When you are buying a franchise, it can feel like the stack of paperwork is never-ending. Not only do you need to work through the logistics of securing a location, but there are forms from the franchise headquarters that need to be finalized before you can get started. In this franchise legal documents guide, we are taking a closer look at the most important paperwork that you will be signing and what to watch out for as a buyer.
Why It’s Worth Hiring a Lawyer for Assistance
Even if you think that you have everything under control, it’s worth the investment to bring in an experienced franchise lawyer to review the documents. Keep in mind that the documents you receive are drafted by the franchisor’s attorneys with the goal of protecting the franchisor. Just because all franchisees are signing the same agreement doesn’t necessarily mean that there is no room for negotiation to protect your personal interests.
Make sure that your lawyer understands both federal rules and local knowledge. The reality is that both contract terms and enforcement can vary from state to state, which is why it makes sense to choose a legal team that has experience with your physical location.
Document 1: Franchise Disclosure Document Explained
One of the first documents you are going to see is known as the franchise disclosure document (FDD). There are 23 sections that are required, covering everything from fees to startup costs, litigation history, financial statements, and more.
The requirement is that you must receive the FDD at least 14 days before you sign or pay for anything. As soon as you receive the document, maximize this window of time to ensure that you understand every detail of the document you are signing.
A few areas to pay close attention to are the litigation and earnings claims sections. Also, keep in mind that item #19 is about financial performance, and this section is optional for franchisors. If this section is missing, then it’s worth reaching out to other franchisees to learn more about their actual profit margins.
Document 2: The Franchise Agreement
Your franchise agreement review lawyer will help you evaluate important details in this agreement:
- Term length
- Renewal rights
- Grounds for termination
These details are important because sometimes there are agreements that allow the franchisor to end the deal based on minor violations. It’s critical that you understand what you are agreeing to so that you don’t end up in a situation where the franchise is pulled out from under you unexpectedly.
Also, make sure that you are clear about what will need to be paid for royalties, marketing funds, and technology fees. These costs will be obligatory for the length of the agreement and should be accounted for in your budget planning.
Finally, make sure that you understand the exclusive territory guidelines. Sometimes, this only blocks a new location for the brand, but channels are still open for online sales or other methods.
Document 3: Franchise Personal Guarantee
One thing that can be risky about franchising is when you are required to put a personal guarantee on the deal. In this situation, it means that you (not just your LLC) are responsible for the costs if the business fails. It’s common for franchisors to ask for a personal guarantee since new businesses have few assets to seize if the business goes under.
Is a franchise personal guarantee negotiable? Yes, there is often room for negotiation here. Talk to your franchise attorney for custom recommendations. Negotiations might include things such as capping the guarantee, limiting it to a period of time, or releasing the guarantee when specific milestones are met within the business.
Note: Pay attention to see if there is a second guarantee on the lease. In this situation, your exposure might be doubled.
Document 4: Non-Compete and Confidentiality Terms
Most franchise legal documents will include a section that stops you from running a competing business while you are a franchise owner. Additionally, there might be post-term restrictions that must be followed if you choose to leave the franchise.
Here in the state of Texas, these non-competes are enforced in contracts that are reasonable regarding the timeline, area, and scope. So, make sure that you understand both the radius of the non-compete area and how long you will be restricted from any competitor activity.
Document 5: The Commercial Lease
This document relates specifically to your site and building. Often, franchisors require that the site be approved, and there is often specific lease language that needs to be included in the paperwork. For example, you will likely have a section that gives the franchisor the right to take over the space if you default.
The best strategy is to work with your franchise attorney to review both the lease and franchise agreement at the same time. Make sure that the document details all line up to reduce the risk of avoidable complications, such as having a lease that runs shorter than your franchise term (which could potentially leave you without a location).
What to Know Before Signing a Franchise Agreement
Our legal team recommends that every franchisee follow these best practices before signing a franchise agreement:
- Never sign the paperwork before the 14-day period ends. Maximize this time for your due diligence.
- Don’t rely on the sales rep for legal advice, because they don’t necessarily have your best interests in mind.
- Talk to current and former franchisees for tips and to learn about their experiences.
- Always consult with an experienced franchise attorney for document review.
- Get legal advice about how to structure the entity, such as whether you should set up an LLC or a series LLC (for a multi-unit plan).
Keep in mind that there is often room for negotiation. Not every franchisee signs the same agreement, especially since the terms can vary depending on the location and the year that the agreement was signed.
FAQs
How long do I have to review an FDD before signing?
It’s required that you receive the FDD at least 14 days before you sign or pay money for the franchise. This timeline gives you the opportunity to do your due diligence before moving forward.
Do I need to hire a lawyer if I’m going to buy a franchise?
Even though you aren’t legally required to hire a lawyer, it’s smart to have legal representation since these documents can be complex.
Talk to a Franchise Attorney for Personalized Recommendations
If you are preparing to buy a franchise, then our team at Bhojani Law is here to help. Reach out for a consultation to learn about the best way to move forward.