Power of Attorney - September 2000

Looking Before You Leap

Seek Legal Advice Before Purchasing a Franchise

by Paul Ray

"Franchising is the most successful device for small-business ownership ever invented. One person invests his or her own capital and builds a retail concept using the trademark and proven business systems of the franchisor, all while tapping the power of group purchasing and advertising….Franchising is minting new millionaires both in the United States and abroad at an unprecedented clip."

-Andrew A. Caffey
"AnalyzeThis," Entrepreneur magazine - January 2000

Historically, the word franchise meant the granting of a right or privilege to an individual or group. In more recent times, it has come to mean a contractual agreement between two parties, the franchisor and the franchisee. The franchisor grants the franchisee the right to market a product or service, including the use of the trademark, and provides a tested format or system to which the franchisee is required to conform. The franchisee must maintain quality standards and pay a royalty or fee for the franchise.

The Federal Trade Commission defines a franchise as a business relationship in which each individual owner:

• Uses a common name (such as McDonalds or Millers Outpost)

• Receives training, assistance and guidance from the parent company

• Pays a fee to the parent company ($500 or more within the first 6 months of operation)

If a business arrangement includes these 3 elements, it's a franchise and it must comply with the rules of the Federal Trade Commission and certain state regulatory authorities.

Here are some points to remember if you are planning to purchase a franchise:

It is important to seek legal counsel to properly negotiate agreements. You will be dealing with professionals, so you need to know how to deal with them on a professional basis.

Educate yourself as much as possible before going into the business. This includes researching the company in the library, on the Internet, and where possible, with other franchisees.

You should also find out if a franchisee association exists, which can serve you much as a labor union serves an employee. Many times franchisee associations have more power than individual franchisees when it comes to negotiating specific policies to be approved by the franchisor. But, associations often have board members who are "hand-picked" by the franchisor, keeping the control within the franchisor’s grasp.

You are entitled to a number of disclosures, including the company’s history and success rate. Find out the statistics about franchises in areas similar to yours-what are the average costs? average annual income? Find out how many franchisees have left the company. This will give you an indication of their satisfaction with the arrangement.

Be sure to read franchise agreements carefully, because they are generally written in favor of the franchisor. Many franchise documents carry "traps" that a buyer may overlook, such as your obligations if the franchise is unsuccessful. Franchisees should be careful not to over-commit themselves to excessively burdensome financial responsibilities.

Franchisors are not immune to bad ethics. An easy pitfall for a franchisor to fall into is anti-trust. Anti-trust violations could range from unfair competition and misuse of trademark issues to unfair pricing requirements and unequal franchise support practices.

You and your attorney should create a checklist while negotiating the contract. This should include the financial aspects and business obligations you are willing to accept, such as required practices and procedures under the franchise agreement and required contributions for nationwide and local advertising.

Franchise agreements usually have a "no compete" clause, which means the franchisees are forbidden from opening a similar business for a certain amount of time if they leave the franchise. You would not be able to use or ever disclose the company’s trade secrets; if you break this clause you would face claims for damages.

These warnings should not frighten away franchise investors who do their homework. Tremendous financial opportunities exist for franchisees, and you can maximize your profits by knowing what you are getting into.

Paul Ray
Paul Ray, attorney at John Peter Lee, Ltd.