In an earlier article posted on the Law Works Franchise Blog on July 27, 2014, Seven Tips for (Experienced) Franchisees When Buying a Franchise, I discussed the important overall aspects of a franchise purchase that sophisticated franchisee purchasers should assess and negotiate. This includes broad elements of negotiating the franchise agreement and lease agreement, reviewing the disclosure document, site selection issues, and conducting due diligence investigations.
In this article, I will focus on some of the key elements of the franchise agreement and will provide a closer look at this important aspect of the overall purchase.
Many of the issues that relate to assessing and negotiating a franchise agreement tend to be more or less “standard”, in that they are frequently used in Canadian franchise systems, from large and sophisticated systems with extensive track record, to small and even start-up systems with little or no track record.
Just because a legal requirement is “standard” does not mean that a prospective franchisee buyer should automatically consent to all such conditions.
The more established and reputable the franchise system, (i) generally the less business failure risk there will be, and therefore (ii) the less room there will be to negotiate the franchise agreement.
By the same token, the less established the franchise system, including small systems, relatively new systems or start-up brands, (i) the more business risk a buyer will be taking on since the system will not have as strong a track record as a more established chain, and (ii) the more room there should be to negotiate some key aspects of the franchise agreement.
Regardless of the sophistication or track record of the franchise system, or lack thereof, a prospective buyer must not forego a full review and should craft a suitable negotiation strategy with the help of an experienced franchise lawyer.
Here is a sample of the frequently encountered issues:
1. Personal Guarantee
Most franchisors will require a personal guarantee. The franchisee will be personally required to guarantee the obligations of his or her corporation under the franchise agreement.
By providing a personal guarantee, a franchisee will be risking not only his or her significant financial investment in the business, but also any personal assets that he or she may own.
There are various ways to negotiate a personal guarantee, including strategies to reduce or limit it.
2. Territorial Exclusivity
Many large franchisors do not offer any territorial exclusivity.
But some do. Where territorial exclusivity is offered, it often comes with significant caveats and limitations, including the franchisor’s ability to operate in various forms within the territory.
A territorial right often includes the franchisor’s ability to degrade or take it away upon certain events.
3. Non-Competition and Other Restrictive Covenants
A typical franchise agreement will likely contain several restrictive covenants, such as a non-competition and non-solicitation restriction, both during the term of the franchise agreement and for a period of time after its termination or expiration.
These covenants during the term will significantly restrict the franchisee’s ability to operate or be involved in any competing business.
The restrictive covenants – primarily the non-compete restriction – after the termination or expiration of the term aim to significantly restrict the franchisee’s ability to operate or be involved in any competing business after the end of the relationship.
Particularly with respect to post-termination and post-expiration restrictions that are triggered after the end of the franchise relationship, their legal strength should be carefully assessed by an experienced franchise lawyer and, where necessary, negotiated.
4. Transfer and Renewal Conditions
Transfer conditions found in many typical franchise agreements contain some or all of the clauses outlined below. They may impede the franchisee’s ability to successfully resell the franchised business at a future time:
– the requirement that the purchaser enter into the franchisor’s then-current franchise agreement which may contain materially different terms and higher payment obligations from the current franchise agreement;
- the requirement that the selling franchisee undertake potentially significant renovations to the premises of the business;
- the requirement that the purchaser provide a personal guarantee;
- the requirement that the selling franchisee provide a significant deposit of the purchase price to the franchisor, and
- the requirement that the selling franchisee continue to personally guarantee the ongoing obligations under the franchise agreement.
In addition, a franchisor may reserve a right of first refusal for a period of thirty days, requiring the selling franchisee to provide the franchisor with a thirty day period to decide whether it wishes to match a third party buyer’s offer on the business. This often creates an obstacle in the franchisee’s resale effort, and sometimes creates a significant loss of momentum with potential buyers.
Many issues relating to renewal conditions are similar to the issues relating to transfer conditions, as outlined above.
A prospective buyer and his or her franchise lawyer should evaluate these issues and assess which of them need to be negotiated and to what extent.
5. Rights Upon Termination
A typical franchise agreement will give the franchisor rights to take over the assets of the franchised business and control of the lease and the premises.
These takeover and related rights upon termination are very fundamental and directly relate to the investment that the franchisee is making in the business.
Ultimately, the prospective buyer, together with the expertise of a franchise lawyer, will need to evaluate all issues and assess how much legal risk and business risk the prospective franchisee is prepared to take on having regard to the nature of the franchise system that is being considered.