Franchise Agreements

Franchise Agreements

A franchise agreement is a business arrangement between a franchisor and a franchisee.  Typically, the franchisor has a business model, a reputation, or some track record for profit, prospect, or success for a particular business.  For example, most McDonald restaurants are operated as franchises, but there is only one franchisor (the McDonald’s franchisor) authorized to sell or operate the McDonald’s franchise. However, the business world is filled with franchises that failed, did not perform as anticipated, or performed dismally.

A franchise’s benefits are that the franchisor has created, operated, and/or planned a business and has or proposes to have a system in place.  Each franchisee operates the business under strict guidelines set by the franchisor.  If the franchisee deviates from the franchisor’s business model, not only may it affect the reputation of the franchisor, but also other franchisees as well.  Thus for instance, if one franchisee acts to tarnish the franchise brand or reputation, it may affect other franchisees.

The law requires that franchisors provide prospective franchisees with disclosures about the principals or officers of the franchisor; their history in the business; the franchise’s track record, success, or failure; the history of lawsuits or disputes with franchisees; key financial information about the franchisor; the franchisees’ successes, failures, or prospects; and more.  A prospective franchisee should read and study these disclosures carefully and have his or her legal and financial advisers review them before signing the contract with the franchisor.

A prospective franchisee also should know that franchisors have written the franchise agreement contracts (franchise agreements) to protect themselves, obligate the franchisees, and keep the franchisees on the hook. Therefore, before entering a franchise agreement, a potential franchisee should read the franchise agreement carefully, understand it, understand the risks, appreciate the pitfalls, and more.  Typically, any dispute must be resolved by legally binding arbitration in the place chosen by the franchisor, and the franchisee gives up the right to a jury or a court and usually agrees to limit the franchisor’s liability and often, by contract, has placed himself or herself in a legally weaker position than the franchisor.

Many individuals desire to own their own business, and the franchise model may seem enticing.  Often, in order to buy a franchise, the franchisee uses his or her life savings and/or borrows money to buy in.  A franchise will require the payment of substantial monies upfront to the franchisor and often a percentage of gross sales.  In other words, not only must a franchisee pay for to become a franchisee, the franchisor generally collects a percentage of every dollar of sales.  The franchisee must learn the business operations; deal with employees, customers, and regulators; pay taxes; and work under a set of rules written by the franchisor.  The franchisor even may control the retail prices at which the franchisee sells the products, which usually is the only source of revenue for the franchisee.   Thus, typically, the franchisor is in the driver’s seat in the relationship.

Once the franchise agreement is signed, the agreement controls the parties’ legal relationship, obligations, and commitments.  The franchise agreement usually favors the franchisor.  Some franchisors may work closely with their franchisees; others may not.  A franchisor may have economic motives to squeeze the profits of a franchisee and increase its revenues.  For instance, in a slow season, the franchisor may require the franchisee to sell products at a loss but still may require the franchisee to buy the components or supplies by or through the franchisor at non-discounted prices.  Implementing this measure may keep the franchisee’s sales and profits high; nevertheless, during that same time, the franchisee is taking a financial hit.   Moreover, if the franchisor has financial difficulties, it will be tempted to increase its charges for goods and services – or impose other fees indirectly – that it requires the franchisee to buy.

Prospective franchisees also should remember: An amazing product does not translate to an amazing franchise structure automatically, and a rapidly growing franchise network does not translate to a highly profitable structure automatically. Most importantly, potential franchisees should not sign a franchise agreement with a franchisor that still is striving to figure out its operating model. A franchisor that still is figuring out its operating model often makes multiple changes before settling on a satisfactory operating model, and these multiple changes often harm the franchisees and franchises as they struggle to accommodate each change.  Therefore, potential franchisees should not lightly join the team merely because of how amazing the product is, but instead they should determine whether the growing franchise network equals high revenues and profits.

If you are considering purchasing a franchise, consult with an attorney first.  He or she can be a great ally. If you purchased a franchise or signed the franchise agreement and are in a dispute with the franchisor, there may be legal remedies available. If you have questions about America’s franchise laws, talk to a lawyer. For more information and to have your questions answered, contact Nashville Business Attorney Perry A. Craft.

Thus, be very careful if you contemplate becoming a franchisee.  Consult with a lawyer and financial adviser.