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Legal pitfalls for first time franchisees, and how to avoid them

Buying a franchise can be a great opportunity to begin running a profitable business based on a proven business model with support from the franchisor. But despite the benefits of being part of a franchise, there can be some unexpected issues further down the line if you are unprepared when you enter the agreement.

Most franchisors use their standard franchise agreement and state that it is non-negotiable. And many franchisees sign the agreement without taking legal advice.  This can lead to unforeseen legal problems out of which disputes can arise.

Seeking independent legal advice prior to signing the franchise agreement will help you fully understand your legal position clearly. This will allow you to properly evaluate whether the franchise is a good investment or not.

There are key areas where you will want to have a comprehensive understanding. Also, you may wish to explore whether some of the terms can be negotiated before you put pen to paper.

Costs

With any investment, it is essential to know the ins and outs of the costs, and it is no different for a franchise agreement.

There will more than likely be a franchise fee and royalty payments to be paid to the franchisor. The royalty payments may not be calculated on profits rather than annual turnover, so, if you make a loss, you will still be expected to pay.

It's also worth checking whether there will be any additional costs required, eg for training, equipment or marketing.

Before you sign the franchise agreement, it is important to have an idea as to the total amount you will need to invest in order to set up the business. It could be a nasty surprise to only budget for the franchise fee and be lumped with a much greater bill.

Restrictions

A franchisee agreement often contains a number of restrictions on what the franchisee can and can’t do. This is to be expected since a franchisor will want to protect their franchise, but it is important to know what these restrictions are to avoid possible penalties.

A common restriction imposed is on carrying on another business while you are running franchise business. If you are someone who runs several businesses, this would be a term that you would want to know about and potentially renegotiate.

Another common restriction is on opening a business that will compete with the franchise after the franchise agreement has ended. It is important to know about this term before terminating the franchise agreement or investing in another business as it is one that could lead to a lengthy dispute.

Termination                                                                                                                      

Often the franchise agreement will allow the franchisor to terminate the agreement if there is a breach. Therefore, it is important to know what will constitute a breach in order to prevent losing your investment in the franchise.

Equally, there may not be an option for a franchisee to terminate the agreement, even if the business is failing. This could leave you locked into running an unprofitable business for several more years, especially if you are not able to sell the business on.

Renewing

Most franchise agreements last five years.  If, at the end of that period, you have worked hard to build a profitable business, it would be disappointing for the franchisor refuse to renew the agreement, or to only renew it at a greatly increased price.

Many franchisees assume that when the agreement reaches its conclusion, the franchisor is obliged to renew the previous agreement. However, this is not usually the case. Often franchise agreements will not put an obligation on the franchisor to renew the agreement or if it does it could be on the terms of the currently drafted franchise agreement, which could have changed dramatically over the previous five years.

Before the agreement is signed, it is important to check whether the franchisee has the right to renew the agreement otherwise five years of hard work could be wasted.

Article written by John Hillerby of Tebbitts & Co 

DISCLAIMER: This article should not be regarded as constituting legal advice in relation to particular circumstances. It is merely a general comment on the relevant topic. If specific advice is required in connection with any of the matters covered, please speak to Tebbitts & Co directly.

Published on 26th November 2018
(Last updated 27th November 2018)

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