Franchise Lawyer Blog

Some Points to Consider Before Signing a Franchise Agreement

Many of our blog commentaries address franchisor concerns. We also represent franchisees. We offer these observations to that constituency concerning the most crucial step in forming that relationship.

When buying a franchise, it is important to review the franchise agreement with an attorney, preferably one with experience in franchising. This is true regardless of whether the terms of the franchise agreement are ultimately negotiated. It is imperative that you understand the parameters of your relationship with the franchisor. Prospective franchisees sometimes focus only on the products and/or services they will be selling and the fees they will be paying the franchisor. They often do not fully review and understand the terms of the franchise agreement or their future relationship with the franchisor. This can result in dissatisfaction to the franchisee and cause substantial investment losses.

For instance, when purchasing a franchise, you may have the right to operate the franchise for a certain term such as five or ten years. But what happens at the end of that term? Does the franchise agreement provide you with a “right to renew”? And if so, what does that really mean? Are there conditions attached to the right to renew? Will you have to sign a new form of franchise agreement? Can that agreement contain new and increased fees? In what other ways may it differ from your initial agreement with the franchisor? If you are not allowed to renew the agreement, what happens to the value of your business? Will you receive any benefit from the years of operating your business? It is important to fully understand what will happen to your business and investment at the end of the term of the agreement.

Another point to consider is whether you will have the right to terminate the franchise agreement. Prospective franchisees often assume that if the business is not successful, the franchisee can simply close the doors and walk away as it would be able to do with an independent business. However, that is rarely the case in franchising. If the franchisee stops operating the franchise before the end of the term, he or she may be liable to the franchisor for its damages arising from the premature termination of the franchise agreement. Be sure to understand whether and on what grounds you have the right to terminate the agreement.

It is true that one of the benefits to buying a franchise is that the franchisee is buying into a proven system with a known name. Presumably, the franchisor has created a system and worked out the kinks before franchising the business. However, the franchise agreement is likely to provide the franchisor with the right to maintain control of the system. That control may include the right to require you to make modifications to your franchised business during the term of the agreement. These modifications can be quite costly and may include changes in equipment, computers, even changes to the brand name which may require new signs, new uniforms, new office supplies, and the like. While these modifications may ultimately benefit the system, you will be required to implement these changes at a time and cost determined by the franchisor without regard to your situation. It is important to realize that these unlimited costs may be imposed by the franchisor at any time during the franchise relationship.

These are just a few of the contract terms you should review with your attorney prior to purchasing a franchise. Buying a franchise can be a wonderful opportunity for owning a business with a proven brand and concept. Just be sure to understand the entirety of your relationship with the franchisor so that you ensure that the opportunity is right for you.

Posted by Julianne Cowan Lusthaus | Permalink | Email This Post

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Our firm has always been extensively involved in real estate, so this week I walked up 6th Avenue in Manhattan to the New York Hilton to visit the annual New York Conference of the International Council of Shopping Centers ("ICSC"), the premier retail real estate organization in the United States. The ICSC Conference is where commercial landlords, including most of the major mall owners and real estate developers in the country, gather to make deals. The conference also attracts potential tenants of all shapes and sizes, including (and here's the connection to our blog) many franchisors. In fact, a walk around the countless booths brought me face to face with many of the nation's major franchising companies: Burger King and Dunkin' Donuts, among others. There are also a host of lenders, brand experts and other advisors looking to provide assistance to prospective retail tenants.
The tone at this function could not be described as somber; this is, after all, a room full of salesmen (and saleswomen). However, the crowd seemed a little thinner than at prior events, with the occasional booth operator standing forlornly alone with no one to talk to. Various speakers gave the bad news, retail chain store sales have fallen a record 2.7% year over year in November. With this morning's Wall Street Journal announcing that the World Bank predicts an unprecedented global recession, it wasn't hard to detect a panicky note in the air, a more strident tone in the hub bub of conversation.
What does this mean for franchising? Well, obviously this worldwide slowdown is going to have a negative effect on just about everyone. Franchisors and their franchisees will have to adjust to reduced demand, tightened credit, rising costs and everything else that goes with it.
But within the real estate context the news from this conference is that attractive real estate deals can be made. It is a buyer's market for premium locations. A franchise system that is weathering this storm and cautiously thinking about expansion will be able to find attractive sites at prices that are significantly more affordable than they were even a few months ago. And those prices will probably be reduced even further as demand continues to weaken. A franchisee who secures a long term location at this point will be paying prices that a few years from now, when (not if) things turn around, will look like the deal of this new century.

