Buying a Franchise

Hillel Goldman

You’re sitting in your favorite coffee bar or ordering coffee and donuts while thinking about the stress at the office and a light bulb goes off. I can do this. I’ll just buy a franchise. I’ll be my own boss and sell a product that I really like.

But is buying a franchise the right business move for you? Being a franchisee has advantages and disadvantages and both need to be examined carefully.

When you buy a franchise, you pay to obtain the reputation, the public perception and other goodwill that has been built by the franchisor. You also receive training, supervision and guidance under the franchisor’s standardized management system.

The disadvantages include the requirement that you comply to the franchisor’s strict standardized system including usually purchasing all product through the franchisor or its designated suppliers. You are dependent on the franchisor’s financial strength and goodwill. You must pay various franchise fees to the franchisor. Also, if you fail, your obligations to the franchisor do not necessarily go away and you will be unable to operate a similar business for the period of the covenant not to compete that the franchise agreement inevitably contains.

For these reasons, prior to purchasing a franchise, you must perform careful due diligence.

Franchisors are required to provide prospective franchisees with an extensive document called the offering circular which contains certain uniform disclosure categories of information about the franchisor. This must be reviewed carefully both by you and your attorney.

In addition to containing the franchise agreement that the franchisee will be required to sign, the offering circular also contains the following franchisor information: the franchisor’s business experience; litigation against the franchisor; bankruptcy information about the franchisor and its key people; the initial franchise fee; other fees; estimation of the franchisee’s initial investment; restrictions on sources of products and services; the franchisee’s obligations; what financing is available; the franchisor’s obligations to the franchisee; what your territory will be; what trademarks are held by the franchisor; what patents, copyrights and proprietary information is owned by the franchisor; what the franchisee’s obligation are to participate in the operation of the franchised business; whether there are restrictions on what the franchisee may sell; franchise renewal, termination, transfer and dispute resolution requirements; whether any public figures are involved in promoting the franchise; earning claims; a list of franchisees; the franchisor’s financial statements; and contracts entered into by the franchisor.

Besides examining the franchisor’s background and products, there are 3 critical things you should look at after obtaining the offering circular.

First, speak to as many existing franchisees as you can. Find out from them whether they are happy with the franchise relationship. Is the franchisor supportive? What problems have they encountered? Are the estimated initial investment figures accurate? Find out whether the franchisor has negotiated franchise terms with prospective franchisees in the past (no franchisor will admit that it does this and most established franchisors will never agree to any changes). You can waste a lot of money for legal fees needlessly in attempting to negotiate franchise agreement terms with a franchisor who never negotiates its terms.

Second, is the franchisor involved in any litigation? If it is, is the litigation with franchisees (current and/or former)? Does it concern the proprietary information that you are paying for the right to use? Are there any product liability issues?

Third, what is your territory? Is it clearly drawn or can other franchisees or even more disturbing can the franchisor itself compete with you? This becomes even more interesting in the electronic age.

There are many other legal (corporate, real estate, contracts, zoning, etc.) and business issues that need to be reviewed. In addition to meeting with an experienced attorney, one excellent resource that you may want to use is the Small Business Development Center. This valuable resource provides free business counseling and is located at the Chamber of Commerce.

So as you’re drinking that cup of coffee and thinking about buying a franchise, sit back and begin to do your homework.