Unsinkable luxury liners aren’t supposed to hit icebergs on their maiden voyages, let alone plummet to the bottom of the Atlantic. Yet, notwithstanding watertight compartments and thick steel hulls, even the sturdiest of ships will sink.
Likewise, franchised businesses aren’t supposed to fail, given that the franchisee is supposedly buying into the franchisor’s successful business system. But, on occasion, they do. That’s why prospective franchisees should do their homework before they buy. Count those lifeboats before boarding!
A franchise is essentially a licence to operate the franchisor’s business system and trademark according to the franchisor’s standards for between five and twenty years, depending on the franchise agreement and the lease. In exchange for the right to carry on business under a trademark such as “”Emma & Jeremy’s Coffee Emporium”, the franchisee usually pays the franchisor an initial franchise fee for these rights ( somewhere between $15,000 and $70,000), plus an ongoing royalty linked to the gross sales of the franchised outlet ( between 5% and 8% of gross sales). There is often a requirement for the franchisee to make regular contributions to a regional or national advertising fund as well (between 1% and 4 % of gross sales), so that the franchisor can advertise the brand in high cost media. Additionally, the franchisee either develops the premises itself (at its cost), or buys the constructed premises on a “turnkey” basis from the franchisor. Either way, there are dollars at stake.
Franchisors are essentially selling three things: the value of a (hopefully) recognizable trademark and brand; the know-how associated with the franchisor’s business system (and the Franchisor being able to teach that know-how to the franchisee); and the lower unit costs that come from the purchasing power of a large buying group.
Legally, franchising is very document intensive and it is important for the prospective franchisee to understand what he or she is signing. Someone who sends the franchisor a 20-page list of changes to the franchisor’s standard agreement is arguably unfamiliar with the norms of the franchising relationship. Part of the job is to know what is “boilerplate” and what is not; what is negotiable and what is not. Here are a few legal matters that prospective franchisees should keep in mind when considering buying a franchise:
Don’t get the idea that you are actually buying it. You’re not.
You're simply acquiring the rights to use a Franchisor's business system, trade-mark and “know-how” for five or 10 or even 20 years, depending on the term of the franchise and any renewal rights contained in the Franchise Agreement. Think of it like a lease; you’re “renting” the Franchisor's business system for a time, and when that time is up, its over. Those rights revert back to the Franchisor.
Don’t forget to talk to other franchisees in the system.
Even if they are in other parts of the country thousands of miles away, their input is invaluable. And if they are reluctant to speak with a stranger out of the blue, ask these three questions: Are you happy? Are you making any money? Would you do it again?span>
Critically assess all financial and other information given to you.
Franchisors will often provide pro forma financial statements to prospective Franchisees to indicate how they think the business venture will perform. Look these financial statements with a critical eye; things are not always what they seem, and often, it's just someone's best estimate of future (not past) performance. Note that Franchisors awarding franchises in Alberta and Ontario are required by law to provide a Disclosure Document to prospective Franchisees at least 14 days before the Franchisee signs any agreement relating to the franchise or pays any money (slightly different in Alberta). Read this and the documents attached to the Disclosure Document carefully with your franchise lawyer. Although, these documents will assist you in assessing the nature of the investment, they're always written for the Franchisor's benefit, and will be crafted to put the Franchisor and the franchise system in the best light possible. PEI and New Brunswick are have legislation regulating franchising.
Reading books on franchising in Canada is helpful for background knowledge, but it’s a specialized area.
A Franchise Agreement is a complex contract, and there are books out there that will help. This is a good one: Buying a Franchise in Canada: Understanding and Negotiating Your Franchise Agreement. But it’s a specialized area from a legal perspective.
Be careful of U.S. Franchise Agreements that have not been adapted to Canadian laws.
Sometimes U.S. based Franchisors forget that Canada is a separate country. They don't modify their Franchise Agreements to suit Canadian laws, practice and customs. There may be provisions in their agreement which might make sense if you were in Oregon or Ohio, but don't make sense in Canada. So be careful of agreements that haven’t been "Canadianized", or you might end up complying with the Patriot Act or having to pay your royalties in U.S. dollars. If they haven't adapted their Franchise Agreement for use in Canada, ask: “Why not?”
Don’t get sidetracked negotiating the boilerplate.
Franchisors pay their lawyers lots of money to draft standard, solid and enforceable Franchise Agreements which they can use with all their Franchisees with little or no amendments. A long shopping list of little changes and picky modifications to the standard and normal provisions will likely make it harder to discuss and negotiate the four or five important issues which really count. So pick your most important “deal points” to discuss, and try to leave the boilerplate alone unless there’s something unusual in it.
If you can, try to avoid entering a Franchise Agreement where both you and your spouse have to guarantee the contract.
It only means the Franchisor has 2 of you to sue if the business
fails. If at all possible, limit your exposure so that one of you
assumes all the risk. You might also consider capping any personal
guarantee to a maximum amount.
Who am I dealing with? Is the prospective franchisee dealing with the owner of the franchised concept, or an area developer or master franchisee who owns the rights to a particular territory or a salesman who sells all sorts of franchises?
Training. How extensive is the training and where is it held? An extensive training program is a good thing and probably means they want you to succeed.
Trademark. Does the franchisor own or control the trademark? (You can search the Canadian Trademarks Office database to check the status of any filed and registered mark.)
Pricing. What assurances are there that the products for sale by the franchisor can be bought by the franchisee at competitive prices?
Focus on acquiring a franchise that interests you.
If you have an advanced degree in engineering, do you really want to be making sandwiches all day? Find something that you enjoy doing because you'll be doing it a lot, and for a long time. (And who knows, it may be making sandwiches!)
Don’t let your expectations get away from you.
Like any other investment, acquiring a franchise involves a degree of risk. Some franchises work out very well for the franchisees. And some do not. Appreciate that all franchises involve both risk and hard work. Learn as much as you can about franchising and work with a franchise lawyer so that you can understand what you’re getting in to and minimize the risk
The Canadian Franchise Association urges prospective franchisees to “investigate before investing” because there are franchisors with less than lily-white reputations selling franchises in Canada. Currently only Ontario and Alberta have laws where franchisors are required to provide to prospective franchisees a “disclosure document”, disclosing all material facts related to the offering of the franchise. This is similar to the legislative framework in the United States where franchising is extensively regulated. PEI has enacted similar legislation and New Brunswick will have regulations for its Franchise Act by the end of 2009.
Tony Wilson is a Franchise and Trademark
lawyer at Boughton in Vancouver and the author of
"Buying a Franchise in Canada: Understanding and Negotiating Your Franchise Agreement (published by Self Counsel Press)."
He can be reached at firstname.lastname@example.org