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Spotting red flags in a franchise agreement

by | Jun 16, 2023 | Business Transactions

Entering into a franchise agreement can be a pathway to business ownership that offers the benefits of a recognizable brand and an established operational blueprint. However, these agreements can be complex, and potential franchisees must be vigilant in scrutinizing the contract details. Understanding what constitutes a red flag in these agreements can prevent future hardships and potential legal disputes.

Just like any business venture, entering a franchise agreement requires careful consideration and due diligence. Some clauses or terms may seem beneficial at first glance, but may have potential pitfalls that could cause problems down the road. Here are some red flags to look out for when reviewing a franchise agreement.

Unfavorable termination clauses

Termination clauses stipulate the conditions under which the franchisor can end the agreement. It is crucial to look out for terms that give the franchisor broad powers to terminate the agreement. This could leave franchisees vulnerable and without recourse if the franchisor decides to end the relationship.

High fees

Franchise agreements will specify the fees that franchisees must pay. These could include initial franchise fees, ongoing royalties and marketing fees. If these fees are too high, it could significantly affect the profitability of the franchise.

Lack of territory protection

Without territory protection, the franchisor could open another location close to your franchise, potentially cannibalizing your customer base. Make sure the agreement clearly defines your territory and protects it from encroachment by the franchisor.

Unspecified training and support

A strong franchise system will offer comprehensive training and ongoing support to franchisees. If the franchise agreement is vague about the training and support you will receive, this is a warning sign.

Inability to sell the franchise

Some franchise agreements can restrict your ability to sell the franchise to a third party. This could limit your exit options if you decide you want to move on from the business.

Opaque financial performance

Franchisors must provide a document called a Franchise Disclosure Document, which gives potential franchisees insight into the financial performance of the franchise. If this document is vague or does not provide a clear picture of the financial health of the franchise, this is a red flag.

Remember to read the agreement thoroughly to ensure the franchise opportunity aligns with your business goals and financial capacity.