Some franchisors like to push the market envelope when it comes to deal terms. That’s a good thing for franchisees if the franchisor, in so doing, aligns its economic interests with the franchisee’s prospects for success. While many and maybe even most franchisors operate on such a unity of interest principle, some less reputable franchisors do not. And it’s not so great if the deal stretches the market by one-sidedly advancing the franchisor’s financial goals or is otherwise overreaching.
In order to fully understand the merits of your franchise deal, you must evaluate at least two things: (1) what the franchise disclosure document (FDD) and franchise agreement say and (2) how their terms compare to what the market offers. This article will focus on the second consideration.
Before you begin thinking about how your franchise deal stacks up to the market, you first have to understand how the market is defined. While the FDD is uniform and basic structure of a franchise agreement is fairly consistent among franchisors, some deal provisions, particularly economic terms, vary considerably according to franchise sector.
For example, franchise royalties for established restaurant chains – QSRs, fast casual and full service – tend to cluster in the 4 to 6 percent range while those for commercial and residential cleaning service franchises as well as for tutoring franchises tend to be somewhat higher.
Franchise fees also vary by sector. In theory, initial franchise fees (the amount a franchisee pays for the right to enter into a license) are linked to the franchisor’s obligations to get you started: training, site selection and the like. In fact, some state franchise authorities will compel a financially weak franchisor to escrow or otherwise defer the franchise fee until it has performed its initial obligations and the franchisee is open for business. But in practice, franchise fees are often set with the only consideration being what the market might bear. And, again, the market tends to be defined by sector. Accordingly, franchise fees for some franchise sectors tend to deviate from a broad market range of between $25, 000 to $50,000. For example, certain advertising services franchises are well north of that range and many home-based franchise opportunities are well below it.
The length of the franchise term also may differ according to sector. Franchise sectors that have higher infrastructure requirements generally, but not always, are coupled with longer franchise terms. Retail franchises with substantial build-out requirements lean toward longer terms while some business services franchises tend to favor shorter terms.
In addition, certain other franchise agreement terms and conditions may vary by sector. For example, although liquidated damages provisions remain the exception rather than the rule for franchises in most industries, they are common among hotel franchises.
So, before evaluating the merits of your franchise deal, you need to understand the market practices of the sector within which your franchise resides.
Of course, some contractual provisions defy sector categorization and, accordingly, you need to evaluate them against the entire franchise market. A good example is a performance target or guarantee. You won’t run across these provisions too often because most franchisors do not impose them. And for good reason: they can put your entire investment at risk for things that may be completely out of your control. Like a recession or other economic dislocation. They also send a decidedly mixed message: we have a great franchise concept and we select only the best people (like you!) to run them, but if we are wrong on either or both, we want the right to drop the hammer on you, move on and leave you licking your wounds.
You also need to be mindful of trade-offs. Most franchisors have specific financial goals and may simply differ with other franchisors with respect to the path they choose to achieve them. For example, a franchisor that wants to grow rapidly through franchising (versus through building company-owned units) in order to goose its royalty stream or expand its footprint may be very aggressive in its pricing (e.g., reduced franchise fees and tiered royalties). But that same franchisor also may wind up with a “support light” structure to match its “asset light” strategy. Franchisee support requires franchisor resources and a franchisor that opts for capital relief may relieve itself of the resources to support its franchisees with, for example, new product development.
When a franchisor takes a position that on the surface provides an “extra-market” benefit for its franchisees, its competitors may wince, much in the same way that a homeowner grimaces when a neighbor offers his or her home at a submarket price. This is particularly the case if that price counters a trend at the expense of embracing expedience – a quick sale related to a job change, for example. But you should be somewhat wary of the reasons underlying the convenience that a franchisor may covet. For example, a franchisor’s excessive debt levels may have forced its hand on aggressive expansion. And, clearly, financial compulsion is not a promising market strategy.
So, where do you go for market intelligence about your franchise deal? When investing in a franchise, in all cases you should engage a qualified franchise attorney to review both your FDD as well as your franchise agreement. But you also should take the extra step and find a franchise attorney who has his or her finger on the franchise market pulse and who has reviewed and/or drafted FDDs and franchise agreements across many franchise sectors. To be sure, a franchise attorney – even a very good franchise attorney – almost certainly will not be able to negotiate some provisions in your franchise agreement, but he or she can tell you whether your franchisor is offering a market transaction. Or a market transgression.
Mike Sheehan is a franchise consultant and attorney. He is the president of Focus Ventures (www.focusonfranchise.com) and formerly served as a securities attorney and as general counsel for a Fortune 100 financial services company. His Franchise Focus Blog (www.franchisefocus.blogspot.com) focuses on helpful information, tips and current news for prospective franchisees.
This article should not be construed as legal advice or a legal opinion on any specific facts or circumstances. The contents are intended for general information purposes only and you are urged to consult your own franchise attorney concerning your own situation and any specific legal questions you may have.