How a Franchise Agreement and a Franchise Disclosure Document differ
There are two documents that are of vital importance...
1. Lack
of Commitment
To determine whether purchasing a franchise is right for you, you
should consider your own personal experience and the time you are
willing to invest. If your goal is to work from 9 to 5,
franchises and other independent businesses will likely not work
for you. All small businesses take an enormous commitment of
time, effort, and money in order to make them successful.
That being said, there are some opportunities in franchising that
may allow you to work around your schedule. For example, a
school teacher may be able to run an ice cream franchise during
summer holidays; a fast-food franchise located in a busy office
tower will likely close during evening hours for those who need
their nights free; and for anyone wanting to work at night, a
franchise focusing on telephone solicitation will work best in the
evening hours when most people are at home. Ensuring that the
potential business fits your personal lifestyle is an important
first step.
2.
Generic Business Concept
Look for unique qualities. Are there things that a particular
franchise does that no one else can do? It may be unique
displays, products, services, pricing, or ambiance. As a
consumer, you should want to purchase the products and services on
more than one occasion and develop some sort of loyalty to the
business. If the products are not unique, then check to see
if they have been packaged in a unique way. If products are neither
unique, nor packaged in an unusual manner, then they should be sold
at very competitive prices. However, if price is the only
advantage, you should consider that it will not take long for
others to find ways to lower their prices thereby leaving consumers
no reason to purchase your product or services.
3. Lack
of Discussions with Existing & Former Franchisees
After visiting one or more locations as a customer, go back as a
potential buyer. Speak to the owner about the profitability
of the location and the following items:
- What is the owner’s overall impression of the franchise system?
- Does the franchisor provide support when requested?
- Is there an operating manual which clearly sets out procedures for operation?
- How much time will you be required to spend at the business?
- Are you required to buy all products and supplies from a single source or from sources approved by the franchisor? If so, are there any issues regarding pricing or timeliness of delivery?
- Were there any problems in construction or delays in opening the franchise?
- Are the revenue and expenses projected in the pro forma cash flow statements realistic?
- Most importantly, ask if the owner would buy the same franchise again if they could do it over?
You should also speak to the owner about any other issues that
you feel may be relevant to your decision whether or not to
purchase a franchise – the worst that can happen is that the owner
will refuse to answer your questions.
4.
Ignoring the Disclosure Document
If the franchise to be purchased is located in either Alberta,
Ontario or Prince Edward Island (or New Brunswick upon enactment of
their regulations later this year), the franchisor is obliged by
law to provide you with a disclosure document at least 14 days
prior to you paying anything to the franchisor or signing any
agreements. Even if the franchise is not located in these
provinces, it may be prudent for you to nevertheless request a copy
of the disclosure document if you know that the franchisor is
selling franchises in these provinces.
If the franchisor is a member of the Canadian Franchise
Association, it is also required by their Code of Ethics that a
franchisor provide a copy of its disclosure document in a similar
manner as required under legislation.
The disclosure document contains information that makes the
investigation of the franchise much easier. Information such
as the franchisor’s financial statements, business history,
litigation history and names and addresses of current and former
franchisees, as well as the estimated costs to establish the
franchise, are all contained in the disclosure document. The
person signing the disclosure on behalf of the franchisor can be
held personally liable for any misrepresentations or omissions in
the disclosure document.
The disclosure document will provide you with a package of
documents that will include a franchise agreement and may include a
sublease, general security agreement and any other agreements to be
signed by you pertaining to the franchise. Make sure you
carefully review the contents of the disclosure document and seek
the necessary legal and financial advice prior to making the final
decision to purchase the franchise.
5.
Ignoring the Competition
Although you may become enamoured by a particular franchise, it may
be helpful to also research other related or competitive concepts.
Having a comparison, you will be better able to objectively assess
the financial and business terms of the proposed franchise. By
reviewing all related franchises within a particular industry, you
may also obtain information regarding current trends and
projections within that industry. Finally, having this
information about your immediate competitors may prove useful as
each of you compete for business and customers within the franchise
territory.
6. Lack
of Proper Legal Advice
Before signing anything, you should seek professional legal
advice. Just as you would not go to an eye doctor for a
toothache, you should not go to a lawyer who does not have
franchise experience. Ask your lawyer when the last time was
that he or she looked at a franchise agreement. If the answer
is not earlier the same day or sometime the day before, it is
likely that you are not dealing with a franchise lawyer.
