Franchise agreement: what pitfalls to avoid?
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Jul 8, 2024
Despite its many advantages, signing a franchise contract still represents a risk. While certain indicators, and even some clauses, allow for anticipating this probability, it nonetheless remains that some candidates, blinded by their enthusiasm, can be deceived during the signing of the contract. In any case, this lack of attention can have dramatic effects. Most disputes can be avoided by considering the points we will explain to you in this article.
The validation of the concept
Before signing your franchise contract, be particularly vigilant about the DIP because it is true that certain elements must be taken into account before wanting to embark!
To begin with, what is the DIP? We addressed it in one of our previous articles what is a franchise contract. As a reminder, the DIP (pre-contractual information document) is a document that the franchisor is obligated to provide you at least 21 days before the signature of the franchisee. This document contains all the necessary information for the franchisee to commit with full knowledge of the facts.
When reading your franchise contract, certain information needs to be monitored, so you must ask the right questions!
Some franchise contracts may have been concluded in the past when they had neither a pilot unit nor know-how, which is essential!
Engaging with a franchise that has not previously tested its know-how means, first, taking the risk of having no support from the franchisor, or worse, that your franchise may not survive.
A more reliable franchise contract means a network that has managed to develop over a more or less long period of time while maintaining a sufficient timeframe. The number and stability of franchisees can also be more reassuring: Very often, well-known brands with more franchisees are reliable chains. Nevertheless, a network that develops too quickly is not always a good sign because some franchises want to expand their network as quickly as possible, even at the expense of not respecting all the commitments in the franchise contract.
Concerning lesser-known or high-risk brands, do not hesitate to consult the representative figures of the network's evolution.
The choice of the franchisor
Franchisors as well as franchisees must comply with certain obligations. The franchisor has primarily an obligation of information but also an obligation of details towards their franchisee.
This information includes:
The evolution of the legal situation
The list of franchisees (location, creation date, contract renewal, etc.)
The duration of the contract
The annual accounts for previous years
The financial obligations as well as the amount of necessary investments
The general state of the market and the prospects for evolution
Furthermore, franchisors have every interest in being benevolent and transparent during the drafting of the pre-contractual information document (DIP). Therefore, you should be wary if they remain vague regarding the previously mentioned elements.
It is true that the franchise contract often implies a certain number of constraints for the franchisee. As long as these constraints are not related to objectives, they tend to upset the contract and give precedence to the franchisor.
The repercussions can be severe: ineligibility for aid for job seekers who create or take over a business, non-recognition of the clientele's ownership.
The contract is unclear
Some contracts lack precision in their clauses. This practice can be risky for both parties and may lead to conflicts between the franchisor and the franchisee.
The contract duration is too short
The duration of the franchise contract must allow the franchisee to recoup their investment and at least cover the expenses they may have incurred. On average, a franchise contract is for 5 years, but this will depend on several criteria, particularly the initial investment. Thus, a franchise contract with too short a duration can lead to financial difficulties for the franchisee. Similarly, the non-competition clause must be taken into account since the law sets the maximum duration at 5 years.
The elements related to the financial aspect
Generally, the amount of the franchisee's personal contribution must represent at least 30% of the total project cost. The total cost of investments includes all specific costs related to the brand, namely: entry fees, royalties, real estate, etc., but also those that are not connected to the franchise and for which the franchisor does not provide information (lease rights, security deposit for the commercial lease...). Before becoming a franchisee.
But beware, the franchisor may also demand investments from the franchisee during the contract, for instance, to update the network with new standards, new equipment, etc. Consequently, the contract clauses must take into account the terms of these new investments. The concept of investment is very important when wanting to be a franchisee. Some franchises can be particularly expensive due to the entry fee and their high royalties. Therefore, it is your responsibility to ensure that all these charges do not overly impact the profitability of your business.
The important clauses of the franchise contract
In the franchise contract, a great deal is said about the clauses: The clause for the use of distinctive signs, the exclusivity clause, the assistance clause, but there are other clauses that can be considered risky if not examined carefully.
Deferred entry fees
This type of clause, rarely addressed in the contract, allows the franchisee to pay the entry fees at the end of the contract. However, it carries a risk for the franchisee. They may simply be unable to pay the amount at the end of the contract.
It is therefore advisable not to adopt such clauses. Prefer the time limitation of the staggered payments of your entry fees when this method is applied.
Non-competition clauses
The non-competition clause serves to protect the know-how transferred by the franchisor to their franchisee. It is important to emphasize that this clause does not intend to constrain the franchisee and their partners in their initiative.
Conversely, the law has determined that it is preferable to limit non-competition clauses to the sole protection of the know-how, thus allowing the franchisee the possibility to consider developing their own activity afterward, provided that it is not similar or competitive.
Non-competition clauses post-contract can also have perverse effects. Although limited in time, they sometimes lead to depriving the former franchisee of all possibilities of engaging in a commercial activity.
Linked contracts (commercial lease and franchise)
This type of contract generally concerns franchisees located in shopping center galleries. It may happen that landlords have certain requirements incompatible with the franchisee's situation: as is the case with the signage clause that prohibits the franchisee from changing signs during the term of their lease when the franchise contract does not correspond to the same duration.
The charter of the National Council of Shopping Centers allows a franchisee to change signs during the duration of their lease. However, the post-contract non-competition clauses of franchise contracts are often restrictive due to their impact on the exercise of this freedom.
In summary:
Before signing a franchise contract, it is important to verify certain elements to avoid disputes. The DIP (pre-contractual information document) is a mandatory document that the franchisor must deliver at least 21 days before the signature of the contract. It contains all the necessary information for the franchisee to engage with full knowledge of the facts.
It is crucial to verify that the franchisor has previously tested their know-how and that the network has a certain stability. The franchisor has an obligation of information and details toward their franchisee, and they must be transparent and benevolent when drafting the DIP. Constraints for the franchisee must be linked to objectives and not imbalance the contract.
The contract must be clear and precise in its clauses, and the duration must allow the franchisee to make their investment profitable. Financial elements must be taken into account, particularly investments during the contract. Non-competition clauses must be limited to the protection of know-how and not deprive the franchisee of all possibilities of engaging in a commercial activity.
F.A.Q:
1. What is the DIP?
The DIP (pre-contractual information document) is a mandatory document that the franchisor must deliver at least 21 days before the signature of the franchise contract. It contains all the necessary information for the franchisee to engage with full knowledge of the facts.
2. Why is it important to check that the franchisor has previously tested their know-how?
Verifying that the franchisor has previously tested their know-how is important because it ensures that the franchisee will benefit from support from the franchisor and that the franchise has a certain stability.
3. What are the franchisor's obligations towards the franchisee?
The franchisor has an obligation of information and details toward their franchisee. This obligation includes the delivery of the DIP, the list of franchisees, the duration of the contract, the annual accounts for previous years, financial obligations and the necessary investment amounts, the general state of the market, and the prospects for evolution.
