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The Franchise Contract: All You Need to Know (Part 2)

franchise contract

When it comes to a franchise contract, forewarned is forearmed. In other words, it’s wise to go in with a strong understanding of exactly what you’re agreeing to. In last week’s post, we looked into basic characteristics of the franchise agreement contract. Today we will dig into some of the more subtle considerations to be aware of.

Provisions that might be relevant in the future

The franchise contract may include restrictions that don’t seem immediately relevant. Don’t ignore them, as they can inform your evaluation of the company. They may address strategies or ideas the company is considering. Or they may protect the company’s rights in areas like alternate channel distribution of products or services. If you’re unsure as to the meaning, importance, or relevance of any provisions like these, be sure to ask about them.

Provisions affecting your exit strategy

The franchise contract will likely place some restrictions on your ability to sell your business. Review these provisions carefully.  Many prospective franchisees devote little attention to these restrictions, and that’s a mistake. Keep in mind that most franchise agreements specify an initial term of 10 to 20 years. And many franchisees seek to exit before this full term is completed.

Typically, the franchisor will require the purchaser of your business to meet all of its standards for new franchisees. Another provision might require you to offer the franchisor the right of first refusal to purchase your business. There are typically transfer fees you will have to pay the franchisor. Carefully examine any clauses governing your eventual exit.

Do you need an attorney?

Conventional wisdom dictates that you should have an attorney review the franchise contract. And yes, as a general matter, it’s wise to have an attorney advise you on any important contract. But first make sure to weigh the costs and potential benefits of an attorney’s services.

Of course, we all enter into numerous contracts without an attorney’s review. Common contracts include those governing your cell phone service and your insurance coverage. Most people sign them without an attorney’s advice. Think also of your home mortgage. Most people sign the entire inch-thick set of documents without even reading them, and certainly without an attorney’s advice. That’s because most if not all of the provisions are non-negotiable.

In last week’s blog post we looked at the non-negotiable nature of a strong franchise company’s franchise contract. If you are signing on to a company where the contract is negotiable, hire an experienced franchise attorney so you can get the best deal possible. But if the franchise agreement is not negotiable, ask yourself whether the potential benefit of a review will be worth the expense.

Documents incorporated by reference

Most franchise agreements effectively let the franchise company “change the deal” in material ways, after the fact, without giving the franchisee any recourse. They do this by incorporating other documents, which may be amended from time to time, by reference. And many such referenced documents are proprietary. Thus, you will not receive a copy or be able to review them prior to signing your contract.

This isn’t as nefarious as it might sound, but it’s something to be aware of and keep in mind. The most commonly referenced document is the operations manual. This manual usually outlines the exact specifications required for building, running, and maintaining the business. These specifications can be changed at any time. And if a change is made in a referenced document, the franchisee must conform under the terms of the franchise agreement.

This type of provision takes effect, for example, when a franchisor requires additional investments into the physical assets of the unit. It could require a new computer system or expensive remodeling to match a new brand design. It could even require additional equipment for the provision of a product or service that didn’t exist at the signing of the franchise contract. Be aware of this possibility, but before you get too concerned, read on for our final point.

The collective power of franchisees

By now you’re probably realizing that the typical franchise contract will not provide you with all the contractual protections you might like to have. That fact makes many people uneasy. There is, however, one very important “real world” protection against arbitrary or capricious behavior by the franchisor. As a group, franchisees have the “power of the purse.” This is because virtually all of a franchise company’s revenue comes through its franchise owners.

Recognizing this “check and balance,” most franchisors will actively court franchisee support for an important or potentially expensive decision. This outreach may take place through elected advisory councils, and/or at regional meetings and national conventions. As a new franchisee you might not feel that you have much power, but more experienced franchisees will be seeking to protect their interests (and, by extension, yours). Take the opportunity to learn from them and follow their lead when appropriate.

Entering into a franchise contract is an exciting beginning as long as you’re careful and deliberate in the process of selecting a franchise company that suits you. Part of this determination involves understanding the ins and outs of the franchise contract. When you understand the details of the contract before you sign on the dotted line, you’re much more likely to become the next franchise success story!