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Advice & Tips July/August 2020 Resource Articles

Franchise Due Diligence: Legal Aspects to Consider Before You Get Started

Franchising is often referred to as a mutually rewarding relationship between franchisors and their franchisees. While this is true, the franchise business model is also built on contracts and other documentation, which makes the relationship that much more complex. Luckily, there’s help for prospective franchisees in wading through the paperwork and fully understanding the rights and obligations of the franchise relationship that are outlined within.

Franchise legal counsel

Franchise lawyers are well versed in the ins and outs of the franchise business model. It’s vital for you to fully understand all documentation involved in your franchise investment, particularly the disclosure document (a comprehensive summary of pertinent information about the franchise system, its officers, finances, etc.) and the franchise agreement. As a potential franchisee about to invest your time, effort, and money, you should have a complete understanding of the relationship you’re about to enter. This is where an experienced franchise lawyer comes in.

Though there are common features found in franchise agreements, they can vary from franchise system to franchise system, and from franchisee to franchisee. Some provinces – British Columbia, Alberta, Manitoba, Ontario, New Brunswick, and Prince Edward Island – have franchise legislation that prescribes the information that franchisees must receive before signing the franchise agreement. This is just one of the reasons why retaining a lawyer who has experience with the franchise business model is a wise choice.

So, where can you find a franchise lawyer? Prospective franchisees can find a lot of the information they need online, through sites like the Canadian Franchise Association (CFA) directory of franchise support services members (www.cfa.ca/listings). You can also turn to page XX of this issue, where you’ll find the Franchise Lawyers Across Canada feature, including details about all CFA member lawyers. Although these are great tools for initial inquiries, prospective franchisees should speak and meet with lawyers before retaining one.

When selecting a lawyer, there are a few things you should consider. Look at the lawyer’s experience – have they dealt with the franchise you’re interested in before? How often have they acted for franchisors and franchisees?

A large part of researching the franchise system involves reviewing its disclosure document and agreements. When meeting with a franchise lawyer, you’re advised to bring in everything you’re being asked to sign, from the franchise agreement itself to any leases or other contracts. These are usually standard documents, but each should still be reviewed. It’s also important for some documents, such as the franchise agreement and real estate lease, to be examined together.

The lawyer is looking for two main things: franchise obligations and potential risk. If, upon review, everything is in order, you can sign on the dotted line and move forward with establishing your franchise location. But it doesn’t necessarily signal the end for the relationship with the franchise lawyer, as once a good working relationship is established, many clients will return with other legal work down the road.

Having an experienced franchise lawyer on your team is an asset both during and after your franchise investigations.

Franchise disclosure document

As part of a proper due diligence process, prospective franchisees should collect pertinent information about franchising and franchise systems. You should also be evaluating this information against your goals, attributes, capabilities, and assets. During due diligence, some of this information (financial capacity, skills, passions) will come from you, while other details will come from the franchise system. An important piece of this investigation puzzle is the franchise disclosure document. Here’s how you can put these valuable resources to best use and collect as much information as possible.

What is a franchise disclosure document?

A franchise disclosure document is a written resource designed to provide franchisees with vital information that they need to make an informed decision about investing in a franchise opportunity.

A typical franchise disclosure document may include:

  • Background on the franchisor and the key players within the system, such as its directors and officers
  • Any history of litigation, civil action, convictions, bankruptcies, etc. of the franchisor and/or its directors and officers
  • A summary of the trademarks and other intellectual property
  • A summary of the costs and fees required to start and run the franchise business
  • An outline of the training and ongoing assistance provided by the franchisor
  • A list of current and former franchisees and their contact information
  • Financial statements and other fiscal information

The disclosure document must meet requirements set out in any provincial franchise legislation. Prospective franchisees are given a minimum of 14 days to review the document before signing on with the franchise.

Will a franchise disclosure document specify how much money a franchisee can make?

Franchisors can, but aren’t required to, provide information on projected earnings. As a variety of factors can play into the success of a franchise location, it can sometimes be difficult – and risky – for franchisors to provide earnings claims that apply widely.

The financial information that franchisors will include in the disclosure document is likely the franchisor’s overall fiscal performance during the most recent year (which will show the assets, liabilities, and earnings of the franchisor itself). It might also include the historical actual gross sales of anonymous individual locations.

Franchisees are advised to review all financial statements with an accountant, who can explain the numbers and extrapolate the financial viability of the franchise system.  They can also help you put together a solid business plan (more information about business plans can be found on page XX of The Franchise Guide).

No matter how the financial information is presented, you need to be able to substantiate and justify the information.

Another way to find out about earnings potential is to speak with existing franchisees in the system.

When will a prospective franchisee receive a franchise disclosure document?

When a prospective franchisee will receive the disclosure document can vary from system to system.

Just as you’ll be evaluating the franchise opportunity, the franchisor will also be assessing whether you’ll be a good fit for the system. The franchise disclosure document usually comes into play when a prospective franchisee is considered a serious candidate.

What should a prospective franchisee do with a franchise disclosure document?

When a disclosure document is provided, a prospective franchisee has a minimum of two weeks to review the materials. You shouldn’t sign any contracts or agreements until this period has passed.

The first step is to gain a full understanding of the information it contains, with help from an experienced franchise lawyer. A franchise lawyer will be able to “translate” all the essential rights, responsibilities, and obligations that the documents outline for both sides of the franchise relationship.

The lawyer will also point out anything different or unusual about the information or what the franchisor requires. They can also often identify anything that may be negotiated with the franchisor (and lead these negotiations when the time comes).

In addition to speaking with a franchise lawyer, you should consult with other professionals during this time, like an accountant and banker, who may also want to review the disclosure document.

You’ll also want to put that list of franchisees the disclosure document provides to good use by contacting current and former franchisees for their firsthand knowledge. You should speak with eight to 10 franchisees, with varied performance levels.

Franchise disclosure documents play an important role in a franchisee’s due diligence. By consulting with franchise professionals, a disclosure document can help you make your investment decision with a better understanding of the franchise opportunity, as well as the rights, responsibilities, and obligations you’ll be undertaking as a franchisee.

Franchise legislation

In certain provinces, there’s a legal framework that sets out how the relationship between franchisees and franchisors. The legislation intends to help ensure that prospective franchisees are making an informed investment decision; once they’ve joined a franchise system, the legislation encourages franchisees and franchisors to deal with one another in good faith. Franchise law helps ensure franchisees receive certain information to make an educated decision about investing in a franchise business.

At the time of writing, franchise legislation exists in British Columbia, Alberta, Manitoba, Ontario, New Brunswick, and Prince Edward Island. In provinces without specific franchise legislation, the franchise business relationship is usually governed by common and/or general business laws.

For prospective franchisees, certain components of the franchise legislation will have a big impact right away. Franchise legislation helps potential franchisees make more informed decisions by requiring franchisors to provide serious franchisee candidates with disclosure documents. Franchise legislation usually outlines what information needs to be included in disclosure documents and how they may be delivered to prospective franchisees.

Under legislation, franchisees are prescribed a certain amount of time to review the disclosure document, usually two weeks, and consult franchise professionals, such as a lawyer, accountant, and banker, to go over the documents in detail. See section XX for more details about what should be included in a disclosure document.

Legal experts encourage prospective franchisees across Canada to request a disclosure document, as franchisors should be willing to share the information with serious prospects.

Franchise legislation also provides for rights for established franchisees, such as the right to associate and share information with fellow franchisees.

 

 

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