What You Need to Know Before Entering a Franchise Agreement

Purchasing a franchise allows a start-up venture to enter the business world with the backing of an established brand, but this opportunity should be approached with caution and careful preparation. The best way to prepare is to conduct thorough due diligence and to gain a thorough understanding of the obligations and protections that are afforded to franchisors and franchisees. 

Before buying a franchise, you should investigate the franchisor, its financial health and its operational structure. Start by reviewing the Franchise Disclosure Document (FDD), which the franchisor is required to provide under the Federal Trade Commission’s Franchise Rule. The FDD must contain detailed information about the franchise, including the following:

1. Franchise fees and other costs — This includes the initial franchise fee, ongoing royalties, advertising contributions and other operational costs. 
2. Franchise performance — This disclosure details business operations at existing franchise locations. 
3. Legal history — The FDD will disclose any litigation involving the franchisor or its executives. This can provide insight into potential risks or patterns of conflict.
4. Financial health of the franchisor — Ensure the franchisor is financially stable. Review audited financial statements to see if the company has the resources to provide ongoing support.
5. Territory protection — Understand the geographic rights you will receive. Some franchisors grant exclusive territories, while others do not. This can impact your ability to grow.

It is also advisable to speak with current and former franchisees about their experiences, the support provided by the franchisor and whether their expectations were met.

The franchise agreement is another vital aspect of the purchase. It defines your rights and obligations with respect to the franchisor. The following provisions require special attention:

1. Franchise fees and payment terms — There should be a clear recitation of all initial and ongoing fees, including royalties and advertising contributions, and of when they are paid. 
2. Territory and expansion rights — The contract should state if you have exclusive rights to operate within a specific area and if you have opportunities to open additional locations.
3. Control over pricing — Some franchise agreements dictate pricing structures, while others leave flexibility to the franchisee. Make sure that the pricing model meets your business goals.
4. Operational requirements — Review all provisions concerning the franchise’s operations, including supply chain requirements, training mandates and marketing guidelines.
5. Termination and renewal terms — Understand the conditions under which the agreement can be terminated or renewed, and what consequences apply if you breach the agreement.
6. Dispute resolution — Look for clauses that outline how disputes will be resolved, whether through arbitration or mediation. 

Franchise agreements are one-sided and the franchisor almost always wins in litigation. Thus, before making a commitment, it is very important to have a good practical and legal understanding of the transaction and its effects.

An experienced Arizona franchise lawyer can review the FDD and franchise agreement to identify any unfavorable terms or risks. The lawyer can negotiate for better contract terms and provide guidance on compliance with federal and state franchise laws. In the long run, a franchise lawyer can assist with franchise renewals, compliance issues and potential expansions.

The Law Offices of Donald W. Hudspeth P.C., in Phoenix assists Arizona business clients in all legal matters relating to franchise purchase and operation. We draft and review franchise agreements and, should disputes arise, will represent during negotiations or litigation. Call us at 866-696-2033 or contact us online to set up a meeting.