Posted by Terrence M. Dunn | Permalink | Email This Post

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A few blogs ago we spoke about Jason Puleio's The Barker Lounge, a dog day care franchise. In that blog entry we identified how Jason has had success in developing his franchise system by focusing on entering into agreements with individuals who are a good match for the system and the business. That inquiry led us to look at another one of our franchisor clients, Sir Grout, a business that provides grout and tile cleaning and restoration services.
Since the issuance of their first UFOC in October of last year, Sir Grout has sold six franchises, taking a deliberate approach to laying the groundwork for a franchise system. Another large franchise deal is in the works. Jeff Gill, one of the two principals (Tom Lindberg is the other) says that most of the franchises so far have come from previous acquaintances and word of mouth, built upon the business reputations of the two principals. They have taken a careful and economic approach to marketing, with a focus on developing their website and finding advantageous placement on other franchise oriented websites.
The franchises they have established have succeeded, which supports their growing reputation and builds on the word of mouth support. Jeff says this success is because they have adhered to their carefully developed business model and training practices that were defined in their UFOC (now FDD). In fact, says Jeff, "Every time someone has slipped a little, we have been able to pinpoint where they are struggling at the point where they deviated from the business model." Jeff says one key component is the availability of the principals. They have always made it a priority to be responsive to franchisee problems.
Jeff notes that the economic downturn has not impacted them as much as some other franchise systems, because they present a low cost alternative to home improvement. "We're a good alternative to a major home repair," says Jeff, "Our service gets you a bathroom that looks like new, as opposed to the huge expense of a new bathrooom."
The principals also place a priority on advertising, which they see as crucial to building confidence in the system. They require their franchisees to spend a minimum and encourage them to do more. In this business, says Jeff, "the more advertising you do, the more you make." However, conscious of the fact that they are a low cost franchising option, they look for inexpensive advertising options, so that they can increase the exposure without increasing the costs. For instance, by investing in an SEO specialist, they have gotten all of their franchisees placement on the first page of a Google search.
In difficult economic times, the recipe for success seems to always include personal attention to the franchisor-franchisee relationship and a focus on keeping costs down without sacrificing quality. It has worked for Sir Grout. We will be examining the success and struggles of other systems as we continue to analyze what works and what doesn't in this volatile economic landscape.

Posted by Terrence M. Dunn | Permalink | Email This Post

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On October 22, Julie Cowan Lusthaus wrote a piece on this blog about franchisors helping their franchisees obtain financing in this difficult credit market. In the past couple of weeks, as the credit markets have tightened to the point where they are frozen, it seems as if no one is talking about anything else in the franchising world.
The Franchise Times November/December issue features an article on the steps franchisors are taking to work in a frozen credit market; it also features another piece on the credit contraction, which provides some tips on how to ride it out.
A recent article in NuWire Investor discusses how Domino's is offering short term financial credit solutions to its franchisees. Papa John's is featured in Nation's Restaurant News attempting to ease the economic pressures on its franchisees by cutting the price of cheese and trying other short term credit assistance.
Some franchise systems have still found it possible to finance their operations and even acheive expansion, proving that that there are still some businesses, at least for now, that may lay claim to the elusive title of being "recession-proof." Great Clips, Inc. just announced plans for 300 new salons through 2009, aided by $14 million in new financing. The AOL Money and Finance story reporting that development notes that franchises remain a viable source of business development and job opportunity in a turbulent employment market.
We will keep an eye on financial developments as they unfold in the economy as a whole and as they resonate throughout the franchising space. Although there is no question that tightening credit availability will negatively impact on many franchised businesses, all franchisees theoretically belong to a community of businesses with shared needs, hopefully supported by a franchisor with a mutual interest in seeing each of them succeed. That offers many more prospects for support than would be available to the independent business owner.

