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Buying a Franchise? Read this first

Buying a Franchise? Read this first

By Wisewould Mahony
March 22, 2016

Although the terms of each Franchise Agreement are different, there are a number of key elements that many agreements have in common. It is helpful for franchisees to understand each of the following points when considering buying a franchise.

Franchisee’s right to terminate

Under the franchising Code of Conduct, franchisees have the right to terminate a franchise agreement within 7 days of the earlier of entering into the agreement and making any payment under the agreement. If a franchisee exercises its right to terminate the agreement within the cooling off period, the franchisor must refund all payments made by the franchisee less the franchisor’s reasonable expenses.

It is very uncommon for a franchisee to have the right to terminate a franchise agreement outside the cooling off period. Franchisees are therefore required to continue operating the business for the term of the agreement, regardless of the level of success of the business. Generally, if a franchisee wishes to be released from its obligations under the agreement, the only options are to assign its rights to an incoming franchisee (ie sell the business) subject to the franchisor’s consent or seek the franchisor’s agreement to early termination. 

Operations Manual

In most franchise systems, the franchisor will provide franchisees with an operations manual. Franchisees will be required to operate the business in accordance with the policies and procedures set out in the manual and a breach of the manual will be deemed a breach of the franchise agreement. As a result, the contents of the manual will have a significant impact on a franchisee’s business.  We therefore recommend asking to view a copy of the manual before signing the franchise agreement. If the franchisor will not provide a copy prior to signing the franchise agreement we recommend reviewing the manual carefully within the cooling off period to ensure that the franchisee has the right to terminate the agreement if the contents of the manual are unacceptable (noting that the franchisor will have the right to update the manual throughout the term of the agreement).

Royalties are calculated on gross revenue, not profit

Many franchise agreements require payment of a royalty which is calculated as a percentage of the franchisee’s gross revenue. This means that the franchisee will be required to pay the franchisor regardless of whether the franchisee is making a profit and/or drawing a basic wage from the business.

No compensation for goodwill

When the franchise agreement ends (either by expiration or earlier termination) franchisees will generally not be entitled to any payment or compensation for the value of the goodwill in the business. It is therefore important to ensure (as far as possible) that the business will generate sufficient income throughout the term of the agreement to justify the upfront and ongoing costs of operation.

Franchisor control of marketing expenditure

If a franchisee is required to contribute to a marketing fund, the franchisor will generally have the discretion to determine how and where the marketing fund will be expended. There is no guarantee that the franchisor will use any part of the marketing fund on marketing within a particular franchisee’s territory or on a particular franchisee’s business.

Franchisor support

Franchise agreements generally place very few obligations on the franchisor. Where there is a positive obligation on a franchisor to provide support and assistance, it is not uncommon for that support to be provided “as the franchisor determines is reasonably required” or words to that effect. We therefore recommend prospective franchisees speak to existing franchisees to get an idea of the level of support provided by the franchisor to ensure that this is in line with the franchisee’s expectations.

Franchisor’s control of supply of product

Franchisors often require franchisees to acquire product from the franchisor, its associates or approved suppliers. If, under the terms of a franchise agreement, the franchisee does not have the discretion to acquire product from alternate suppliers (regardless of potentially more favourable terms including price) it is important to consider the terms of supply of the approved suppliers prior to entering into the franchise agreement.

Read the documents carefully

Every franchise agreement is different. There is no substitute for reading the franchise agreement and disclosure document carefully and seeking independent legal and accounting advice. Wisewould Mahony Lawyers can prepare a detailed written report explaining the key terms of the agreement and highlighting any areas of particular concern for a fixed fee.

If you require assistance regarding entering into a franchise agreement or any other franchising matter, please contact Adam Rich.

Our services

Our Franchising department can also assist you with:

  • Reviewing and advising on franchise documents;
  • Drafting Franchise Agreement and Disclosure Documents;
  • Dispute resolution for franchisees and franchisors.