Legal Advantages and Disadvantages of Buying a Franchise

Rather than form a startup, some business owners decide to buy into a franchise business model. Some common examples are fast food chains like McDonald's or coffee locations like Starbucks. This allows the small business entrepreneur to use the franchisor company's brand name, customer base, and brand recognition.

Before you agree to open your own business under a franchise agreement as a franchisee, understand your legal responsibilities and potential consequences. This FindLaw article explains business ownership under the franchise business structure.

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Franchise Agreements

As a franchise owner, your franchise agreement explains your legal obligations when you buy into an established brand franchise. It should mirror what you got in the Franchise Disclosure Document (FDD). It lists your initial investment, including initial costs and franchise fees. It also includes franchise location restrictions and your ongoing royalties to the corporation.

Your franchise agreement also acts as your franchise contract. If you or the franchise do not follow it, then that is a breach of contract. It means you are in default and could face a court case with damages.

There are lower risks in opening a franchise instead of an independent business, but risks still exist.

Advantages of Franchising

Thanks to the advantages available to franchisees, you can be a successful business. For example, you get a fully vetted and proven business plan. You also get an existing business marketing plan, business operations and manual, and proven systems and processes.

Brand Recognition

Customers will recognize your brand name more than if you were an independent business owner. There is an established fan base built into your new business. There is also an inherent trust by consumers that you will have franchise standard food, products, or services.

Franchise Operations Manuals

You get proven processes and systems as part of your initial franchise fee and ongoing franchise fees. These are Standard Operating Procedures (SOPs). They are checklists and manuals that detail how your store should look, operate, and handle employee situations. The typical entrepreneur has to do this from scratch and work through trial and error. This should get solved before a franchisor offers their franchise to others.

Insurance Coverage

Your franchisor should insure your location. If someone sues you, the corporate policy covers the damages to an extent. You will have to have your liability insurance as well, but two policies are helpful.

Marketing Plans

With an established business franchise as your business model, you will likely have access to their social media marketing campaigns. This means your franchisor may give you:

• Access to franchisee-only marketing templates and portals
• Email marketing campaign templates
• High-quality images of products or company stock photos
• Pre-made captions to post on your social media feeds

Joint marketing plans affect you. These are the franchisor's national or regional marketing plans. Since you are a franchisee under them, you get a marketing windfall from their advertisements.

Some franchisors allow the franchise small business to decide whether to take part in the marketing plan provisions, while others make it mandatory.

Supply Agreements

A perk of being a franchisee is getting discounted goods or services from the franchisor. This will be your inventory or discounted third-party programs they partner with if you provide services.

Access to this lowers inventory costs, creates an efficient supply chain, and allows franchisee consistency. This enhances customer satisfaction across the franchisees, which could entice a return customer to visit your store.

Disadvantages of Franchising

Being a franchise business owner is fantastic. But, there are cons to franchising. One is that it restricts your buying power and ability to make your franchise unique.

Brand Recognition

A downside to being in a more extensive franchise system is that if one franchisee creates negative publicity, it can affect your profits.

Franchise Operations Manuals

You can't change anything while you now have an SOP and process. That's even if that means your franchise is less efficient. Changing the process or procedure can open your location to lawsuits and liability.

Limit on Locations

Some franchisors prohibit the opening of new locations in the first few years. Others say you can't open a competing franchise within a set radius of a store. Some franchisors could allow another franchise location next door to yours. That would hurt your profit margins and could cause you to lose business. Review your franchise agreement to see what you have.

Many franchisors do not sell the land where the business sits to the franchisee. Instead, the franchisor owns the land and the building but charges the franchisee a fee to use it. This means you can't move locations or buildings without approval.

Marketing Plans

Your franchise agreement lays out the advertising fund you must pay into. This is not voluntary. Suppose the franchisor runs an advertising campaign in your area on local television. You may have to buy local advertising spots and honor the sale prices, even if you don't like the commercial and would lose profit. If your franchise struggles to profit, these extra expenses may strain an already struggling business's finances.

Ongoing Costs

Just because you signed a franchise agreement and paid the initial startup costs does not mean you stopped paying the franchise. You will have to pay ongoing fees to the franchisor:

• Advertising funds
• Ongoing fees
• Ongoing costs like mandatory purchases of new inventory, furniture, or remodeling costs when corporate requires it
• Royalty fees to use the trademarks, licenses, and manuals

You pay royalty fees monthly, quarterly, or yearly. They are usually a percentage of your revenue, a set flat fee, or a combination. If you miss a payment, you are in breach of contract. The franchisor could shut your operations down.

Supply Agreement

A consumer's most basic right in the marketplace is the ability to seek a different source for their products. In a franchise agreement, you can't do this. You must buy inventory or supplies from where the franchisor tells you and at their price.

Statutory Protections

It may seem that franchisors have more protections or advantages. Federal and state laws provide some protections for franchise relationships.

These laws typically protect issues that relate to franchise advantages and disadvantages, such as requiring:

• Good cause to deny transfer of a franchisee's rights to another business owner (selling the franchise)
• Franchise associations to form for franchisee protection
• Material breach of contract before parties can end the agreement
• Parties to send notices of default to the other party and allow them a set period to cure the defect
• Prohibiting discrimination
• Reasonable limits to out-of-state litigation

Your state's franchise laws can help you make the right decision.

Talk to a Franchise Attorney

Attorneys are usually associated with disputes, but they help avoid litigation. Local lawyers can help you make critical business decisions and understand the laws affecting your rights in a franchise agreement. Contact a local franchise attorney to discuss how they can help you maximize your franchise opportunity.