Posted by Terrence M. Dunn | Permalink | Email This Post

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In the current economy, questions arise more than ever about how to finance the purchase of a franchise. In fact, many people think that it simply will not be possible to borrow money for the purchase of a franchise. While it is true that it may be more difficult and that lenders are being more careful about lending money, there are some ways a franchisor can improve the ability of a prospective or existing franchisee to get financing.

Franchisors should be aware that some lenders are paying greater attention to the information contained in the franchise disclosure document ("FDD"). Therefore, when preparing an FDD, a franchisor should take into account the necessity of prospective franchisees to obtain financing.

For instance, more lenders are looking for information that might be provided in Item 19 of the FDD. Such information is known as financial performance representations. Not surprisingly, lenders may want to know about the earnings and earning potential of units in the franchise system. Of course, a lot of factors must be considered when a franchisor decides whether to provide Item 19 information and if so, what specific information to provide. But one of those factors should be that franchisees are going to require financing and if so, some lenders may expect and require such economic data.

Also, lenders may want assurance that the franchisor will provide the franchisee with the necessary training to succeed. One of the great things about buying a franchise is that a franchise is supposed to be a “turn-key” business. That is, a franchisor is supposed to provide a franchisee with all of the knowledge and skills necessary to operate the franchise. When deciding whether to lend to a prospective franchisee, lenders are more and more interested in assessing the type and extent of training the franchisor is going to provide. Therefore, when providing information in Item 11 concerning the franchisor’s obligations, a franchisor should take care to ensure that sufficient detail is provided about the training program. This way, lenders will be able to ascertain whether a franchisee without any experience may be provided with the tools necessary to succeed.

While financing for the purchase of a franchise is harder to come by these days, it is possible for a prudent franchisor, with attention to detail, to increase a prospective franchisee’s ability to obtain such financing.

Contributed by Julianne Cowan Lusthaus

Posted by Einbinder & Dunn | Permalink | Email This Post

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There are many individuals running successful small businesses who decide that franchising their concept is the best way to grow. With the assistance of franchise counsel and sometimes business consultants, they develop a business model and create the appropriate franchising documentation; registering their franchise disclosure document (“FDD”) where necessary. At this point they enter into the most crucial phase of franchise development: identifying and attracting the right people to become franchisees of their new systems.

At this stage, many franchisors find that there is an art to finding the right match. We spoke to a new franchisor that this firm represents, Jason Puleio, about his franchise concept, The Barker Lounge, a dog daycare center and boarding facility offering full service dog care in large, “cage-free,” climate-controlled facilities. The Barker Lounge plans to have 4 or 5 franchises developed this year.

The Barker Lounge was recently featured in the October Franchise Times. You can find out more information about The Barker Lounge franchise system by going to the The Barker Lounge website.

Jason tells us the main component to identifying the right candidate for a franchisee is transparency – a totally honest approach. He makes the candidate aware from the start that his system is growing at a deliberate pace and that he is willing to wait for the right people. Jason provides interested parties with everything that they ask for in terms of information and guidance. And as the candidates are checking his operation out, he is simultaneously checking them out. Jason is looking for someone that is passionate about dogs, it simply won’t work otherwise. He wants franchisees who are going to love the work.

Jason says that he is breaking with convention and finding most of his interested parties in non-franchise environments. Rather than trolling the big franchise business conventions, he is meeting people through industry connections, such as pet shows and animal rescue organizations. That is where he can find the type of people who are willing to commit to Jason’s carefully developed brand of dog care.

