Tip #4: Have an Attorney Review Your Franchise Disclosure Document and Franchise Agreement
In case you haven’t gotten your Franchise Disclosure Document (“FDD”) yet, they’re wonderfully dense reading material. Weighing in at 150-300+ pages of Size 12 Times New Roman, FDDs are some of the largest contracts in existence. Some of the content within them is boilerplate. However, the majority of the terms are specific to the individual franchise. Then, throw a 30-60+ page Franchise Agreement on top of that, and you’ve got some great reading. Hope you like non-fiction and “legalese.”
At Barber Power Law Group, we represent many franchisors. Naturally, we’ve drafted over 100 FDDs and reviewed over 300 of them for franchisees like yourself. We know where to look and what to look for. Let us take care of reviewing your FDD and Franchise Agreement. We’ll provide you with a full legal opinion, any red flags, and negotiation points. We’ll even negotiate on your behalf if you’d like.