Many franchise agreements include “deal-breaker” provisions such as insufficient start-up support, liquidated damages clauses, mandatory arbitration stipulations and more. Before signing a franchise agreement, entrepreneurs should carefully review the agreement and be wary of those that contain certain components.
A franchise is an independently owned and operated business that is part of a larger network of related businesses under the umbrella of a large parent company. The parent company creates a franchise to expand its reach while reducing the upfront costs of siting, establishing, and overseeing the new stores. Franchises provide many advantages for ambitious entrepreneurs to start a business. Small business owners buy into franchises because they typically include start-up assistance, they are automatically connected with a well-known name, and the parent company provides guidance on how to run a profitable franchise.
The Deal-Breakers of Franchise Agreements
Individuals should beware of franchise agreements that contain any of the following.
Insufficient Start-up Support
One reason people buy into a franchise is that they can tap into the resources of the parent company to establish themselves. Starting any business is difficult, expensive, and probably may include a few years of negative-profits. To get over the initial hump, parent franchises usually include start-up support like training, remodeling assistance, and reduced supply costs. Franchise agreements that do not include sufficient support should be entered into cautiously.
Liquidated Damages
Liquidated damages sometimes occur when a provision of a contract isn’t fulfilled. Liquidate damages clauses benefit franchisors to the detriment of franchisees. They tend to include provisions such as sales targets and profit goals. If a franchise operator doesn’t hit these targets, a liquidated damages clause could obligate the franchisee to pay money damages to the parent company. Buyback provisions that enable the parent company to repossess or repurchase the franchise may be a safer option.
Mandatory Arbitration
Arbitration is an out-of-court dispute resolution method. Similarly to a courtroom dispute, each side submits evidence and testimony, there is an arbiter, the parties can cross-examine witnesses, submit briefs, and present oral arguments. However, forced arbitration will typically benefit the franchisor and by agreeing to submit disputes to arbitration, the franchisee may be giving up legal protections.
Arbitration clauses in franchise agreements include provisions such as:
- The parent company selects the arbitrator;
- The parties share arbitration costs equally (which can run into the tens of thousands of dollars); and
- The franchisee surrenders the right of appeal.
