A: BUYING A FRANCHISE IS EXCITING RIGHT? The prospect of opening the door to a shiny new outlet and having customers rush in to experience your brand is part of the allure of franchising. But that excitement fades the moment you receive the Franchise Disclosure Document, an epic tome the size of a phone book that sets out the franchise agreements and describes the opportunity. Franchisees and their counsel have to wade through this document to decipher the real business deal lurking beneath the placid surface. As the picture takes shape, the question immediately arises: How do I negotiate the terms?
Franchisors are quick to reply that you can’t. A litany of excuses will be thrown at you, ranging from “this is the standard form, we don’t change it for anybody,” to “all changes have to be approved by head office,” to “this is how we have been doing it for “x” years, no one has ever complained before.”
But where is the truth? In fact, it lies somewhere in between. Purchasing a franchise is a commercial transaction, subject to the laws of supply and demand. A successful, high profile franchise may not need you as much as you need them, and the appetite for change may be slim to none. At the other end of the spectrum, an aggressive new concept may be hungry for growth and may consider changes if it means adding a strong franchisee to their stable.
Here are some points for you to consider:
- Franchisor’s Status and Reputation: If a large established franchisor is sitting across the table, be realistic in your expectations. While most franchisors will be receptive to reasonable commentary, firing off a laundry list of demands will not get you far and may sour the relationship. However, if a real deal-breaker exists (for example: a termination for convenience clause in favour of the franchisor, prohibitive transfer or renewal fees, unrealistic sales quotas, or development obligations), then you need to voice your concerns. As earlier noted, early stage franchisors may have more flexibility to negotiate as their systems develop.
- Exclusive Territory: It is rare in the modern era for a franchisor to offer exclusive territorial rights to a retail franchisor. Most contracts for retail outlets expressly state that no territorial exclusivity is granted and licensed rights are specific to the store location. The franchisor reserves the right, subject to its statutory duty of good faith, to open a store in proximity to an existing franchisee. However, it is not unreasonable for a prospective franchisee to negotiate a protected territory adjacent to their franchise. This takes the form of a covenant from a franchisor that it will not offer a franchise or open a corporate store within a prescribed territory (often a radius) around the existing franchise, provided the existing franchisee is compliant with the franchise agreement.
- Term and Renewal: A short initial term, limited renewal rights, or unreasonable renewal terms will harm the marketability and liquidity of your investment. Ensure that the term and renewal conditions are standard and that you enjoy renewals as of right upon satisfaction of reasonable conditions, and not subject to the franchisor’s discretion.
- Additional Franchise Rights: In certain cases, it may be appropriate for strong prospects to request the rights to develop one or more franchises in other territories within a specified development period. If the franchisor is agreeable, these rights can be embodied in an option, right of first refusal or development agreement and may require you to pay additional fees to reserve the rights during the option period.
- Support and Assistance: Certain franchise agreements provide for extensive startup support and ongoing assistance by franchisors to franchisees. Some are silent on this point or promise a bare minimum of help to new franchisees. In certain cases, franchisees may consider requesting a larger support commitment from the franchisor, or a promise to provide additional assistance on the basis of negotiated maximum fees.
- Initial Fees and Royalties: The price of admission for an established franchise will typically be non-negotiable. However, this may not always be the case for early stage franchisors who are still finding the market for their franchises. A strong prospect may be able to negotiate a lower, or deferred, initial franchise fee or royal-ties. This “side deal” can be set out in a separate letter agreement to avoid having to amend the standard form template and permit the franchisor to maintain its stated fees as it builds demand for its franchises.
- Advertising Contributions: New franchisors that have fewer than three or four franchisees may not collect sufficient advertising contributions to execute a substantial advertising campaign. In these cases, some franchisors may be prepared to defer ad fund contributions until a certain minimum number of franchisees are in the system, provided that each franchisee redirects the funds to local advertising.
- Transfer and Renewal Fees: As noted above, if these fees are prohibitively high, they can inhibit your desire to sell or renew and in that way impair the value of your franchise. While these fees are typically non-negotiable, consult with your counsel to ensure that they are reflec-tive of market and if not, consider pushing back.
- Remodelling/Capital Expenditures: Be wary of any requirements that require significant additional capital expenditures or remodelling early in the relationship. Seek to extend remodelling obligations to a reasonable interval consistent with common practice within the system or industry.
- Guarantees and Security: Franchisors may require that all shareholders, directors, and officers of the franchisees and each of their respective spouses personally guarantee all of the obligations of the franchisee to the franchisor. This will in some cases be supported by a lien in the form of a general security agreement. Franchisees should try to restrict the guarantees to principals with a controlling interest in the franchisee, and if appropriate, seek to negotiate dollar limits on the guarantees, especially if these are secured.
- Franchisor Purchase Rights: Franchisors often reserve the first right to purchase the franchise from the franchisee on the terms of any third party offer received by the franchisee. The franchisee should resist permitting the franchisor to “sit” on the offer for an extended period of time while considering whether or not to match it. An extended notice period has a chilling effect on the sale process and can frighten away prospective purchasers, diminishing the value of the franchise. These are but a few examples of areas where it may be prudent to seek amendments to the boilerplate “standard form” franchise agreement. As noted, some cases may truly be “take it or leave it” offers. But in most instances, franchisors will entertain rational and respectful discourse over controversial terms in their contracts. If nothing else, these discussions will help the franchisor gauge what the market will bear and refine the terms of their own franchise agreements. As always, ensure that you retain qualified legal and accounting professionals to guide you through your purchase of any franchise.
Miller Thomson LLP