Buying a franchise is a significant investment. For many people, it’s one of the largest financial commitments they’ll ever make outside purchasing a home.
One of the comments I hear most often from prospective franchisees is:
“I’ve started reading the agreement, but it’s nearly 100 pages long and I have absolutely no idea what I’m looking for.”
That’s completely understandable.
Modern Franchise Agreements are lengthy documents, often accompanied by a Disclosure Document containing several hundred additional pages. Whilst every clause is important, experience has taught me that some provisions deserve closer attention than others.
After acting for both franchisors and franchisees for many years, I’ve developed a fairly consistent approach to reviewing franchise documentation.
Interestingly, I don’t usually begin on page one of the Franchise Agreement.
Instead, these are the first things I look at.
1. Item 6 of the Disclosure Document
The very first place I usually turn isn’t the Franchise Agreement at all.
It’s Item 6 of the Disclosure Document.
If you’re unfamiliar with franchise law, Item 6 sets out information about changes within the franchise network over the last three financial years. Whilst it’s only one section of the Disclosure Document, it can tell me an enormous amount about the health and stability of the network.
For example, I look at:
- how many franchisees have entered and left the system;
- how many agreements have been terminated;
- whether franchisees are regularly selling their businesses;
- whether the network is growing or shrinking; and
- whether there are any obvious trends that warrant further investigation.
There is no magic number that tells me a franchise system is “good” or “bad”. A mature network may naturally experience a number of transfers or retirements each year.
On the other hand, if a relatively small network has experienced a large number of terminations or departures over a short period, that’s something I’d almost certainly want to discuss further with my client before they commit.
It’s one of the reasons I always review the Disclosure Document together with the Franchise Agreement. Looking at one without the other only tells part of the story.
2. Capital Expenditure
One of the most expensive obligations in many Franchise Agreements is the requirement to spend more money after you’ve already opened.
These clauses often allow the franchisor to require franchisees to:
- refurbish the premises;
- purchase replacement equipment;
- upgrade point-of-sale systems or technology;
- implement new branding;
- install new signage; or
- otherwise invest additional capital throughout the term.
Sometimes those obligations are perfectly reasonable. Brands evolve, customer expectations change and businesses occasionally need updating.
The issue isn’t that capital expenditure exists—it’s whether the obligation is appropriately limited.
When reviewing these clauses, I’m looking at questions such as:
- Is there any cap on expenditure?
- How often can upgrades be required?
- Does the franchisor have complete discretion?
- Is the expenditure linked to maintaining brand standards?
- Is the franchisee given a reasonable period to comply?
These obligations can have a significant impact on the profitability of a business, so it’s important to understand exactly what you’re agreeing to.
3. Termination Rights, Penalties and Liquidated Damages
Nobody buys a franchise expecting the relationship to end badly.
Nevertheless, one of the first things I do is review exactly what happens if it does.
Most Franchise Agreements contain provisions allowing the franchisor to terminate in certain circumstances. Some are entirely reasonable—for example, where there has been fraud, abandonment of the business or serious criminal conduct. Others allow termination following a breach notice if the breach isn’t remedied.
What many prospective franchisees don’t appreciate, however, is that termination itself is often only the beginning.
Some agreements contain provisions requiring the franchisee to immediately pay:
- all outstanding fees;
- future royalties or licence fees;
- liquidated damages;
- contractual penalties;
- reimbursement of legal costs;
- marketing contributions; or
- other amounts triggered simply because the agreement has come to an end.
In some cases, these amounts can be very significant.
Whenever I review a Franchise Agreement, I don’t just ask “Can the franchisor terminate?”
I also ask:
- What financial consequences follow termination?
- Are those consequences proportionate?
- Are they likely to be enforceable?
- Do they fairly reflect the parties’ commercial bargain?
Understanding what happens if things go wrong is every bit as important as understanding how the relationship starts.
4. Territory
Many prospective franchisees assume they’re buying an exclusive territory.
Sometimes they are.
Sometimes they’re not.
One of the first questions I ask is exactly what protection the franchisee is receiving.
For example:
- Can another franchisee operate nearby?
- Can the franchisor establish company-owned outlets?
- Are online sales excluded?
- Can products be sold through supermarkets or third-party retailers?
