Franchises drive a significant segment of the modern business world, generating more than 40 percent of retail sales (or nearly $1 trillion) in the U.S alone. The right franchise opportunity can provide an ideal entry into business ownership by giving you all the ready-made tools and processes necessary for success. The right franchise can also generate a handsome retirement nest egg or provide a second revenue stream. However, just like any other business or investment, the wrong franchise can generate losses and frustrations instead of success. Before you sign a franchise agreement, you must understand the various kinds of franchise situations you might be getting yourself into, as well as the value of consulting with an experienced attorney on a prospective opportunity’s pros and cons.
The 3 Types of Franchises
Franchises can vary widely in their structure, protocols, track records, and levels of franchisee support. They tend to fall into one of the following three categories:
- “Old Reliable” – Think McDonalds or other similar franchises that have been in existence for decades. These are the franchises that have been around seemingly forever and have grown into universal household names. They could only attain this level of achievement through strong, tight organization based on a longstanding, proven plan. This type of franchise will feature a large support network that gives its franchisees high odds of success providing that those franchisees work the plan correctly. The costs of starting and operating this type of franchise will be well known. Ideally, you will encounter no surprises when you investigate this opportunity.
- “The Question Mark” – Many newer, younger, smaller franchises fall into this category. They aren’t necessarily poorly designed and structured, nor do they make success for their franchisees impossible. Instead, they may simply have yet to prove themselves. However, they may also hold hidden pitfalls such as structural flaws, lower brand visibility, unknown costs, or patchy franchisee support. To make such an investment pay off, you may need to put in a lot more “sweat equity,” with a successful outcome highly dependent on your own personal energy, organization, drive, and commitment.
- “The Money Pit” – This type of franchise will never turn a profit for you. In fact, the reverse may well be true, with the franchisor simply trying to turn a quick buck by selling as many “opportunities” as possible and then getting out before the whole business plan and structure collapses like a house of cards. These franchises typically provide no support and no reliable structure or plan whatsoever. They may even drain your profit potential further by cheating you through unfair or imbalanced royalty calculations and unknown expenses. Avoid these franchise money pits at all costs.
Red Flags for Prospective Franchisees
Certain trouble signs may leap out at you as you research your prospective franchise investment. One obvious example involves lack of communication. Perhaps a franchisor dodges your questions or refuses to return your calls. Worse, the franchisor may not give you the Franchise Disclosure Document (FDD) required by the Federal Trade Commission. Since this document includes all the key terms and particulars of your agreement, a failure or delay in providing this information to you should trigger a serious alarm.
Other warning signals include current franchisees who refuse to comment on their investment or have only negative things to say about it. The franchiser’s interaction with you may offer further clues that something is amiss. For instance, watch out for a franchisor who seems overly eager to push you into investing, or who sells multiple franchises that take forever to open.
How A Business Attorney Can Help
Even when a franchise appears to fall into the “Old Reliable” category, you should still perform as much due diligence as possible. The franchise agreement itself can take the form of an enormous, complex, hard-to-follow document. Before you sign or agree to anything, you must retain a business attorney who can review the agreement in detail and determine whether you’re looking at a strong, smart investment or an outright disaster in the making. Keep in mind that you might have to submit a hefty sum of money up front, along with a personal guarantee, meaning that an unfortunate outcome could lead, not just to a failed investment, but to personal bankruptcy. The stakes are high, so arm yourself with the legal expertise you need to play a winning hand.
© 2022 Matthew W. Harrison and Harrison Law, PLLC All Rights Reserved
This website and article have been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal or financial advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.
