In Short:
- Carefully review key terms like fees, franchise term, and area to ensure clarity.
- Understand your financial commitment, including royalties and additional costs.
- Assess renewal terms, performance metrics, and exit clauses to manage long-term risks.
Tips for Businesses:
Before committing to a franchise, thoroughly review the agreement, focusing on fees, obligations, and renewal terms. Consult a franchise lawyer to identify potential legal issues or unfair clauses. Ensure the business is financially viable by scrutinising hidden costs and evaluating performance metrics, while keeping exit options in mind for flexibility.
Entering into a franchise agreement is a significant decision that requires careful consideration and thorough evaluation. A franchise agreement serves as the foundation for the relationship between the franchisee and franchisor, outlining the terms and conditions that both parties must follow. Before committing to a franchise opportunity, potential franchisees should conduct a comprehensive review of the franchise agreement to ensure they fully understand their rights, responsibilities, and the overall structure of the business arrangement. This article explores what you should look for when reviewing a franchise agreement.
Consult a Franchise Lawyer
The first thing you should do is consult a franchise lawyer. Like any other thick bundle of legal documents, the devil is often in the detail. A franchise lawyer will be able to review the documents for inconsistencies, onerous clauses or clauses that do not comply with the Franchising Code of Conduct and other applicable laws.
Use your franchise lawyer to your advantage. Do not be afraid to ask them questions if you are having trouble interpreting a particular clause or how the agreement will apply to certain situations.
Key Points to Look Out For
Not understanding key terms in your franchise agreement can cause you to overlook important details that are either missing or need amending. When reviewing the franchise agreement, there are key points you should review:
- look at the basics of the agreement, usually within the schedule of the franchise agreement. Ensure the agreement clearly defines terms like the franchise term, fees, area and the parties;
- review the itemisation of expenses within the Disclosure Document, and use those figures to prepare a cash flow forecast and detailed business plan;
- consider the number, location and turnover rate of existing franchises – this information will be within the Disclosure Document. Specific details to look out for include a high turnover or transfer rate (suggesting not all franchisees are successful), the existence of legal proceedings against the franchisor, and the location of other franchises. What business performs well in one state may not necessarily do so in another;
- read the Information Statement provided with the document. The law requires that franchisors provide this statement to all franchisees. It contains important information relating to the nature of the agreement you are entering into;
- talk to other franchisees – usually their details are within the Disclosure Document. It is incredibly valuable to talk to someone who is already doing exactly what you propose to do; and
- look at the ability to transfer or sell. Usually, these provisions will be under the sub-heading “Transfer” in the Franchise Agreement. Before you sign up for a long-term contract, you want to make sure your business will be sellable if, for whatever reason, you cannot carry it out for the entire term.
Understanding the Financial Commitment
One of the first aspects to scrutinise in a franchise agreement is the financial commitment required, including:
- the initial franchise fee;
- ongoing royalties; and
- additional costs, such as marketing fees.
Ensure that these financial obligations align with your budget and business expectations. Be aware of any hidden costs that may arise during the course of the franchise relationship and carefully evaluate the financial feasibility of the investment.
Examining Duration and Renewal Terms
Carefully review the terms of the franchise agreement and renewal conditions. Likewise, determine the agreement’s initial duration and the renewal conditions.
Some franchise agreements have a predetermined renewal fee, while others may require meeting specific performance criteria. It is crucial to be aware of these terms to make informed decisions about the long-term commitment to the franchise.
Performance Metrics and Consequences
Franchise agreements often include performance metrics or standards that franchisees are expected to meet. These may relate to sales targets, customer satisfaction, or other key performance indicators.
Evaluate these metrics carefully and understand the consequences of not meeting the specified standards. Clear communication on performance expectations is essential for maintaining a healthy franchisor-franchisee relationship.
Exit Clauses and Termination Terms
Understanding the exit clauses and termination terms is crucial for managing risks associated with the franchise. Review the conditions under which either party can terminate the agreement and the associated consequences.
Additionally, inquire about any penalties or fees that may be incurred upon termination. Having a clear understanding of exit clauses provides peace of mind and flexibility in case unforeseen circumstances arise.
The ultimate guide to setting up a franchise.
Key Takeaways
While starting a new business venture is exciting, always take time to review any legally binding agreements rather than signing them amid your excitement. Franchising is an expensive, long-term commitment that largely relies on your franchisor’s business practices and success. It is important to take careful steps in reviewing a franchise agreement.
If you need assistance drafting or reviewing your franchise agreement, our experienced franchise lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Key elements to review include franchise term, fees, territory, financial commitments, renewal conditions, performance metrics, and exit clauses.
You should understand the initial franchise fee, ongoing royalties, and additional costs like marketing fees. Ensure these align with your budget and business expectations.
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