What You Need to Know Prior to Purchasing a Franchise

What You Need to Know Prior to Purchasing a Franchise

Xavier Navarrete and Glen Perinot

As a litigation lawyer, I would estimate that 70% of the franchise work I do is for franchisees that are experiencing problems in operating a franchise or are experiencing problems with the franchisor’s demands. The tragedy is that clients often come to see me after they have already purchased the franchise and often after their life savings have been depleted trying to operate the franchise. Many of the problems experienced by franchisees that I typically encounter could have been avoided, or could have been spotted with a little due diligence by the franchisee, prior to paying money over to the franchisor.

Below I set out some things to consider and some words of advice for the prospective franchisee.

TIP 1: READ YOUR DISCLOSURE DOCUMENT

The franchise legislation in Ontario places onerous requirements on a franchisor prior to accepting any payment of money from a franchisee. Specifically, before accepting any money the franchisor must provide a franchisee with a disclosure document which must include certain information. The legislation requires the franchisor to disclose:

  1. all material facts, including material facts as prescribed;
  2. financial statements as prescribed;
  3. copies of all proposed franchise agreements and other agreements relating to the franchise to be signed by the prospective franchisee;
  4. statements as prescribed for the purposes of assisting the prospective franchisee in making informed investment decisions; and
  5. other information and copies of documents as prescribed.

The franchisor must give the prospective franchisee at least fourteen (14) days to review this documentation, prior to accepting any money from the franchisee.

Clearly, the first step would be to read the franchise documents, the lease documents and the personal guarantee documents which are standard in most franchise systems. If there are any specific questions or concerns then it would be wise to retain a lawyer to help explain the obligations imposed on both parties under the agreement. An experienced franchise lawyer can often review the documentation and explain the terms of the agreement for a couple of thousand dollars. When you consider that the cost of opening a franchise can range from $200,000.00 to $500,000.00, the investment in having a lawyer review the franchise documentation and explain its terms is relatively insignificant.

TIP 2: DUE DILIGENCE – USE THE DISCLSOURE INFORMATION

In addition to the inclusion of the standard documents (franchise agreement, lease, etc.), the disclosure document is also required to include important information which can reveal to the prospective franchise, potential problems with the franchise system. Among the most important information that must be disclosed are the following:

  1. a list of the current franchisees;
  2. a list of the franchises that have closed; and
  3. a list of any ongoing litigation that alleges that the franchisor, the franchisor’s associate, or a director have been found liable or are involved in a civil lawsuit alleging misrepresentation, unfair or deceptive business practices or of violating a law that regulates a franchise business.

Tragically many franchisees do not take the time to use this information to help them make an informed decision about the franchise system that they are purchasing. From experience, I know that consumers will spend hours on the internet researching a car or a digital camera, before deciding which one to purchase; incredibly franchisees will not spend the same amount of time in researching a franchise system, before investing their lives savings.

By calling and visiting existing franchisees a prospective franchisee will learn a tremendous amount of information about how the system operates, whether there are any pressing problems from the perspective of the franchisee, and how a franchisor reacts to concerns raised by the franchisee. Without question, this is the most important information that you will need prior to making an important investment.

If the franchise system is involved in ongoing litigation alleging misrepresentation, unfair or deceptive business practices or of violating a law that regulates franchises, then it would be money well spent to hire a lawyer to order copies of the lawsuits, to contact the other franchisees in order to give you a better picture of what has been going on in the franchise system.

TIP 3: UNDERSTAND and SPOT ENTIRE AGREEMENT CLAUSES

If for whatever reason you decide that you do not want to hire a lawyer to help you negotiate the franchise agreement and you proceed to perform your own negotiations, the most important tip I can give you is to carry out your negotiations in writing. If you meet with a franchisor and they promise you certain things (for example how much the franchisee makes per year, or projected level of sales) then confirm that in an email or in a letter. You should also keep track of what has been promised because you may want to include it as a schedule to the eventual agreement that you execute.

Having confirmed all the representations and promises by email, the next most important step is to beware of the entire agreement clause. Typically a franchise agreement will contain a clause that says that the entire agreement is contained in the franchise agreement and that there were no oral or other representations made other than those set out in the agreement. If you see that in the franchise agreement then you should go see a lawyer and discuss amending the agreement to include the representations which have been made to you into the agreement.

The reality is that most good franchisors will not make promises that they cannot keep and most will not guarantee minimum sales, etc. The only thing that most franchisors can promise is that they will provide you a reasonable level of support, that they own or have a license to use the intellectual property (signs, logos, recipes, etc). Since you are opening a business most franchisors realize that, as with any business, there is the possibility that the business will fail and that its success will depend on a number of factors which are often times beyond the control of the franchisor. For this reason, you will seldom see a good franchisor make promises about the viability of the franchise system.

Finally, I would close by saying that an “ounce of prevention is worth a pound of cure”. What this means is that quite often spending a few thousand dollars on a lawyer up front will save you from spending tens of thousands of dollars in the future. By getting advice early you can ensure that you start your franchise business on a solid footing.




Comments are closed.