How to negotiate the franchise agreement
At first look, the grandiose franchise disclosure document is not something mere mortals can understand, let alone negotiate. But between the FDD and the franchisee there is the franchise agreement, and everything there is on the table.
“Unless it’s something ridiculous,” said Harold Kestenbaum, of Spadea Law. “Everything else is pretty fair game.”
Kestenbaum, the Legal Eagle with the most nominations in 2020, said getting a good deal still requires a franchise legal expert on either side to zero in on what are the most impactful things to negotiate, and importantly for his franchisor clients, what not to negotiate. For franchisors, there are a few things that fall in the “ridiculous” category, namely royalties.
“You try to make no concessions on the fees. They ask for a bigger territory, ask for five locations,” said Kestenbaum, noting that territories can be a balance, too. “But if they get a bigger territory early on and the concept blows up and the territory is too big, you’re stuck.”
The key for franchisors is just being open. After all, the franchisee-franchisor relationship is a long and intimate one, and saying no to comments on the franchise agreement is a good way to avoid even the first date.
“Don’t just say we won’t negotiate, that will kill the deal. You’ve got to see what the comments are,” said Kestenbaum.
For Mark Dady, a lawyer at Dady & Gardner in Minneapolis, his work on the franchisee side of the agreement means he has a lot of go-to things to negotiate around.
“My top five are territorial protection, renewal rights, transfer rights, the franchisor termination rights, and does the franchisee have any early-out rights or protection against claims or lost future damages,” said Dady.
Territorial protection begins with a simple yes or no. Does the franchisee have any protection from the franchisor or other franchisees encroaching on their trade area?
“You see, some agreements say that you don’t have any protection, this is a site-only franchise and we can compete with you anytime, anywhere,” said Dady. “Then it’s how is that denominated? Most frequently, it’s a radius, you get a three-mile or five-mile radius. Sometimes you’ll see ZIP codes. But we want to see if you have it and if so, can we increase it.”
He said another quirk is exceptions to exclusivity, such as non-traditional spaces like airports, hospitals or the growing number of food halls. That’s easy to overlook, but “if you’re located a half mile away from a hospital, you don’t want them going in there, so you want to carve out the carve outs.”
The next three key points of negotiation all fall under the category of what happens at the end of an agreement term, which you can learn more about on page 56. But some key things for franchisees to think about are, how does this affect the long-term plan for my business?
“Oftentimes it’s a 10-year term and then you have a five-year renewal right. That’s fine if you’re 70, but if you’re 40 that’s not enough,” said Dady. “That’s important for transfers as well, because you want to make sure you have something to sell. A buyer might say, ‘You only have seven years left on the term, so why would I buy?’”
Another key is what protections there are if a business fails. It’s not something bright-eyed franchisees often think about, but if they don’t, they could be on the hook for major payments when their business is floundering.
“This is a big one that most people don’t pay attention to. Most people think, I have the right to do this. But the way most FDDs are written, you have the right to operate but also the obligation to operate for 10 years,” said Dady. “Even if you’re losing your shirt you have to keep operating because they expect to be paid.”
He said part of his job is to see if those damages are reasonable and whether that’s attached to a personal guarantee. He said the smart thing for franchisees to ask for is a cap on the liquidated damages that would come after a business fails, and if it’s connected to a personal guarantee—which most franchisors want—can that be eliminated or reduced to a sensible level.
Jason Brisebois, a lawyer at Sotos, works on legal compliance with U.S. firms expanding to Canada. He said while some of the legal code is quite different, the negotiations are largely the same. He said franchisees should certainly try to negotiate some things, but a rubber stamp on a list of comments may be a red flag.
“It’s great if they are willing to give you concessions, but if they are so willing, why are they so willing to give concessions when cohesion is the rule? Should that worry me? It sounds counterintuitive, because it’s in the franchisee’s interest, but it raises questions,” said Brisebois. “Ultimately, it’s not to your advantage if others aren’t adhering to the standards.”
He said in general, smaller systems are more willing to acquiesce on things such as personal guarantees and territories, but he advises his franchisor clients not to go too far. The best areas to negotiate are those with mutual benefits for both the franchisee and franchisor.
“Kick in a little more money to help with grand openings? That, I see, is met with open arms,” said Brisebois. “Early days operational support, too. These are concessions that improve the system. There are areas where franchisees can find some meaningful concessions; maybe not on the royalty or ad rate.”