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Jun, 01 2007

CAUTION, THE WATCHWORD

WHEN prospective franchisees search for franchise opportunities, they have the advantage of accessing a wealth of valuable information.

WHEN prospective franchisees search for franchise opportunities, they have the advantage of accessing a wealth of valuable information. In the course of evaluating various franchise opportunities, individuals can learn a lot about the entire franchise process, particularly about 'franchise agreement'. Entire exploration of a franchise will include knowing what-to-ask, evaluation of the franchisor and interview of its existing franchisees. Franchising demands diligence and therefore, before signing any franchise agreement and paying the fee, interested parties should be through with the ins and outs of the deal. For reviewing franchise agreements, a prospective franchisee must have, at his disposition, a legal advisor or competent franchise consultant. If you want to enter into a deal, reviewing is a must: carry it out at the beginning of the franchise process or at the end. When a prospect franchisee considers a franchise agreement and its ramifications, it calls for many investment-permutations along with the territory and the earnings claims.

Investment

Generally speaking, the total amount required for starting a franchised business will include the initial investment, franchise fee, inventory, equipment purchases and working capital for at least three months' operation (amount varies from franchise to franchise). Moreover, you may need to maintain some extra balance in your account. To have sufficient working capital available when you start your business and to maintain it until your business generates profits is of prime importance and determines success. At the time of reviewing franchisor's investment costs, prospect franchisees should look out for the following checklist items: royalty payments, advertising payments (local and national advertising funds), grand opening or other initial business promotion, business or operating licences, product or service supply costs, real estate and leasehold improvements, discretionary equipment such as a computer system or furniture and fixtures, cost of training, legal fees, financial and accounting advice, insurance, compliance with local authorities and other safety codes, health insurance, employee salaries and benefits. Also, do consider personal living expenses for up to two years as your business may take several months or more to start giving returns.

Territory

A 'franchise agreement' outlines the rights that protect, within a prescribed geographical area, your business. In most cases, the franchisor is not permitted to sell other franchises within this territory. The idea is to restrict competitive activity. One of the key elements that you must examine is whether you (franchisee) will be able to operate the franchised business in the area specified. Will the area be just a shopping centre? Will it be a territory covering an area defined clearly in the franchise agreement? Will there be a non-exclusive territory or no territory at all? If there is no territory, how does the franchisor prevent a 'free for all' situation with numerous franchisees conducting their own separate business with no demarcation line?

The issue of territory is, therefore, very important and calls for careful consideration. Territorial issues constitute one of the main areas where disputes do arise. These disputes come mainly from franchisors due to two reasons. First, they allow new franchisees to operate franchises within a protected territory (at least for franchisee). Secondly, they exercise the same practice under the pretext that the existing franchisee is under-utilising the territory.

Concise territory

Although there are cases of inappropriate territories, a franchisor will, very often, divide up territories for allocation to new franchisee. These territories should be defined carefully. This type of clause gives certainty to a franchisee with the boundaries of the territory clearly defined.

Some franchisors, at times, make the mistake, in initial stage, of giving franchisees a territory too big. This may appear attractive to the buyer and therefore make a franchise easier to sell, but it can lead to problems in future. If a franchisee does not or cannot serve the full area, and therefore exploit it fully, there will be a gap in the market area, which will encourage the growth of competition.

A franchisor might recognise the problem of having granted a territory too big. If a map of boundary details is attached to the franchise agreement, the franchisor cannot alter, without the consent of the franchisee, the contractual arrangement. As you can imagine well, it is very often not an easy thing to accomplish.

Good faith

It is important that both the parties act in good faith towards each other. The subject matter of the territory demands always a crucial consideration and it is essential for a prospect franchisee not to enter into the franchise with wrong idea about territory and its boundaries. Should there be reasonable grounds, a franchisor may retain the right to put a second franchisee in the first franchisee's territory. In such cases, the franchisor may agree to share the initial franchise fee (of the second franchisee) with the first one on a 50/50 basis. Principle or principles behind the right of a franchisor to appoint an additional franchisee within the original franchisee's territory should be reasonably fair. The franchisee may also be a 'forward thinker' and anticipate the possibility of owning more than one franchise. If such is the case, it may be convenient, depending on circumstances, to have adjacent or neighbouring territories. The franchisor may, in this case, be amenable to the inclusion, in the franchise agreement, of an option in favour of the franchisee to take additional territories upon notice to the franchisee by the franchisor of its requirement for a new outlet to be opened in the adjacent territory. Failing exercise of that option within a specific period, the franchisor itself would then be able to open the outlet in that territory or offer the territory to a new franchisee.

No-territory franchises

Some franchise systems prescribe no territory whatsoever. In some cases, retail franchises are defined by location such as a specific shopping mall. Where no territory or no exclusive territory is granted, franchisees may be understandably concerned about the potential for 'saturation' of the area of a new franchisee's proposed operation - i.e. how far is the new franchisee going to travel to get business? This is especially relevant in the case of a new system where there are no actual figures to justify a viable business.

The logical reaction for a franchisee is to request a limit on the number of franchisees to operate in a wider area. Although, this can also be counter productive because it may stultify the establishment of the growing brand awareness among the public, it can work.

Your franchise agreement will designate the territory in which you will operate and whether you have exclusivity rights or not. The territorial description in this item can be complicated and often misunderstood. Read it carefully and be sure to go over with your legal advisor. Be sure to understand what rights you have both inside and outside of any designated territory.

Earning claims

Prospective franchisees want to know how much money they are likely to earn. They are very likely to rely upon the franchisor's earnings claims about returns of other franchisees in recent years. Claims are made by the franchisor regarding past performance of franchisees or potential financial performance of a franchisee. Statement of sales, profit or other financial information made by the franchisor regarding the operations of their franchisees and their locations should be cross-checked with the existing franchisees. Acting defensively, most franchisors do not provide earnings claims to prospect franchisees. Yet, a franchise salesperson tells the franchisee (usually verbally) about how much the franchisee can expect to earn based on the experience of other franchisees. In other words, an oral earnings claim is made. If a franchisor chooses to do so, the franchisee should ask the franchisor to give in writing. Because of this, only very few of franchisors include them.

Conclusion

What a franchisee always requires before entering into a franchise arrangement is certainty. There must be certainty as to the upfront franchise fee payable, certainty as to the ongoing service fees or royalties payable together with advertising levies, and most importantly, certainty in relation to territory. As your entire franchise investment begins and ends with the franchise agreement, it is the first and the last step. Before you start your journey as a franchise owner, you have to ascertain careful review, understanding and advice of qualified franchise lawyer or consultant.

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