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The Franchise Contract: All You Need to Know (Part 1)

By FranChoice Blog | Nov 28, 2018

franchise contract

So you’re thinking about franchise ownership–an exciting prospect. Before you sign on the dotted line, let’s take a look at the franchise contract. This important document governs the legal relationship between the franchisee and the company. This includes setting forth what will happen if for some reason the relationship doesn’t work out.

One way to think about the franchise contract is that it’s like a pre-nuptial agreement. Perhaps it’s not very romantic, but you need to give it careful consideration before you sign. Here are five important aspects to understand before you execute the franchise contract:

Typically Non-Negotiable

Strong franchise companies (i.e., those that are proven and successful, with satisfied, prospering franchisees) typically have a non-negotiable franchise contract. They have learned that standardizing all aspects of operations and the franchisor/franchisee relationship maximizes the benefit to the company and franchisees. This standardization begins with a uniform franchise contract. So don’t be surprised if the franchisor tells you the wording of the franchise agreement is unchangeable. Your choice will be to sign or not to sign.

If portions of the agreement are unclear or concern you, you can ask the franchisor for a letter clarifying the points you have issues with. This can give you a level of comfort and understanding that a non-negotiable contract may not otherwise provide.

If Negotiable, Be Careful

Take heed if a franchisor is willing to negotiate substantive provisions of the franchise agreement. That may be a red flag. Although this seems counterintuitive to most prospective franchisees, keep in mind that strong franchise systems typically standardize everything. When a contract is open to negotiation, you may question the company’s level of certainty about the success of its brand and operating system. And if you’re questioning the brand and operating system, then it’s likely not a good idea to go forward with signing on.

As part of your due diligence, always ask the franchise company whether the terms of their franchise agreement are open to negotiation. Most will initially say no. It’s a good idea to test this by asking a follow-up question. For example, you could ask, “So if there are just a few words I’d like to change, you wouldn’t even consider it?” If they waffle and respond that they’d consider changing a few words, they are really saying the contract is negotiable. In that case, it’s a good idea to seek expert guidance and negotiate accordingly.

Usually Unilateral

A franchise contract is typically unilateral in nature, written completely from the company’s perspective. This may not seem fair or reasonable, especially when the contract is non-negotiable, but it’s almost always the case. And it’s understandable when you think about it further.

Remember, a strong franchise company seeks to protect the system as a whole. This includes the brand, the integrity of the operating system, and the way each franchisee runs their business. The franchise company has determined the way the business must operate for it to be successful and they’ve written those specifications into the contract. If you’re uncomfortable with that approach, you may want to look for a franchise company with a contract that puts you more at ease.

Full of “Must Do” Rules …

You will notice during your very first reading that the franchise contract contains a lot of rules. It usually outlines very clearly a number of things you must do on a regular basis when operating the business. These specific rules are the most important things you’ll need to do to make your business successful. The franchisor spells them out in the contract so their importance is clear and understood.

You may want to do a quick check on the necessity of any “must do” rules in the contract you have questions about. You can reach out to a few franchisees and ask them for their thoughts. If you are uncomfortable with any of these mandatory contractual provisions even after discussing them with franchisees and/or the company, you should probably find a different franchise to pursue.

… and “Can’t Do” Rules

The franchise contract will also include numerous “can’t do” provisions. It will specify in detail things that you are forbidden from doing when operating your business. Many of these rules will be expected and understandable, like non-compete clauses. When a franchisor provides you with all their trade secrets and operating techniques, they’ll expect you to be part of their system if you’re running the same (or a similar) business.

Many other “can’t do” rules are designed to protect the system (and all of the franchisees) from any rogue actions by other franchisees. Remember, other franchisees will be running (as it appears to the public) the exact same business right down the road or around the corner from yours. The way those other franchisees operate their businesses can affect the value of the brand and your business. When you think of the “can’t do” rules from this perspective, they likely make much more sense.

