Seven Tips For (Experienced) Franchisees When Buying A Franchise

If you are an experienced franchisee looking to purchase a franchised business, chances are that, this time around, you are looking to engage in a more comprehensive review and due diligence process.

You may recall that, as a first time franchisee, you perhaps rushed to sign the franchise documents that you received from your franchisor. You probably did not consult with an experienced franchise lawyer. And even if you did, you likely did not have an appetite for a comprehensive review or negotiation.

When you finally started operating your first franchised business, you undoubtedly discovered the many perils involved in the operation of a franchised business. From product purchases, to advertising and marketing, support, renovation, renewal, resale and termination, you must have appreciated how complex the franchise relationship tends to get. You realized that with a more diligent and professional initial review and negotiation of the legal documents, you may have been able to meaningfully improve your financial investment.

This time around, you are prepared to commit a reasonable budget to hire an experienced and reputable franchise lawyer and conduct the necessary due diligence investigation. You figured that the money you would spend on this process will most likely save you a little fortune (and possibly not so little…) down the road.

Here are the key aspects which, in my opinion, you ought to review, assess and consider raising for negotiations:

1. The Franchise Agreement

1. You should first identify with your lawyer all the provisions in the franchise agreement that give you a concern. The following are just some of the key provisions that require particular attention:
   • Term and renewal;
   • Site selection;
   • Remodelling and renovations – both during the term and as a condition of a renewal;
   • Relocation obligations;
   • All monetary obligations;
   • Personal guarantee;
   • Territory and exclusivity;
   • Termination rights, and
   • Post-termination restrictive covenants (such as non-competition and non-solicitation).
2. In addition, ask your lawyer to identify the clauses that are more or less overreaching beyond what is common in the industry.
3. Do the same with respect to the franchise-related agreements, such as the general security agreement, personal guarantee and whatever other agreements are required to be signed as part of the purchase.

2. The Lease Agreements

1. Apply the same principles to the lease agreements as with respect to the franchise agreements. This includes the offer to lease (if one exists), head lease and sublease. Identify the issues that are important to you and those that are beyond standard clauses in your industry. The following are some of the core provisions:
   • Term and renewal;
   • All monetary obligations;
   • Personal guarantee;
   • How TMI or operating costs are calculated;
   • Landlord’s work;
   • Tenant’s work and fixturing period;
   • Relocation obligations;
   • Damage obligations, and
   • Termination rights.
2. If the landlord or franchisor require that you provide a personal indemnity with respect to the head lease, carefully consider if this is a liability that you are prepared to take on.
3. Construction of the store: Who is constructing the store and when do you have to start paying the rent? Often, constructing a turnkey store ends up taking much longer than the time that was initially projected, particularly if your franchisor does not have an extensive track record in retail construction. If that is the case, pay particular attention to the tenant’s fixturing period.

3. The Franchise Disclosure Document

Does the franchisor’s disclosure document comply with the requirements of provincial franchise disclosure legislation? This may be a technically complex analysis that goes beyond the basic technicalities, such as inclusion of the required documents or other required components. The analysis needs to include material facts: whether the franchise disclosure document contains all “material facts”, as defined in the franchise legislation.

4. Are you a business person or a consumer?

All too often, franchisees decide to purchase a franchised business because they love the product (burger, coffee, wrap, salad, whatever is the key product offered by the franchise). This is great if you want to buy from this franchise as a consumer, but it is not enough if you want to invest in it and become a franchisee operator.

You need to approach the purchase as a business investment. Consult with your accountant and prepare a reasonable and conservative business plan. Ask yourself this question: Do you know your monthly hard costs (how much money you need to put in the bank account to keep the business afloat)? Do you know your breakeven point? Do you know what your food or other product cost will be? Move away from the consumer mindset and approach the purchase in a serious, methodical approach.

5. Site selection

Go beyond the franchisor’s unofficial recommendation about the proposed site. Consider hiring an experienced site selection consultant (not to be confused with a real estate agent – the two are very different) to help you evaluate proposed sites.

The franchise agreement likely contains a clause that seeks to diminish any legal weight to the franchisor’s selection of the site and likely puts the ultimate responsibility for the selection of the site solely on you. Therefore, you may as well do it right and consult with a qualified professional.

A proper evaluation will consider the local demographics, local competition, the nature of the business, and many other relevant factors.

6. Resale

If you are buying an existing location, whether directly from the franchisor or from the existing franchisee, consider insisting on obtaining the sales and financial records of the business for at least the past several years.

7. The Franchisor’s Track Record

All franchisors are not made equal. On the one end of the scale are highly sophisticated and mature franchisors with extensive track record of success and financial backing. On the other end of the scale are start-up franchisors with practically no financial backing, no head office support, and no significant experience operating a successful system. Many franchise systems fall somewhere along the spectrum between these two extremes.

If you are considering purchasing a single unit (as opposed to several units, rights to an area or beyond), here is a general rule of thumb: the more experienced and mature the franchise system, the less negotiating leverage you will have. Conversely, the less experienced the franchisor, the more negotiating power you will have or should insist on.

The closer your franchise system is to the start-up end of the spectrum, the more emphasis you should put into the “on the field” due diligence investigation: from extensively speaking to franchisees to conducting an analysis of existing or potential litigation against the franchisor, purchasing power, marketing and advertising fund, and many other issues.