Negotiating a Fair Franchise Agreement
Signing a Franchise Agreement
Recently, we wrote a blog article entitled Beware of Franchise Agreements, where we discussed how one-sided most franchise agreements are, and identified one of the few ways to really tell if a franchise is worth it.
In this article, we’re going to assume you’ve decided to purchase a franchise. One question you must answer for yourself is, how can you negotiate a better franchise agreement with the franchisor? Don’t despair. Despite what you may have heard, franchise agreements are negotiable — to a point.
Negotiating a Franchise Agreement
In general, franchisors will not negotiate terms that effect their (i) overall business processes, (ii) control over their brand, and (iii) their recurring revenues. For example: franchisors do not generally allow you to purchase supplies from a third-party. Doing so would impact their revenue, quality control and management style. Most large franchises prefer to have all their franchisees on the same process and any changes mean an increase in costs and risks.
However, knowing the way most franchisors operate can help determine what topics most franchisors are willing to negotiate. Keep in mind this will depend on the particular franchisor and/or the business.
One Time Transactions and Business Issues Can Usually be Negotiated
So what are some common terms to negotiate in franchise agreements?
- Territory– this covers:
- Geographic scope: The overall geographic boundaries of your exclusive market, make sure these are as clear as possible. Avoid simply using distance as a boundary.
- Distribution channels: Are you permitted only to sell from your retail location, or do you have some rights to online sales?
- Customer location: Is your territory defined by distance to your retail location, or where the customer sits? What makes most sense for your business and how easily enforceable is the territory?
- Penalties: What rights do you have if someone intrudes on your territory? What happens if you accidentally cross into someone else’s territory?
Get any promises in writing!
- Enforce franchisor promises. Is the franchisor making promises to you regarding sales volume? Are they promising new customers and revenues? Are they making any other promises critical for you meeting your financial goals? GET IT IN WRITING! Make sure those promises are reflected in the franchise agreement. See our previous blog article on Smart Goals, and do your best to make franchisor promises S.M.A.R.T. If such a goal or goals are not achieved, they should be willing to give you more time, reduce payments owed to the franchisor, or other concessions to reflect not hitting an important promised financial milestone.
- Assets. Did you bring some significant asset to the agreement? For example: a customer list, tools, equipment, phone system, etc. If so, make sure you negotiate the franchise agreement to ensure that your property stays yours! If you have to give up any assets you’ve contributed to the relationship, make sure you’re adequately compensated for the loss of such assets.
- Negotiate the non-compete. Most franchise agreements forbid a franchisee from setting up a similar business, within a certain period of time and within a specific geographic area. If the non-compete prohibits you from providing your services within a reasonable distance from your home upon termination of the franchise agreement, this can become a real problem for you. Negotiate both the duration of the non-compete and the distance, as much as possible, to your benefit. Furthermore, if the franchise agreement is terminated for reasons outside your control, why should you be held to the non-compete? Make it conditional.
- Negotiate instances of transitions and transactions. Most franchise agreements will control if and how you can sell the franchise or acquire other franchises. For example, they will include a “right of first refusal” clause, giving the franchisor the right to swoop in and buy your franchise at the same terms and for the same price as a third-party may have offered. That’s fair. What isn’t fair is that some franchise agreements explicitly allow the franchisor to buy your franchise for LESS than fair-market value! Many will often include some made up formula designed to reduce the value of your franchise or the price contained within your third-party offer. Such a clause only serves to rob a franchisee of the legitimate fair-market value of the franchise. Do not agree to such language and negotiate as favorable terms as possible. Other related issues to negotiate include:
- Franchisor approval. Not “at their sole discretion,” but instead make it “not unreasonably withheld or delayed.”
- Right of First Refusal for Franchisee. You should request that you are given right of first refusal for acquiring the franchises in adjoining territories or within some radius of your territory that makes sense to you and your business.
- Dispute Resolution. Negotiate a fair, cost-effective and timely process for dealing with disputes involving transactions. Keep in mind that many franchise transactions involve distressed assets — you want the ability to move quickly, without the franchisor burdening you with delays.
- Negotiate fair time frames. Does the franchise agreement have very tight time requirements for your performance, but long time frames for the franchisor’s performance? If so, negotiate more time for yourself. There’s no reason to give the franchisor opportunities to terminate the franchise agreement.
- Negotiate the penalties. Penalties have three major components: What triggers a penalty, time frames, and the penalty itself. For example, consider “late payment.” Many franchise agreements will require their franchise fees and commissions get paid by a specific date each month (the trigger), and if they are late by more than 3 days (the time frame), they can charge you an exorbitant fee or terminate the contract (the penalty itself). In this case, the trigger is non-negotiable, but the time frame is negotiable and the penalty itself can also be negotiable.
- Negotiate the dispute resolution process. Don’t allow the franchisor to make key decisions “at their sole discretion”. You want to have a say in matters such as the value of the franchise, the value of certain assets, etc. Make sure you have the opportunity to negotiate important deadlines, decisions and actions. A good dispute resolution process involves first mediation among key personnel / executives, then binding arbitration in a mutually fair setting.
- Make clauses reciprocal. Finally, negotiate to make a more fair franchise agreement by making key clauses reciprocal. An example would be the clause that says something to the effect of “franchisee represents and warrants that it shall reimburse franchisor for all its legal fees associated with enforcing franchisor’s rights in this agreement.” Turn that clause around and make it more balanced, for example, the above should read “both parties represent and warrant that the prevailing party shall be entitled to a reimbursement of all its legal fees associated with a dispute arising under this agreement.”
Make sure your valuable assets remain yours!
Do Not Let Yourself be Pressured
Do not fall for the sales pitch!
Franchisors are very skilled at putting constant pressure on their potential franchisees. Many franchisors often claim that they are in talks with other interested parties and that if you don’t move quickly or you make too many waves, you’ll loose your opportunity.
Don’t fall for it. Yes, a franchisor is in talks with other people, because that’s what they do. Do not let such tactics pressure you into signing an unfavorable agreement. There are literally thousands of franchises, and another will present itself. Be patient. Patience is your strongest asset in negotiating a fair franchise agreement, and a fair franchise agreement is critical to your long-term success.
If you can negotiate some of the terms as discussed in this blog article, not only will you end up with a more valuable franchise, but your chances of success will greatly increase. Good luck to you!
Law 4 Small Business, P.C. (L4SB). A little law now can save a lot later.