 

These important considerations should give you a foundation for understanding the franchise contract and how it can impact your life as a franchisee. In Part Two, coming next week, we will explore more subtle considerations that equally important to your understanding of the franchise contract.

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Developing a Business Plan for Your Franchise: When and How to Do it

By FranChoice Blog | Nov 21, 2018

business plan

Creating a business plan is a critical step toward the launch of any new business, including a franchise. It’s a step to take earlier in the process than you may think. Will you be seeking financing from a third party? If so, your business plan should be complete before you even ask. And that’s a good thing, because the process of preparing a business plan is very useful. It forces you to anticipate and answer a number of questions about your expectations for the new business. You’ll identify the challenges ahead and be ready to tackle them.

Developing a business plan for a franchise is much easier than for an independent business start-up. You’ll have a good deal of information already at your fingertips or readily available. You can find much of the verbiage you’ll need for the narrative portions of the business plan within the franchisor’s documents. Look to any earnings representations in the franchisor’s disclosure documents to find the financial information you need.

5 Key Sections to Include in Any Business Plan

Each business plan is unique to the particular business it describes. Nonetheless, there are several sections common to any business plan. Franchise business plans will have an additional section outlining the track record, personnel, and support available from the franchise company. You can also include items like the franchise company’s sales brochure or Franchise Disclosure Document (FDD) as attachments to your business plan. This additional section will give lenders (and others you may be trying to impress) a great degree of confidence going forward.

Five key sections contained in a typical business plan, whether for a franchise or independent business, are:

Introduction

This section describes the business in detail. It specifies the product or service involved, the size and characteristics of the market, and the degree of competition present in the market. It also sets forth the operational approach for taking the business to market, as well as any associated challenges and risks.

Management

This section lists key management roles for the new business. It names the people who will fill each role and provides background information about each one. Each bio should emphasize prior experience that’s relevant to the new business. For a franchise business, this section will also include information about the franchisor’s staff who provide support to franchisees.

Marketing

This section defines the target market: who is your customer and how will you attract them to to the business? It explains advantages your business will offer over competitors and details marketing and advertising plans.

Pro Forma Financial Projections

This section includes projected income statements, cash flow statements, and balance sheets that show the anticipated financial performance of the business. It discloses all material assumptions that are used to prepare the projections. Make sure to prepare these projections on a very conservative basis. There will always be delays and challenges that you can’t anticipate.

Financing Needs

Be sure to prepare this section even if all funding is coming from your savings. It includes a complete analysis of all start-up costs, including working capital to cover initial marketing plans and operating losses until the projected breakeven point. Even if you are not borrowing, the process of carefully detailing this information will better prepare you for whatever might happen as you get the business up and running.

Don’t be overwhelmed as you consider the information above. Remember, for a franchise business, most of this information will be readily available from the franchisor. Check out the franchise company’s website for information that will help you complete the Introduction and Marketing sections. The franchisor’s FDD will help you with the section on Financing Needs. And, if the franchisor’s FDD includes Item 19 earnings representations, you’ll be on your way to completing the Pro Forma Financial Projections section.

Preparing a Franchise Business Plan: The Early Bird Gets the Worm

Some franchise companies require franchisee candidates to begin work on (or substantially complete) their business plan before they can be approved as a new franchisee. Even if they have no such requirement, it’s a good idea to prepare your business plan relatively early on. The process will help you identify a number of questions that may not have otherwise occurred to you. You’ll then have a chance to contact the franchise company and get answers. Make certain you have a clear understanding of all aspects of the franchise prior to making your final decision.

Finally, remember to update and finalize your business plan after you complete the franchisor’s initial training for new franchisees. You will have a deeper understanding of operations, marketing plans, and many other aspects of the business after you complete the initial training. And many franchisors will supply pro forma financial models that you can use to double-check or even replace the financial projections in your business plan. Take the time to carefully review your entire business plan based on your new knowledge. That way, you’ll be fully prepared to get your new franchise business successfully up and running.

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