Should You Buy A Franchise?
by Stephanie L. V. Hendricks, owner of Hendricks Law Firm
Owning a franchise can be an attractive option for the person who wants to own a business, but who also wants to reduce some of the associated risks, including the risk of whether or not the idea is one that works.
This article addresses some of the things that a prospective franchisee should think about generally, what the Franchise Disclosure Document (FDD) is, and sets out questions that the prospective franchisee might consider asking franchisees who are in the system and as well as franchisees who have left the system.
In order to determine whether owning a franchise is a good option for you, you should first think generally about your experience in the particular industry and your experience as a business owner. You should create your own independent business plan that includes projections for the franchise’s financial performance for the first three years; and, in preparing the plan, you should research the industry and where the particular franchise fits into it. Specifically, focus on whether the industry is saturated (like food service), and review any industry studies that might indicate that this particular franchise is likely to be successful or unsuccessful.
The FDD is the document that the person selling the franchise will give to you that describes, among other things, what the relationship between you and the franchisor will be. Its contents are based on legal requirements about disclosures that must be made to prospective purchasers of franchises. Such disclosures include: “who” the franchisor is in terms of its business structure, and its business and litigation experience, how the franchise operates, franchisee fees, and intellectual property that the franchisor owns, among other things.
Typically, the FDD will have several attachments, including a franchise agreement, financial statements, and a list of other franchisees. Because the FDD contains what the franchisor is required to furnish to you by law, you should consider your review of its contents as the start of your investigational process rather than as the answer to all of your questions. You will typically be required to sign an acknowledgment at the end of the document stating that you received it within a certain time period, and that it contained certain information. The FDD contains the definitive and binding terms of the franchise being offered. Therefore, although your signature will not bind you to purchase a franchise, it is an acknowledgment that you received all legally required information from the franchisor, and that you received it within the legally prescribed timeframe. This acknowledgment could have legal implications if you decide to purchase a franchise and you later find yourself in a dispute with the franchisor.
Therefore, despite its length, a prospective franchisee must carefully review the FDD and develop a solid understanding of its terms before signing any acknowledgments.
Specifically, focus on the following:
- Duration; is the duration of the agreement sufficient to justify the investment? What conditions are imposed on renewal?
- If the deal goes bad and you want out, are there provisions in the franchise agreement that will let you out?
- Are you required to pay any minimum royalties over the entire duration of the agreement?
- What is the experience of the franchisor, and is their business stable?
- Is the company public?
- Has the franchisor experienced any financial difficulties, including a bankruptcy?
- What is the background and experience of the franchisor’s principals?
- What is the franchise’s litigation history?
- Has the franchise violated any franchise sales laws?
- Has the franchise ever been fined?
- Has the franchise ever been subject to claims for fraud?
- The number and location of the existing franchisees
- What is the turnover of franchisees?
- What is the total proposed investment, which includes not only initial franchise fees, but any other investment in things required to operate the business such as computers, advertising funds, insurance payments, legal fees, and other contingency payments?
- What are the obligations of the franchisor?
- What assistance does the franchisor give in setting up the business?
- Is there a well-established and thorough training program?
- Is there a detailed operations manual?
- Who is available to answer questions on a day-to-day basis?
- Is there territorial protection? And if so, does the franchisor reserve any rights with respect to its own conduct of business in that territory?
- What are the obligations of franchisees?
- What are the financial statements?
- What are the terms of the franchise agreement?
In addition, a prospective franchisee should speak with several existing franchisees and several who have left the system.
With respect to existing franchisees, the prospective franchisee should contact people that the franchisor did not suggest because those franchisees are more likely to respond honestly about their experience. The prospective franchisee might consider asking the following questions:
- How long have you been in business? (Someone who has been in business for less than a year probably does not have enough experience to give you reliable information; look for franchisees who have been in business at least 2 to 3 years.)
- Have you had any difficulty meeting quotas?
- Is your business making a profit after paying yourself a reasonable salary?
- Has your experience been consistent with what the franchisor said it would be?
- How frequently do you hear from the franchisor’s representatives?
- Do the franchisor’s representatives assist you in operating your business?
- Is the software functional and helpful?
- If you want to make a complaint, is it easy to do so, and how does the franchisor respond?
- What would you change?
- What is the most negative thing you can say about the franchisor?
- If you had it to do over again, would you do it again?
With respect to franchisees who have left the system, you should ask the questions above, and, most importantly, ask them why they left.
Finally, you should make sure that you know the status of the franchisor’s trademarks. You should think about:
- Whether the trademarks are well known,
- Whether they are federally registered; they should be listed on the Principal Register of the United States Trademark Office (PTO), and there should be no competing marks, and
- How long they have been registered.
While it is likely that the franchisor will be reluctant to agree to changes in the FDD, the franchisor may be willing to negotiate on the following issues:
- Changes in territory or the terms of exclusivity,
- The duration of the agreement and renewal terms,
- Initial and continuing franchise and advertising fees,
- More freedom to transfer the franchise or assign the agreement, and
- A provision requiring that you receive terms as favorable as any other franchisee.
Owning a business can be one of the most rewarding and challenging experiences that a person can have, and it is important that you approach such an the endeavor carefully from the outset. Besides following the foregoing guidelines, you should also make sure to find good legal and accounting professionals to assist you along the way.
Stephanie Hendricks owns Hendricks Law Firm, which focuses on providing New York entrepreneurs, small businesses, and start-ups with a full range of business services. Stephanie Hendricks provides pro bono legal services monthly at NYC Business Solutions, Staten Island Center.
Note that this blog is for informational purposes only and should not be relied upon as a legal advice.
The views, opinions, or expressions provided by Stephanie Hendricks do not necessarily represent the views, opinions, or expressions of the City of New York, the New York City Department of Small Business Services, and/or NYC Business Solutions.