Before you start shopping for a franchise, you may want to get familiar with the legal aspects of buying a franchise and becoming a franchisee. Unlike a business you purchase or create, franchising has its own set of rules and some mythology on its side.
Franchising is governed by federal and state law. Both require franchisors to provide prospects with information describing the legal and business relationship between franchisor and franchisee. The Federal Trade Commission (FTC) is the regulator at the federal level. States may have an office of consumer affairs or a state securities division backed by the power of the state Attorney General’s office.
Other helpful resources include:
- Accountants and attorneys
- Banks and financial institutions
- Better Business Bureau
- Franchise.org and other online sources
- Other franchisees
Are you thinking of becoming a franchisee?
About Franchising - Condensed
Before you become a franchisee ask yourself if you are comfortable following someone else’s rules and instructions. The franchise business is highly constrained and regulated by the franchise owner with little room for creativity or entrepreneurship on your part.
Know the market you are entering and do not believe the myth that only 5% or some other low percentage of franchises fail. Even in a good economic climate, franchises fail at the same rate as any other business; typically only two-thirds of businesses with employees make it to the two-year mark. At five years, only half remain.
Try working in one of the stores for at least six months. Some franchisors require you to work your way up or work in the franchise for several years before accepting an application for franchisee.
Pros of franchising:
- Established brand and name recognition
- Proven market
- Training
- Staffing guidelines
Not-so-pros of franchising:
- Unexpected costs and liabilities
- Franchise fees and royalties
- Marketing expenses
- Merchandise mark-ups
- Franchise mandated discount promotions and giveaways
You can find out about available franchises locally or through the Franchise Opportunities Handbook at the local library or online. Do a little research to narrow down your choices and visit a Franchise Exposition to meet with some of the people involved.
When selecting a franchise to consider:
- Demand
- Competition
- Your business abilities
- Name recognition
- Growth potential
Understand the franchisor controls site approval, the design or appearance of the store, restrictions on what you sell and your methods of operation. You are also restricted as to sales territory.
Contractual Obligations to Buying a Franchise
When it gets down to contracts, find an experienced Dallas business attorney to help you understand your obligations to the franchise, some of which still count after you sell or terminate your franchise.
Two major documents control the franchisor-franchisee relationship:
- Franchise disclosure document
- Franchise agreement
The FTC requires the franchise to provide a franchise disclosure document (FDD) at least 14 days before you are asked to sign a contract or pay any money. You may also have the right to receive a copy once the franchisor has received your application and agreed to review it. It is possible to obtain one before you begin investigating the franchise.
Once you receive, read it. All of it. Talk to a lawyer. Go to FTC.gov for help understanding it. It is critical you know what you are signing and paying for.
The FDD contains a lot of information about the franchise, its management, and its financial capabilities.
- Franchisor, franchise system, and the agreements a franchisee is required to sign
- Key company staff
- Management’s experience in franchise management
- Financial statements
- Bankruptcy filings and litigation involving franchisor
- Type of training franchise offers
- Your required purchases and investments
- Territory rights
- Non-obvious costs
The franchise disclosure document also contains the franchise agreement. More specific than the FDD, the franchise agreement sets up the terms of the relationship between the franchisor and franchisee. It has more information about the:
- Franchise system, including the use of trademarks and products
- Standards
- Procedures
- The term of the franchise (duration)
- Payments to be made from to the franchisor
- Training, assistance, and advertising
The franchise agreement is the legal, written document containing the terms of purchase. Scrutinize it with your attorney and accountant before signing.
When it comes time for renewal, the franchisor is not obligated to renew your contract and may require you to sign a new one with different obligations than before. A franchisor may also terminate your franchise for breaking the rules or failing to pay royalties.
Again, speak with your attorney to prevent misunderstandings and clarify your obligations.
Your Resources
The Federal Trade Commission exists to protect the consumer (that’s you) from fraud, deception, and unfair business practices. It also provides information to businesses to help them comply with the law.
Banks and other financial institutions can provide a Dun and Bradstreet report or something similar of the franchisor with valuable business information. The bank may also be able to get sales and profit information although, since it is provided by the franchisor, it may not be accurate.
Your best partner when seeking to buy a franchise is an experienced franchise attorney who is familiar with FTC requirements and the regulations of the state your store is located. The franchise disclosure document and the franchise agreement are legally binding contracts with legal terms and perspectives most people don’t have.
Do your homework and decide if franchising is still for you. If you think it is, find an attorney you can trust to help you avoid the legal pitfalls.