- Does the territory change over time?
Territory provisions often have a direct impact on the future value of the business.
5. Marketing Fund
Marketing contributions are another area that deserves careful attention.
It’s not simply a question of how much you’ll pay.
I also want to understand:
- how the fund may be spent;
- whether local area marketing is required in addition;
- whether contributions can increase;
- what reporting obligations apply; and
- whether the franchisor has broad discretion regarding expenditure.
Marketing is one of the key benefits of joining a franchise network, so it’s important to understand exactly how the system operates.
6. Personal Guarantees and Indemnities
Many people focus on the company purchasing the franchise.
I focus on the people standing behind it.
Most franchisors require directors (and sometimes shareholders) to personally guarantee the performance of the Franchise Agreement.
That means your personal assets may become exposed if the company defaults.
I also pay close attention to indemnity clauses.
Indemnities often extend much further than many people realise and, depending on how they’re drafted, can require a franchisee to compensate the franchisor for a wide range of losses, claims and liabilities.
Some indemnities are entirely appropriate—for example, where loss has arisen because of the franchisee’s own conduct.
Others are drafted so broadly that they can operate quite harshly in practice.
Understanding exactly what you’re agreeing to, and whether the allocation of risk is commercially reasonable, is an important part of any Franchise Agreement review.
7. Transfer Rights
Most people focus on buying a franchise.
I spend just as much time thinking about how they’ll eventually sell it.
After all, your franchise is often one of your most valuable assets.
Questions I ask include:
- Can the franchisor refuse to approve a buyer?
- On what grounds?
- Are there transfer fees?
- Must the purchaser undertake training?
- Does the franchisor have a first right to purchase the business?
The easier it is to transfer the business in the future, the more valuable that business often becomes.
8. Restraints and Other Restrictions
Most people think restraint clauses only apply after they’ve sold the business.
In reality, many Franchise Agreements impose significant restrictions throughout the entire term of the agreement as well.
For example, some agreements prohibit franchisees from:
- owning another business;
- having an interest in a competing business;
- being involved with another franchise network;
- investing in competing businesses; or
- undertaking certain activities without the franchisor’s consent.
Those restrictions may be entirely reasonable depending on the circumstances, but they should always be understood before signing.
I also carefully review the post-termination restraint clauses.
These often restrict where you can work, how long the restraint lasts and what type of business you can become involved with after leaving the network.
Some agreements even attempt to extend these obligations to spouses, family members or related entities. Whether those provisions are ultimately enforceable will depend on the circumstances and applicable law, but whenever I see unusually broad restraints, they’re something I discuss with my client.
9. Ongoing Fees
Most buyers know about the initial franchise fee.
Far fewer appreciate the number of ongoing payments that may arise over the life of the business.
When reviewing a Franchise Agreement, I identify every payment obligation, including:
- royalties;
- marketing contributions;
- technology fees;
- administration fees;
- software subscriptions;
- training costs;
- audit fees; and
- any other charges that may arise during the term.
Understanding the true cost of operating the business is critical before making an investment decision.
10. What Happens at the End?
Finally, I always review what happens when the agreement comes to an end.
Questions I commonly ask include:
- Is there a right to renew?
- If so, on what conditions?
- Must the premises be refurbished?
- What happens to stock and equipment? Are any option to purchase clauses market standard?
- Can the franchisor refuse renewal?
- What obligations continue after the agreement has ended?
It’s easy to overlook these clauses because they may not become relevant for five or ten years.
However, understanding your exit options at the beginning often prevents unpleasant surprises at the end.
Final Thoughts
One of the biggest misconceptions I encounter is that a Franchise Agreement is either “good” or “bad”.
In reality, most agreements sit somewhere in the middle.
Many provisions are entirely market standard.
Some are more favourable to the franchisor than others.
Occasionally, I come across clauses that I believe warrant further discussion or negotiation.
The important thing isn’t necessarily changing every clause. It’s understanding what you’re signing, what risks you’re accepting and whether those risks are appropriate given the opportunity you’re buying.
At Magnolia Legal, every franchise review includes a comprehensive review of both the Franchise Agreement and the Disclosure Document, practical written advice in plain English, responses to your specific questions, and recommendations as to what (if anything) we believe should be negotiated before you sign.