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10 Things About Franchise Contracts- Part 2

Part two in the series of understanding the ins and outs of a franchise agreement contract, and how to protect yourself.
May 28, 2009
URL: http://www.entrepreneur.com/article/201914

The old saying "forewarned is forearmed" is appropriate when trying to understand some basic truths about a franchise agreement contract. In part one of this article, I discussed some basic characteristics that explain the nature of the franchise agreement contract. Now, let's pursue the contract a little deeper by covering more subtle considerations to be aware of.

6. The franchise agreement can contain additions or restrictions that don't seem relevant. These tend to originate from two sources, both of which help to evaluate the company better.

The first source--the franchise company itself. It can insert clauses which address future planning strategies and ideas. The second source--the franchise company's attorney. Attorneys can insert clauses designed to protect the future rights of a company, like alternate channel distribution of products or services.

These provisions can give you some big clues to a company's potential future plans, so whenever you see them in an agreement, make sure you ask why they're being included.

7. The franchise agreement can contain clauses that restrict your ability to sell your business. These requirements will affect whatever exit strategy you may have in place, so review carefully. Often, prospective franchisees consider this the least important consideration, but don't be fooled. In actuality, most franchise agreements are for an initial term of 10 to 20 years, and most franchisees leave before that term is completed.

The most common of these provisions explains that the person you sell your business to must meet the same requirements as all other franchisees that entered the system at that time. Another provision might require you to offer the franchise company a first right of refusal to purchase your business on the same terms and conditions you reach with a third party buyer. There are also usually some transfer fees you will have to pay the franchisor. You should carefully examine any clauses associated with leaving the system so you're aware in advance of the rules you'll have to follow in that event.

8. Always have an attorney review the franchise agreement contract for you. Why have an attorney evaluate it before agreeing to the contract? It's good practice in the normal course of business, as in life, to have all important contracts reviewed; always consider the cost, advantages and disadvantages when deciding whether to sign.

It's a fact of life that most people enter into contracts all the time without even reading them, let alone having a lawyer review them. Minor contracts, such as with cell phone companies, will have you commit to a monthly, minimum payment for a few years. Other contracts can be far more substantial-- insurance policies to protect your property and family, or the largest single contract most people enter into-- a home mortgage. Virtually anyone who has a mortgage signed the inch-thick contract without hesitation.

As discussed in the first part of this article, most franchise agreements from strong franchise companies are non-negotiable. If you can negotiate, hire an experienced franchise attorney, and get busy working out the best deal possible. If the franchise agreement isn't negotiable, then you need to ask yourself if the potential benefit of a review will be greater than the expense. Ultimately, it will come down to whether you really want the franchise, and if you do, then the contract "is what it is."

9. Virtually all franchise agreements contain a clause that lets the franchise company change the deal-- in material ways, after the fact, without any recourse by the franchisee. This is done by incorporating other documents, as amended from time to time, into their franchise agreement by reference. To make this even more interesting, most such referenced documents are proprietary, meaning you will not receive a current copy nor can you review them prior to signing your franchise agreement contract.

This isn't as nefarious as it might sound, but you need to be aware of this power. The most commonly-referenced document is a franchise company's operations manual, which outlines all rules and requirements in detail for operating the business. This manual also outlines the exact specifications required for building and maintaining the business. These specifications can be changed at any time, and if such a change is made in a referenced document, the franchisee is required to conform under the terms of the franchise agreement.

In the real world, this could mean requirements to make more substantial investments into the physical assets of the unit: A new required computer system, remodeling to match a new décor need, or additional equipment in order to provide a new product or service. Be aware of these possibilities, but also consider the final point below before getting too concerned about this clause.

10. One real-world, non-contractual protection: As a collective group, franchisees have a lot of power. You're in a position where you have to trust the franchise company to do the right thing by you in the future. Unfortunately, you're not going to get all of the protections you might like in the franchise agreement, and that can make people uneasy.

However, always keep in mind that you do have one very important real world protection--safety against arbitrary or capricious behavior of the franchise company. If they're out of line, they're not only hurting you, but hurting all of the franchisees. As a collective group, franchisees have "power of the purse" over the franchisor, since virtually all of a franchise company's revenue comes from its franchisees.

Most franchise companies recognize this checks-and-balances factor, and the smart ones actively seek franchisee support with important and potentially expensive decisions, such as elected advisory councils, regional meetings and national conventions. As a new franchisee, you may not feel like you have much power, but more experienced franchisees will be protecting their own interests (and by extension, yours), so learn from them and follow their lead when appropriate.

Now is a great time to consider a franchise business, as long as you're careful and deliberate in the process of selecting the right franchise for you. Part of this process involves understanding the ins and outs of the franchise agreement contract, and how to proceed to become the next great franchise success story.