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Picking the Right Franchisee

May 21, 2013

As a lawyer to the franchise industry, I hear from franchisors and franchisees alike more often when they are having a problem with one another than when they’re not. As a result, it can be easy sometimes to overlook all the benefits of franchising and the mutual success that a franchise relationship can provide.

It is always important, therefore, for franchisors to carefully screen franchisee candidates in as many ways as are possible (and legally permissible) in order to determine how viable a prospect is for long-term achievement within the system. During the courting and application processes, franchisees should be evaluating the eligibility of franchisors for business a business relationship as much as the franchisor is evaluating them, however, most often the franchisor is the party with the checklist, and the criteria which have to be satisfied.

In particular, franchisors should not be afraid to ask (and franchisees should expect to answer) specifics about the prospect’s business and personal background, including prior employment experience, prior salaries, past and current business interests and net worth. That list of assets and liabilities can be a sensitive area, and may also be used to ascertain who among the operators of the individual franchise may be required to personally guarantee the franchisee’s obligations under a franchise agreement.

Franchise agreements can be signed by a company, or by an individual who will then assign his interest in the agreement to a company once it gets incorporated. Either way, the overwhelming majority of franchises are operated by a corporate entity, with its obligations personally guaranteed by its officers, directors and/or principal shareholders. Franchisors should insist that any such company be newly incorporated so as not to have the franchised businesses become co-mingled with other assets and, importantly, liabilities incurred by that company previously. It is also recommended that the company restrict itself in its incorporating documents from operating any other business apart from the franchised business.

And franchisors should also reserve a right for themselves in the franchise agreement to review (and even approve) a franchisee’s shareholders agreement so that it understands who it will be dealing with primarily, and the various buy-out arrangements which that franchisee has come to terms with among its various shareholders. Franchisors may also want to reserve the right to approve of any sources of financing for the franchisee. Some franchisors feel that the less they know the better, but being wilfully blind to an illicit source of funding for the franchised business could potentially come back to haunt them.

Franchising at its best produces long-term, successful and mutually beneficial relationships. Whether you are a franchisor or a franchisee, make sure you know and understand who you’re dealing with on the other side of that contract so that you can both best achieve that end.

Tags: Franchising