When you are going through the process of buying a franchise, it is critical to review the franchise agreement. Not only will the franchise agreement govern your relationship with your franchisor, but it will also dictate what happens if something goes wrong. Will you be required to use designated suppliers (even if you can find lower prices elsewhere)? What will you need to do in order to renew? Will you be required to arbitrate in the franchisor’s home state in the event of a dispute? Will you be liable for liquidated damages if the relationship ends prematurely?
This is just a small sampling of the many questions you need to answer before moving forward.
If you had to pick just one clause to review in the franchise agreement, which one is the most important? Any franchisee lawyer will tell you that it’s impossible to pick one—they are all important for different reasons, and many work together to establish (or restrict) your rights as a franchisee. But, let’s say that you only get to pick one clause to review before you sign. Which one should you choose?
The Most Important Clauses in Your Franchise Agreement
Again, we will reiterate that it isn’t possible to choose just one. As a prospective franchisee, you need to read the entire franchise agreement carefully. You also need to have it reviewed by a franchisee attorney, and you may need to have your attorney negotiate several clauses on your behalf. But, if we have to pick just one, there are several candidates, including:
1. Term and Renewal
As a franchisee, one of your first major milestones will be reaching profitability—assuming you can get there. But, if the term of your franchise agreement is too short and you aren’t able to renew, you might not have the opportunity. As a result, the term and renewal clauses in your franchise agreement are critical.
While it is important to try to make sure that you have the opportunity to become profitable, you also don’t want to be locked in for too long. If it gets to the point that you need to move on, you do not want to have to struggle through another two or three years (or risk early termination).
2. System Standards
The system standards in your franchise agreement are critical as well. When doing your due diligence, you need to make sure that you understand the franchisor’s system standards—and that you will be able to comply. While you are responsible for your own success as a franchisee, you must be able to find success within the confines of the franchisor’s model. If the franchisor’s system standards are overbearing, if they don’t make sense for your proposed location, or if they are subject to change over time (which is almost always the case), they could present a very real threat to your franchise’s viability.
The default clauses in your franchise agreement are important for several reasons. Not only can a declaration of default lead to termination (as discussed in greater detail below), but defaults can have other consequences as well. For example, depending on the specific terms in your franchise agreement, a default may trigger immediate obligations with which you may or may not be able to comply, and being in default could also prevent you from renewing or transferring your franchise.
Franchise agreements give franchisors broad termination rights. Early termination of your franchise can lead to substantial financial losses. As a result, the termination clause in your franchise agreement is undoubtedly one of the most important. You need to know what actions and failures can put your franchise at risk—and you will need to take proactive measures to ensure that you do not unknowingly or unnecessarily put your franchise in jeopardy.
5. Dispute Resolution
The dispute resolution clause in your franchise agreement is important for several reasons as well. While you may not be anticipating a dispute with your franchisor, you need to be prepared for the possibility. Many franchise agreements include mandatory arbitration clauses that require franchisees to arbitrate in their franchisors’ home states. Many include fee-shifting provisions and other terms that are designed to protect the franchisor as well. If you find yourself in a dispute with your franchisor, the dispute resolution clause in your agreement will likely play a key role in determining what options you have available.
The Verdict: What Is the Most Important Clause in Your Franchise Agreement?
So, if we had to pick just one, what would it be? While there is certainly room for debate, we’ll say that the termination clause is ultimately the most important. As a prospective franchisee, you need to know when your franchisor will have the right to terminate your franchise. If the termination clause in your franchise agreement is too risky, then moving forward with the opportunity might not be worth it. This is especially true if the termination clause includes provisions for lost future royalties. If you are liable for lost future royalties, not only could you lose your initial investment, but you could end up liable to your franchisor even though the franchise was a failure.
With this in mind, we could make the case for just about any clause in your franchise agreement being fundamental to your buying decision. As a prospective franchisee, you need to focus on the entire picture, and you need to make sure that you are making an informed decision based on all relevant legal, financial and practical considerations. In most cases, no single clause will be determinative. Instead, you will need to make your decision based on a comprehensive understanding of the many risks involved.
Discuss Your Franchise Opportunity with Franchisee Lawyer Jeffrey M. Goldstein
If you are thinking about buying a franchise and have questions about the franchisor’s franchise agreement, we encourage you to get in touch. We provide fixed-fee franchise business review packages and franchise agreement negotiation services for prospective franchisees. To discuss your opportunity with franchisee lawyer Jeffrey M. Goldstein in confidence, please call 202-293-3947 or request a free consultation online today.