Agreement Negotiation

Once you have narrowed your options down to your top two or three choices, you must negotiate the best deal you can with the franchisor. In most cases, the franchisor will tell you that the franchise agreement cannot be changed. If you accept this explanation, shame on you!

To successfully negotiate, you must have a thorough knowledge of the industry, the franchise agreement you are negotiating (and agreements of competitive franchise opportunities), and access to experienced professional advice. This can be a lawyer, an accountant, or a franchise consultant. Above all else, they should have proven experience in negotiating franchise agreements. Investing in sound professional advice is not a cost that can or should be avoided.

Don't leave it all up to the pros, however. Be aware of the variables at stake and do your own preliminary analysis:

Franchise Fee

  • Are you personally responsible for all franchise obligations or does the franchise agreement allow you to avoid personal liability for franchise-related debts by forming a corporation?
  • Will the franchisor take a short-term note for all or part of the franchise fee? If you plan on opening a second unit, can the franchise fee be eliminated or reduced on that second unit?
  • How much of the fee can you expect to get back if the training program disappoints you?

Advertising Fees

  • Do you have any control over the advertising fund you contribute to, either in the form of a franchisee board or in a portion specified for your use on local advertising?
  • Can the franchisor agree to match the money you spend on local advertising? This becomes a critical issue in areas with only a few franchisees. The franchisor may spend most of the advertising money far away from you such that you may have a right to request some sort of compensating reimbursement for your efforts.

Royalty Fees

Royalty fees are usually a percentage of your gross sales, but be aware of flat weekly or monthly charges. Also be wary of franchisors who charge small initial franchise fees (possibly to reel you in!), but large royalty fees. Large royalty fees can be a real drag on your future profits growth, whereas initial franchise fees are one-time costs.

Hidden Costs

Be careful of the hidden costs we mentioned earlier in the FDD Analysis. It is much more advantageous to you to have most of the income the franchisor receives to be based mostly on royalties. Because the franchisor's financial welfare is directly tied to yours, he will be more responsible in delivering you the support it promised you. Hidden costs reduce the franchisor's incentive to assist you, turning the relationship from a mutually-beneficial "partnership" to a supplier-buyer relationship.

Make sure the prices you are paying for the equipment and other goods/services the franchisor requires of you are competitive, or at least reasonable. The quality of these goods/services should also be comparable with outside sources. Oftentimes, franchisors will allow you to buy equipment and other goods through an approved supplier that has met the franchisor's specifications, so there is some freedom for you to shop around.

Quotas

Be aware of sales quotas you must meet, either to retain your exclusive rights or to even avoid termination of your franchise by the franchisor. Make sure these figures are realistic. It might take you a while to learn how to operate the business effectively, or the area you are operating in may not have enough demand as of yet.

The Franchise Term

A franchise agreement usually lasts anywhere from five to 15 years. Some agreements include a stipulation that the franchisor can terminate the agreement "at will" simply with a written notice. Acquaint yourself with the conditions under which your franchise can be terminated (see below for more on Termination).

You should also know about your renewal rights.

  • Are they automatically offered to you at the end of your franchise agreement?
  • Will some fee be involved upon renewal?
  • Will a new franchise agreement be negotiated? This is an issue if new, higher franchise fees and royalties have been adopted by then!
  • If the franchisor requires you to pay for costly leasehold improvements, will you have enough time to recover your initial investment if automatic renewal of your agreement is not provided to you?

Assignment

Most franchise agreements stipulate that written approval by the franchisor is necessary in order to transfer or assign your franchise agreement to another person. However, you may want to ask for, in writing, the right to transfer the franchise to a family member in the event you fall seriously ill or even die. What is the deadline you are given to close a transfer before the franchisor terminates your franchise agreement?

If a person wants to buy your franchise, what are the proper procedures you must follow? How long does it take to obtain franchisor approval/disapproval of the sale? Some franchisors do give you the right to sell, but they retain the right of first refusal. That is, if someone gives you an offer to buy your franchise, the franchisor has a period of time (perhaps 30 to 60 days) to match that offer and buy your franchise first.

Termination

Franchisors often have the right to terminate your franchise agreement because of defaults or breaches of the agreement. Make sure you are notified in writing of the franchisor's intent and given at least 30 days to eliminate all defaults and breaches. Some examples of defaults and breaches include the failure to operate your business, the misstatement of your sales figures, overdue royalties, or your association with a competing business.

There are many franchise agreements out there that give the franchisor termination rights regardless of whether or not there is an adequate reason. In fact, 16 states limit the right of a franchisor to arbitrarily terminate a franchisee, requiring franchisors to demonstrate "good cause" before termination.

Check your state office to see if your state provides such protection. You may also want to protect your right to terminate the agreement in the event the franchisor fails to follow through on its obligations.

Competition

Competition clearly affects your profits. Does the franchisor grant you a protected territory, such that it agrees not to grant other franchises or start a company-owned store within your area? If the franchisor does not grant exclusive territories, will it at least give you the right of first refusal if a new proposed store is opening in your area? That is, will you at least be given the right to buy the store before anyone else?

You are often forbidden from engaging in a competing business during the term of your franchise agreement and even beyond. Franchisors do this to protect the trade secrets they hand over to you. However, you want to make sure these restrictions are reasonable so that you do not inadvertently give up your right to start another business in the same industry after you've terminated your franchise agreement. Restrictions usually contain details such as number of years and geographic areas.

Solving Problems With a Franchisor

Try to communicate and compromise with your franchisor. A healthy relationship with the franchisor is key to avoiding drawn-out disagreements in court. But to protect yourself, study your options. Does the franchisor state in the FDD that disagreements will be resolved in mediation and arbitration or in court? Are there franchisee organizations in the area you can join or even start on your own to increase your bargaining power? If all else fails, find an attorney that specializes in franchise law and consult the state agencies for assistance.

Next: The 4 Rs of Success