Hot Topic: Buying a franchise: Should you do it?

ON THE HOT SEAT:

Daniel Zalmanowitz, a partner with Witten LLP in Edmonton
and Colin Feasby, a partner with Osler Hoskin & Harcourt LLP in Calgary

You get your coffee at one, get your oil changed at another and dream sweet dreams in a third when you travel. They’re everywhere you look, more are springing up all the time and you’re starting to think owning one just might be the meal ticket you’ve been looking for – a license to print money, even. The groundwork’s been done for you, the business model’s been tested and there’s on-ground support and training. Hot damn, you think, you’re going to do it. You’re going to buy yourself a franchise.

Um … okay. But tread carefully. Franchising is a business relationship like no other, says Daniel Zalmanowitz, a partner with Witten LLP in Edmonton, and would-be franchisees don’t always know what they’re getting into. Zalmanowitz is perhaps the pre-eminent franchise lawyer in Alberta, and one of the few with national experience acting for both franchisors – they’re the big kahunas who got the idea, developed the business model, the processes, and the overall system (system is a big word in the franchising world) of the franchise – and franchisees, which will be you if you make good on your decision to buy a franchise.

Except – oh, yeah, let’s start here. You can’t actually buy a franchise. It’s essentially a licensing agreement between a franchisor and a franchisee. The franchisee gives the franchisor a wallop of cash up front, a payment known as the franchising fee. In return, the franchisee gets the right to use the trademark, brand and operating system and usually, but not always, some training and support.

Confused? The Canadian Franchise Association suggests that a potential franchisee think of it in these terms: “You are not buying the franchise. Instead, you are acquiring a licence to operate a franchise. You do not own the name, but instead have a licence to use the name. You do not own the business model, but instead have the rights to use the business model for a period of time. It is a little like being a tenant and renting. You do not own the space you are renting, but instead have the use of the space for a period of time.”

Are you okay with that? Let’s hope so, because there are more restrictions. You’re buying a business model, really, which means an awful lot of things will be pre-scripted and proscribed: what you sell, how much you charge for it, how you advertise it, who you buy it from and at what price. The trade-off is that you’re getting into something that is, if not exactly a sure thing – there is no such thing – then at least a proven thing.

“I think there are fewer risks with operating a franchise than with starting your own shop,” Zalmanowitz says. “What you are getting in most cases is a system. Somebody established a way of doing it, succeeded at it and is there to help you along. Your chances of succeeding in a franchise if you follow the system are much higher [than those for a standard independent startup].”

But there are still risks, and potential franchisees ignore them at their own peril. Colin Feasby, a litigator with Osler Hoskin & Harcourt LLP in Calgary, represents franchisors in legal tussles with their franchisees when the franchising relationship breaks down. And while franchisors and franchisees fight for a variety of reasons, Feasby believes one of the things that can get franchisees into trouble is not sufficiently appreciating these risks before signing on the dotted line. “Some people enter it with a little less caution because they assume the model is proven,” he says. “But it’s very much like entering any business relationship– you have to do your due diligence.”

That’s the bulk of Zalmanowitz’s work when he’s shepherding a franchisee through a franchise contract. When you express an interest in a system, the franchisor has to provide you with a disclosure document chock-full of critical information. But Zalmanowitz won’t let you sign anything until a) you’ve gotten one and b) he’s taken you through it and made sure you’ve understood it (and yes, he’s had clients ready to sign on without getting one or reading it).

In fact, he’d prefer you not even hire him – and thus waste your money on his fees – until you read through the document and do one important piece of homework. Ready? The disclosure document will include a list of existing franchises, closed franchises, and franchisees that have left the system, as well as their contact information. Zalmanowitz wants you to call a sample of them: a few who have opened recently and are still in the “honeymoon” phase, a couple who have been at it for years and know all the ins-and-outs of the relationship, and a few of the ones who left.

The new franchisees will tell you how much support – or censure – you can expect at the beginning. The veterans might tell you how much money they’re making (that data may not be in the disclosure document). And the ones who left will tell you about all the system flaws that aren’t in the disclosure document.

What? You don’t want to bother making all those phone calls, tracking down the telephone numbers of dissatisfied franchisees? You’d rather just give the franchisor a cheque for $1.5 million and call it a day? Well, it’s your money, dude. Your business. Your future. “Do your due diligence,” Feasby says. You wouldn’t buy the mom-and-pop shop next door without doing a bit of homework, would you? (You would? Well, have I got a deal for you …)

If you are among the first franchisees of a system, you can’t take this precautionary step, in which case it’s doubly important that you pay attention to the next one. Zalmanowitz is now going to take you through the disclosure document and the agreements that will govern your relationship with the franchisor. Listen carefully. And if there’s anything in there you don’t like, decide if you can live with it, or if it’s a deal breaker. Because the odds are that you won’t be able to negotiate it.

“My job is not to rewrite the franchise agreement, but to explain it,” Zalmanowitz says. He’s not being lazy – he’s experienced. “Franchisors, particularly those with mature systems, do not usually agree to changes in any of their agreements.” They’ve perfected (or so they think) the contract and the system. In the cases of particularly successful systems, they’ve got people lining up for the privilege of operating a franchise. You have no leverage.

“If it’s the case of a new system, there might be some room to get changes to the agreement,” says Zalmanowitz. If that’s the case, pay particular attention to the question of personal liability (try not to take on any), the length of the franchise contract (five years with a five-year option is the general default–is that good enough?), the franchise territory (can another franchisee open just up the street from you?) and how easy (or difficult) it is to transfer the franchise to someone else.

Make sure you understand the non-competition clause, which was the cause of a great deal of franchisor-franchisee litigation in the mid-2000 boom when, as Feasby puts it, “some franchisees decided that the times were so good they didn’t need the franchise brand to fill the beds or seats.” The details of each non-competition clause vary, of course, but what it comes down to is this: you can’t just take down the sign and start working for yourself at that location when your agreement runs out, and you can’t quit and go down the block to open up a similar thing, usually for a period of one to two years. (The agreement says five? This you don’t have to sweat: “The courts won’t enforce anything that’s too long or too broad,” Zalmanowitz says. But for those one or two years, you can’t compete with your former franchisor.)

So? Ready to get into a franchise? Scared? Don’t be. As Zalmanowitz stresses, there really is less risk with a franchise than with many another venture – if you do your homework. And although the business relationship between franchisor and franchisee is a complex one with lots of potential friction points, and the occasional class action suit against a franchisor grabs the headlines, “I don’t spend a lot of my time sueing franchisors,” says Zalmanowitz. Feasby concurs.

Lawsuits happen, but they don’t have to if you do your due diligence.