When starting a business, entrepreneurs typically have two options: they can either build a new business or purchase an existing business. Buying an existing business can offer the advantages of name recognition and a proven business model. The advantages can be even greater if the business is a franchise with hundreds or even thousands of locations. Purchasing an existing business, and one that is a franchise in particular, can come with some disadvantages, however. Read on to learn more about owning a franchise and whether it could be the right fit for you.
Reasons to Buy a Franchise
Going into business for yourself involves a lot of uncertainties. You must develop a business plan and then work hard to make the plan come to fruition.
Whether or not your plan succeeds depends on factors such as site selection, the ability to obtain financing, using marketing and advertising to build brand recognition, hiring and training employees, and taking advantage of economies of scale to lower costs as the business grows.
Franchises can be attractive because they offer a business blueprint that has been proven to work. That does not mean it will work in every situation. But franchises offer support with many of the business challenges listed above. By giving franchisees a ready-made business formula to follow, much of the guesswork—and risk—is removed from their business ownership.
Reasons Not to Buy a Franchise
The biggest downside to owning a franchise can be summarized in a single word: control.
Business owners give up significant control when they buy a franchise. The franchising agreement imposes terms that restrict a franchisee’s ability to make independent business decisions. Franchisors may retain the right to control where the business can operate, impose design or appearance standards that increase costs, and restrict the goods and services sold, methods of operation, and sales territory.
Franchising is a double-edged sword. A franchise’s proven track record and methods remove some of the unknowns from business ownership. But sticking to this tried-and-true formula has costs, not only in the form of franchise fees and royalties, but also in terms of limiting a franchisee’s creativity. Business owners who like to call all the shots may find the franchise structure frustrating.
Before You Buy: Franchise Legal Considerations
Standardization defines the franchise business model. The terms that franchisees are expected to follow are laid out in the franchise disclosure document (FDD), which is a document required by the Federal Trade Commission’s (FTC’s) Franchise Rule.[1] Before a franchisee signs a contract or pays a franchise fee, the franchise must furnish them with the FDD, which explains how their business model works.
The FDD contains twenty-three items, such as the franchisor’s background, fee structure, restrictions, advertising and training practices, and the processes for renewal, termination, transfer, and dispute resolution. The FDD can help a prospective buyer identify warning signs for franchise ownership and should be carefully reviewed with the help of an attorney.
- One of the most valuable resources can be found in FDD Item 20—contact information of current and former franchisees. Talking to people who have direct experience with the franchise under consideration can paint a more accurate picture of what is required to thrive under the franchise’s business model. The best information may come from franchisees who left the business; however, if they signed a confidentiality agreement, they will not be permitted to speak with new prospects.
- Another crucial issue is addressed in FDD Item 13, which discloses a franchise’s trademarks. Having a right to use the franchisor’s legally protected trademarks, such as a business name, logo, or marketing slogan, can be a key factor in a franchisee’s purchasing decision. Not having any registered trademarks can be a red flag. Also within Item 13, the franchisor must disclose whether it will provide legal protection to the franchisee in any legal disputes involving its trademarks.
The FDD is the foundation of any negotiations that take place between the franchisor and the franchisee. It provides the standard terms of the franchise agreement, but a potential franchisee may negotiate to obtain more favorable terms on territorial restrictions, development schedules, transfer rights, and other points.
In addition to the FDD and franchise agreement, franchise ownership usually entails a commercial lease for the business site. The franchisor could be the lessee and sublease to the franchisee, or the lessee could be the franchisee, under a separate franchise business entity. The terms of a commercial lease agreement should be closely scrutinized and carefully negotiated to reduce risks to the franchisee.
Due Diligence for Prospective Franchise Owners
Purchasing a franchise can be a safer bet than building a business from the ground up, but there is still plenty to think about before taking the franchising plunge.
Legal guidance during the due diligence process can help to uncover potential risks to the franchisee and clarify their obligations to the franchisor. Armed with this knowledge, a fair and mutually beneficial franchise agreement can be negotiated.
We work with buyers to review legal documents, including the FDD, franchise agreement, and commercial lease, to help them obtain the most beneficial terms. We can also help buyers choose and incorporate the legal entities needed to operate a franchise and other legal issues related to business ownership.
[1] Lesley Fair, Franchise Fundamentals: Taking a deep dive into the Franchise Disclosure Document, Fed. Trade Comm’n (May 24, 2023), https://www.ftc.gov/business-guidance/blog/2023/05/franchise-fundamentals-taking-deep-dive-franchise-disclosure-document.
