Purchasing a franchise is often considered to be less risky than purchasing a business that is not part of a franchise system.

This might be true, but no matter how profitable a business appears, there are many issues to consider prior to signing an agreement to buy a franchised business.

The franchise agreement is the most important document in the suite of documents a prospective franchisee will have to sign as it will govern the legal relationship between the franchisor and the prospective franchisee for the duration of the term of the franchise. The obligations of both the franchisee and the franchisor should be read carefully:

Below are six things franchisees should try and avoid in a franchise agreement. 

1. Term and renewal

Some franchise agreement offer an option to renew the agreement for a further term after the initial term of the franchise agreement ends others do not.

If an option to renew is not offered and the initial term is not very long the franchisee should consider requesting an option for a further term as this may make it easier for a franchisee to raise finance to fund the acquisition of the franchise and will give the franchisee a greater opportunity of recouping its investment. Without an option to renew the franchisee will be at the mercy of the franchisor at the end of the franchise agreement.

Even with an option to renew there is no guarantee of renewal. Renewal is usually subject to the franchisee complying with certain conditions, including payment of a renewal fee, refurbishment of premises and entering into the franchisor's 'then current' franchise agreement, which may be different from the franchise agreement originally signed. 

Franchisees should ensure the conditions of renewal are reasonable.

2. Territorial encroachment

Some franchise agreements are limited to a particular site, some grant a territory. A territory may be exclusive or non-exclusive. Where exclusive territories are granted they are usually quite narrow. Franchisees should consider requesting a larger territory.

If that cannot be negotiated with the franchisor, a franchisee may prefer a first right to be offered a franchise for a business that the franchisor proposes to establish in neighbouring areas. 

Even with exclusive territories there are usually exceptions e.g. the franchisor and other franchisees can sell products/or services online. Franchisees should endeavour to limit the exceptions in the franchise agreement or at the very least understand them.

3. Minimum performance criteria

Consequences of failure to meet minimum performance criteria typically include requirements to attend further training. Non-compliance may also have severe consequences such as the franchisor appointing other franchisees to the territory, the franchisee being forced to sell the business or agree to a termination of the franchise agreement.  

Franchisees should review the provisions dealing with the consequences of non-compliance and insist that the franchise agreement allows the franchisee ample opportunity to improve its performance.

4. Termination

It is imperative that franchisees understand the grounds upon which a franchise agreement can be terminated by a franchisor and ensure these grounds accord with the Franchising Code of Conduct. 

Generally speaking a franchisor can only terminate a franchisee in the following circumstances:

• if the franchisee breaches its franchise agreement and fails to remedy the breach within a reasonable time of the franchisor having advised the franchisee of the breach and what it is required to do to remedy the breach;
• for serious misconduct on the franchisee’s part, for instance if the franchisee is guilty of fraud or behave in manner that endangers public health or safety. 

Franchisees should look out for and avoid other clauses that allow the franchisor to terminate the franchise agreement early termination on notice.

5. Restraints

Most franchise agreements provide for a period after the end of the franchise agreement during which the franchisee is restrained from being in any way involved in a competing business within a specified area from the territory or premises.

The Code provides some protection in that it specifies some limited circumstances in which the restraints in a franchise agreement will not be enforceable. Franchisees need to be aware that in the absence of such circumstances, such restraints may be enforceable. 

Franchisees should therefore, consider negotiating releases from restraints in circumstances such as the franchisor becoming insolvent.

6. Unilateral changes

Franchise agreements often give the franchisor the ability to change the agreement unilaterally in ways that may not be obvious at first glance.

Look for the ability for the franchisor to change things such as menus, approved goods and services, standards, intellectual property and fees from time to time or in accordance with the operations manual.

These types of clauses enable the franchisor to itself make changes to the system and the franchisee’s franchise agreement which may ultimately mean the franchisee incurs cost, either directly such as in the case of an increase in fees, or indirectly, such as in the case of a requirement to refurbish/upgrade premises or replace signage. Changes, especially to fees, may also affect the profitability of the business and hence the ability to sell the business.

There are many things to consider before signing an agreement to purchase a business. In order to make an informed decision, it is critical to read all the documents and undertake extensive research, ask questions of the franchisor and other franchisees and seek the advice of an experienced franchising lawyer and accountant.