I was recently talking with a new business owner who was getting close to signing a franchise agreement and becoming an entrepreneur. She was just in the starting phases but had been in discussions with the franchisor for months. As we talked, I asked about her advisory team — who she was working with on tax/accounting, legal, HR, and insurance. She was confident that the franchisor provided her with this support so, other than insurance, these were areas that she’d included in franchise fees and didn’t leave additional budget for when planning. The conversation highlighted a number of misconceptions franchisees have about what the franchisor does on the legal front, so I wanted to provide clarification in terms of the responsibilities of the franchisee and which elements are often missed when reviewing a franchise contract.
Understanding Your Franchise Agreement
Yes, the franchisor provides franchisees with a Franchise Agreement that, for the most part, is non-negotiable. Franchises are regulated at the federal and individual state level, so it’s tough for franchisors to customize every franchise relationship it has. Therefore, many franchisees figure that it’s not worth the money to have it reviewed by counsel. That’s a misconception – even if you know with 99% certainty that you will sign the franchise agreement, it’s essential that you understand what you’re agreeing to in advance. Most franchise agreements have restrictions on transfer, certain financial and operational standards and thresholds you must maintain, limitations on use of the business name, and situations where the franchise can be terminated or revoked. Without this knowledge, you significantly increase your chances of breaching the agreement and losing your investment.
Minimizing Risk Factors in The Lease
Many franchisors help their franchisees by providing them access to a commercial real estate broker to help them find a space for the premises. The broker is an excellent resource for market knowledge and often understands what the franchisor’s requirements are for the space. The broker, however, is not an attorney. He or she is an excellent resource to help you evaluate whether the terms are typical for the area or the use required. Your lawyer, on the other hand, can help you to evaluate and mitigate the risk of the lease. For many businesses, the lease is one of the highest cost items each month and it’s a fixed cost that can’t be reduced or eliminated. Personal guarantees by the business owner are also commonplace, meaning that if the business cannot pay, the owner is personally responsible. We’ve run into many business owners who didn’t realize they were signing a personal guarantee or didn’t understand how a landlord could pull the rug out from under them because they decided to redevelop the space. Good counsel not only helps you understand what you’re signing but also how to negotiate on the items that are the highest risk.
Your Franchise’s Employment Practices
The franchisor likely provides you with an excellent policy, training, and operations manual; but because every state has different requirements for hiring, managing, and terminating employees, franchisors will not provide you with legal advice regarding employment matters. Washington is a particularly complex jurisdiction for employers — across cities, we have different minimum wages, leave and PTO requirements and other employment rules not only at the state level but also at the city level — and every year, something new comes into play. We’ve run into so many employers wanting to do the right thing for their employees and ultimately getting in trouble for violating the law. What’s logical is not always what’s legal and this is particularly true in employment law matters.
Franchise Entity Structure
The type of business structure and documents required may be mandated by the franchisor. However, once the company is set up, you’re required to govern it correctly. Knowing what is required of owners of an LLC or a corporation is important and keeping these requirements front of mind when thousands of other things are more pressing is difficult. In addition, setting up the proper licensing and tax reporting for your business is essential and it’s not always easy to find what you need to know from the Secretary of State, Department of Licensing, Department of Labor and Industries, Department of Revenue and the city departments with whom you may need to register. It’s unlikely that your franchisor will provide guidance on this considering that, again, every state has different requirements.
Accounting and Tax
The franchisor may provide you with a coach or IT systems you need to use for tracking sales and financial information and maybe refer you to a bookkeeper or CPA. They typically do not support you in managing your business financials and reporting your taxes. We frequently find business owners that have done little planning around the company and personal tax implications of owning a business. Just because Washington doesn’t have an income tax, doesn’t mean that your business doesn’t need to register and pay. The entity you choose drives your tax status and having proper planning in place will help you avoid penalties and legal trouble.
Successfully Setting Up Your Franchise
It’s important to be aware that as a business owner – franchisee or not –you are in the driver’s seat and are the responsible person for compliance and risk in your business. Your franchisor will not take on this responsibility or be there to bail you out in difficult times. Build your advisory team early and leverage them to help you to start off smart!
If you are opening a franchise, Equinox offers Franchise Startup services to give your team the legal support of in-house counsel without the in-house expense. Our Franchise Startup services includes the following:
- Review of the franchise agreement
- Business formation
- State and city business licensing
- Corporate ownership documents
- Employment manual
- Employment agreements
- Lease review
- Unlimited communications with management team
If you are interested in our Franchise Startup services, please contact us.