A franchise system will ultimately succeed or fail with the quality of the franchisees running the system's operations. Jason's hands-on approach to developing his system from the ground up, with committed, passionate franchisees, describes a formula for success.

Posted by Terrence M. Dunn | Permalink | Email This Post

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Even in an economic environment as troubling and uncertain as the current one, the only way for a business to survive is to grow. For many smaller businesses, asking how to grow inevitably leads to an inquiry into the possibility of franchising.

So, is your business right for franchising? The answer is not always apparent, in part because success as an individual business does not guaranty success as a franchise model. There are many reputable sources of useful information regarding the viability of franchising, such as the Web site of the International Franchise Association, a large membership organization consisting primarily of franchisors. You should also refer to the Web site for this law firm.

When asking whether your business can be franchised, important things to consider are the following:
• Is your brand known? Successful franchises are built upon unique and readily recognized brands. If your brand is not already well known, you will need to make it well known as soon as possible.
• Has your business concept been tested and proven? Many entrepreneurs come to us with a concept but no established business. It is very difficult to franchise a mere concept. It is essential that at least one version of your business model is up and running before your can meaningfully consider franchising.
• Do you have a system that is replicable and that can be taught? For your business to become a successful franchise system, you must be able to teach franchisees how to operate the business in a manner that will work in various environments.
• Do you have the people to help you get your franchise off the ground? You must remember that running a franchise system is different from running your business as just a business. You will need expertise in marketing, building brand awareness, and sales. Many aspiring franchisors do not realize that even after the franchise plan is in place, it still has to be sold to the public.

We will discuss the viability of franchising a business further in entries to follow, offering actual practical case studies of successful franchising ventures.

Posted by Terrence M. Dunn | Permalink | Email This Post

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What are franchisees supposed to do when a franchisor goes out of business?

Given the current state of the economy, a number of franchisors are either filing or contemplating petitions in bankruptcy or simply ceasing operations (see this Blog's entry of July 30). There are many reasons why this is happening, but the common result is that this event can be devastating for future franchisees. Franchisees are left without any support, having paid thousands of dollars in franchise fees and royalties and getting nothing in return.

The lack of operational support may be most devastating. Franchisees who rely on the franchisor for menu choices, inventory, even scheduling of appointments, may find themselves out of business. When a franchisor simply disappears, the only choice may be to have the franchisees band together in a cooperative arrangment to fund support.

Among other questions, however, is whether or not the franchisees can continue to use the franchisor's trademark. A more sophisticated approach is necessary when the franchisor is a larger company which liquidates in an orderly fashion and whose assets, including the extant franchise agreements and trademarks, are actually sold to a new owner. In that instance, franchisees may choose to look for a white knight with whom they can chart the course of their ongoing business.

Posted by Michael Einbinder | Permalink | Email This Post

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Wednesday's Wall Street Journal article, "Dining Chains Shut Doors" by Jeffrey McCracken and Janet Adamy, discusses the Chapter 7 bankruptcy liquidation filing of Plano, Texas-based Metromedia Restaurant Group, the parent company of Bennigan's and Steak and Ale. Although the 138 franchisee-owned Bennigan's sites were not included in the filing and apparently intend to remain open, they will be doing so initially without a franchisor or franchise system support. Those franchisees will also be trying to succeed in an environment that has already proven to be glutted with mid-priced, sitdown restaurants. The Ground Round chain went through a similar experience several years ago; ultimately the franchisor was acquired by a cooperative of existing franchisees.

What the future holds in store for Bennigan's cannot be known at this point, but the bankruptcy is a painful indication of the Darwinian survival process that is evolving in the fiercely competitive franchise restaurant landscape. That does not mean that all franchised restaurants are a bad bet in this environment. Only time will tell if the economy is driving a broad move away from eating out, or simply to restaurants that offer cheaper, fast food meals. The latter concept could bode well for the franchisors of those concepts. We will examine how the more nimble franchisors are adjusting to the environment and look at some of those concepts in coming posts.

Posted by Terrence M. Dunn | Permalink | Email This Post

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