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Getting Past the Legalese

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Reading a franchise agreement can be like having dinner at Aunt Martha's. There's a lot of stuff, you're not sure what you'll have to swallow, and you don't quite trust what went into it. Unlike eating Aunt Martha's Sunday Surprise, though, signing a franchise agreement without understanding it could cost you thousands of dollars. Here's a brief introduction to the most common terms.

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You normally have to pay an initial franchise fee (usually between $15,000 and $25,000), plus an ongoing royalty for the term of the agreement. This royalty may range between three per cent and six per cent of the gross sales, depending on the industry. It is very important that you understand how the agreement defines "gross sales." What is included and excluded?

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Term and Territory

A franchise agreement lasts for a set period of time, usually several years. The term of the agreement should last only as long as the lease or sublease of the location. There may be an option to renew the term.

An important part of the franchise agreement is the territory clause. You're usually given an exclusive trading area in which to operate the business. For example, this might be within a 10-kilometre radius around your location. Sometimes, this territory protection is not absolute but merely gives you the right of first refusal. That is, if a new franchise comes up in your territory, you get the first chance to buy it. If you turn it down, you'll have another competing location in your territory.

You should make sure the franchise agreement does not allow the franchisor to sell product through "alternative channels." For example, while there might not be any MegaDonuts outlet near your franchise, the supermarket next door might sell pre-packaged megadonuts.

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Franchisors will usually agree to provide a certain amount of initial training. You may have to pay some fee to the franchisor for this training, in addition to travel and accommodation costs. The franchise agreement may impose mandatory annual or ongoing training seminars which you or designated managers must pay for and attend.

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Authorized Services and Supplies

The franchise agreement may require you to purchase services and supplies from an authorized supplier, because

  • the franchisor may be able to get better prices or quality from the supplier
  • each franchisee will usually get the same quality goods and services
  • the end product sold in the chain is consistent, enhancing the brand's reputation

Sometimes the authorized supplier is the franchisor or a subsidiary, which generates a mark up on the supplies or services. Ensure that the authorized supplier offers reasonable prices.

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The franchise agreement will require you to provide regular sales reports. The franchisor may also do quality-control surveys to assess your performance and to ensure that it is receiving its rightful royalty payments. Some franchisors also require costly audited financial statements. You should see if the franchisor is willing to drop or modify this requirement.

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In addition to the payment of royalties, you may have to pay towards an advertising fund. For example, all the franchisees may have to contribute two per cent of their gross sales to pay for an expensive national ad campaign. Make sure there are controls over how the franchisor uses the advertising fund. Ask questions like,

  • Is the fund separate from the franchisor's regular accounts?
  • Is there input from the franchisees as to how the money is spent?
  • How and where is the money spent?
  • Does the franchisor pay into the fund?
  • Does the fund pay the franchisor an administration fee?

In addition to the joint advertising, you may be required to spend a certain amount of money on local advertising (e.g. local flyers, community newspapers etc.).

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Restrictive Covenants

You're usually not allowed to compete with the franchisor while you are a franchisee, and for a certain period of time after that. This "restrictive covenant" must be reasonable as to the area and length of time, and should go no further than reasonably necessary to protect the business adequately (e.g. three years after the business relationship ends for a radius of ten kilo metres from the franchise location).

There will be a confidentiality clause which prevents you from disclosing or using any of the franchisor's confidential information about the business (i.e. trade secrets, business systems, inventories, methods of production, etc.). There may be provisions which restrict you from "moonlighting" during the term of the franchise agreement. This makes sure that you give your full time and attention to the franchise business.

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Personal Guarantee

Sometimes you will want to operate the business through a limited a company. The franchisor usually insists that the shareholders personally guarantee all of the company's obligations under the franchise agreement and related agreements.

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The franchise agreement usually gives the franchisor a lot of power if you default on any of your obligations under the franchise agreement or related agreements. Also, a default under one agreement will mean a default under all of the agreements, so if you fail to pay the rent, you may lose your right to lease the location, your right to operate the business, and your license to use the franchisor's brand name, trademarks and systems of operation.

The franchise agreement may separate serious defaults from less-serious defaults. The less-serious defaults may be "curable." This means that you may be able to bring yourself back into good standing by fixing whatever you did wrong. For example, by paying the royalties due, by ordering the correct supplies, or by changing management policies. Some defaults may be so serious as to be "non-curable" (e.g. bankruptcy, getting evicted by the landlord, assignment without the franchisor's consent etc.).

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More questions? Phone us at (604) HELP-LAW.

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Legal disclaimer:  The information provided on Lawyers-BC.Com is not intended to be legal advice, but merely conveys general information related to legal issues commonly encountered. Your access to and use of this Web site is subject to additional terms and conditions.

This page last updated: October 5, 1999
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