Generally speaking, a good franchise lawyer spends more than 50% of
his or her time on franchise matters. In order to be properly
advised in this industry, knowledge of how a franchise works is
almost as important as the legal advice and it is important to find
a lawyer with experience in both areas. A lawyer
inexperienced in franchise matters may be able to tell you what a
franchise agreement means, but will not be able to tell you what is
missing from it or what should have been included in an
agreement.
7. Stale
or Fad Franchises
Every business requires change. You are going to have the
franchise for 5 or 10 years, which is a long time for most
businesses to be running on the same format. Good franchisors
invest a great deal of time finding ways to extend the life of
their franchise and thereby add value for their existing
franchisees. Ask the owner of a franchise if the franchisor
introduces innovative new products or services, or requires
renovations during the term of the franchise. On the other
hand, consider whether the franchisor has had any long-term
success, or whether the products or services are a “fad” or have
limited appeal across different markets or in different market
conditions. The franchise concept must be able to stand the
test of time and be adaptable to changing conditions.
8.
Non-Negotiable Franchise Agreement
Franchise agreements, in experienced hands, reveal a lot about the
franchisor’s system and commitment to franchisees. They are
typically one-sided allowing the franchisor to strictly control the
system. In most mature systems, franchisors are reluctant to
make changes to their franchise agreements. In most newer
systems, particularly where the franchise agreement may have not
been previously reviewed by experienced counsel, there may be some
room to negotiate. If a portion of the agreement creates a
situation of unfairness or is unreasonable, or is otherwise not
applicable to particular circumstances, most franchisors would be
willing to make the changes.
9.
Complete Acceptance of Pro Forma Statements
You may also be provided with financial information and projections
from the franchisor in order to assist you in obtaining bank
financing. Most pro forma financial statements state
on the face of them that they are not to be relied upon.
Therefore, without some research, you should not rely on
them. Take the financial statements back to an existing
franchisee and ask if the numbers make sense. Although the
franchisee may not be willing to give you the bottom line numbers,
show the franchisee statements provided by the franchisor and see
if they are in line with the franchisee’s own experience. Are
labour costs correct? Are the amounts shown for rent,
inventory, supplies, advertising and royalties correct? Has
the owner ever achieved the sales levels shown on the pro
forma statement and, if so, how long did it take to get
there? What was the first year like in comparison to
following years?
10. Development Cost
Delays & Overruns
Some franchisors do not deliver the franchises in a “turn-key”
format, ready for the franchisee to operate. In some cases,
the franchisee will have to develop the premises in accordance with
the franchisor’s specifications. If the franchisor requires you to
be responsible for construction, it is important to determine
whether you are required to use construction companies that are
related to the franchisor or whether you can choose anyone you
wish. Even in cases where the franchisor agrees to deliver a
“turn-key” operation, the franchisor may be agreeable to allowing
you to seek competitive bids if they are not using related
construction companies. You should always ensure that any
construction contract has reasonable deadlines and penalties for
the construction company if they fail to meet the scheduled
deadlines. Many commercial leases will allow you a fixturing
period where you will not be required to pay base rent while
construction and leasehold improvements take place; however, this
fixturing period is always limited and as soon as it runs out you
will be charged rent at the full rates whether or not your
construction is completed.
Conclusion
Ensuring that you are properly informed before making a purchase is
very important in helping you to avoid pitfalls and bad
investments. Opening a franchise business for the first time
is a big step for most people. As you can see, most of the
mistakes committed by franchisees in buying a franchise have to do
with incomplete due diligence and/or improper advice. Educating
yourself and getting proper advice, although not itself a guarantee
of success, can help ensure that you are taking a strong step
forward rather than making a leap of faith.
© 2010 Morrison Brown Sosnovitch LLP.
The information provided in this publication is general in nature and relates to the laws of the Province of Ontario, Canada. While reasonable efforts are made to ensure the accuracy of the information, the information contained herein does not replace the need for legal advice which is specific to your situation
This article has been provided courtesy of Derwin Wong and Dixie Ho. They can be reached at: Derwin Wong dwong@businesslawyers.com or Dixie Ho dho@businesslawyers.com
