Legal due diligence by prospective franchisees

Before taking a Franchise you should always carry out due diligence in respect of all relevant matters.

These include:

1) Financial Due Diligence : Do a full credit check on the Franchisor. Check out its latest accounts. Make all appropriate enquiries as to the financial position of the Franchisor.

2) Market Due Diligence : Make sure that there is a real need for the product or service in your area and check out the competition.

3) Franchisee Due Diligence : Talk to as many existing franchisees as you can and glean from them as much information about the Franchisor and the Franchise as you can.

This article will concern a fourth area of due diligence: Legal Due Diligence. There is no substitute for having your Franchise Agreement checked out by an experienced, specialist franchising solicitor but here are some pointers for some basic clauses to look for and to consider. The list is not exhaustive.

1. Misrepresentation and Promises

Most Franchise Agreements will endeavour to exclude any representations, warranties or promises made to you during the course of the procedure which leads to you taking the Franchise. In this respect, it is not unusual to find a clause usually towards the end of the Agreement, often headed up “Entire Agreement”. The aim is to achieve certainty by providing that all of the agreed terms are set out in the Agreement. You should however make sure that they are. An important part of one such clause is as follows:

“The Franchisee acknowledges that he has not relied on any oral or written representations or statements about the System, the Franchisee's Business, the prospects for the same, turnover, profitability or any other matter unless such representations or statements are reduced to writing and annexed to this Agreement and signed by the parties and incorporated herein”.

So, make sure, if the Franchisor has told you something important on which you wish to rely and which is one of the main reasons you are taking the Franchise, that the relevant matter is written down, signed by both parties, is attached to the Agreement and is incorporated into the Agreement.

For example, “It is agreed that you have represented to me that all of your Franchisees are earning net profits before tax of at least £40,000 per annum. This is of fundamental importance in my decision to enter into this Agreement”.

Similarly, if the Franchisor has promised something which is important to you and which does not appear in the Agreement: write it down and have it incorporated into the Agreement.

2. Renewal

Make sure that you can maintain your investment, so ensure that:

(1) You will have a right of renewal at the end of your first term;

(2) No further initial fee or renewal fee is payable on renewal;

(3) The renewal term will be for at least the same period as the first term;

(4) (Since it is likely that you will be obliged to sign a Franchise Agreement in the then current form at the time of renewal) the management service fees and advertising levies (if any) will not increase on renewal (although the Franchisor may well resist this suggestion) and/or that the terms of the renewal agreement will be no more onerous than the terms of your first Franchise Agreement which is being renewed.

3. Sale of Your Business

Make sure, when the time comes to move on, that you can cash in on your investment, so ensure that:

(1) You can sell your business for its market value at any time before the Franchise Agreement expires (albeit the Franchisor will wish to agree to the identity of the purchaser and will probably have the first right to buy your Franchise);

(2) The transfer fees (if any) are not excessive.

4. Read the Agreement

Make sure that you read the Agreement thoroughly and make sure you understand it. Where you do not understand it, take specialist legal advice. You will usually be able to get a fixed price deal from a solicitor which is almost invariably good value for money. If you are going to spend a substantial sum on an Initial Fee and commit (usually) five years of your life to your Franchise, it does not make sense to ‘buy blind'.

Overall therefore the byword is the same in buying a franchise as it is in buying any business. Be careful and do your homework thoroughly.

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David Bigmore

© David Bigmore Limited

1 st July 2010