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“Franchise Homework”

July 9, 2010

Buying a franchise is a major decision in which many factors should be considered. The article “Do your homework before you buy a franchise”, by Tony Wilson, can help potential franchise investors making the right decision by reviewing some important issues.

Franchised businesses are never supposed to fail. But on occasion, they do.

That’s why doing your homework before you “buy” is so important, so the prospective franchisee can avoid disastrous mistakes and the agony of defeat. Legally, franchising is very document-intensive and it is important for prospective franchisees to understand what they are signing.

Here are a few matters to keep in mind when thinking about buying a franchise:

• Although you may be purchasing the tables, chairs and other assets related to the business, remember that, conceptually, you aren’t buying. Instead, you are acquiring the legal right to use a franchisor’s business system and trademark for the term of the franchise and any renewals. When that’s over, the franchisor has no obligation to offer you a new franchise so, in some ways, you’re just renting the rights.• If you’re living in Ontario, Alberta or PEI, has disclosure been provided to you under the laws of those provinces? Have you read the Disclosure Document and Franchise Agreement and discussed it with your legal and financial advisers? If you live in another province, is the franchisor providing you with a copy of its disclosure document (and if not why not)?• The prospective franchisee will normally be required to sign a deposit and confidentiality agreement, which also protects the franchisor’s trade secrets. Is the deposit wholly or at least partly refundable if the deal doesn’t proceed? Is it to be paid back immediately if the deal doesn’t proceed?

• Is the prospective franchisee dealing with the owner of the franchised concept, an area developer or master franchisee who owns the rights to a particular territory, or a salesman who sells all sorts of franchises?

• How extensive is the training and where is it held? Extensive and comprehensive franchisee training is a good thing.

• Some U.S. based franchisors don’t “Canadianize” their agreements. The agreements can contain U.S. legal concepts not directly applicable in Canada. Canadian concepts, such as GST, are also omitted. As well, is the price for the franchise rights in Canadian or U.S. dollars? Does the franchise agreement contemplate that withholding tax will be payable on royalties crossing the border?

• If the franchisor is building out the franchised premises itself, what assurances do you have that you will not have to pay for cost overruns the franchisor has encountered over and above the price you agreed to pay?

• Does the franchisor own or control the trademark? This can be verified by a database search on the Canadian Intellectual Property Office Web site. If the franchisor does not have a registered Canadian trademark, others could stop the franchisor (and you) from operating under that brand.

• Are other franchisees in the system content and making a good living? Is there litigation between the franchisees and the franchisor? Prospective franchisees should get a list of all franchisees in the system and talk to as many as possible. Check the disclosure document for a list of franchisees and a description of any litigation.

• Should both the husband and wife of a “mom ‘n’ pop” franchise personally guarantee the franchise, or should only one party take on that risk? Maybe the personal guarantee can be capped at some predetermined amount.

• What assurances are there that the products for sale by the franchisor can be bought by the franchisee at competitive prices? Are there customs problems bring the products into Canada for resale?

There are dozens of other issues that prospective franchisees have to consider before making what might be the most important financial decision of their lives. The questions are as important as the answers, and one of the keys to survival when buying a franchised business is doing your homework on the franchisor.

Source: The Globe and Mail Online, January 2010 by Tony Wilson

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