Develop Lease Addendum

Your franchisee will most likely be leasing a business location. The lease is a contract between the franchisee and the holding company that owns the building. You are not directly involved in the contract, but you do want to add an addendum protecting your options. The Lease Addendum will be included in the Franchise Agreement and both the landlord and tenant will be required to acknowledge its provisions as part of the lease and sign it. The Lease Addendum ensures your rights and options in the use of the premises, should the need arise. Specifically:

• The leased premises are only to be used for the operation of the franchise business during the entire term of the lease.
• If anything happens that the franchisee will no longer be operating your franchise business, you have the right to take over the lease, if you so desire.
• You have the right to enter the leased premises to inspect the business or to make any modifications required to protect your trademarks.
• The landlord will give you written notice of any breach in contract with the tenant and you will have thirty days to remedy that default on behalf of the tenant before the landlord proceeds with eviction.

Bind The Sale

The Franchise Agreement is included as an exhibit in the Uniform Franchise Offering Circular (UFOC) and is the actual contract between franchisor and franchisee. The UFOC describes the content in the Franchise Agreement. You must be an active participant in writing the Franchise Agreement so that you understand, without question or doubt, all the content. Do not accept a generic Franchise Agreement. Do not accept any phrases or clauses you do not understand. All content should be familiar due to your involvement in the writing of the UFOC.

Typically, there are 16 articles in the Franchise Agreement, and they loosely correlate to the UFOC. There are also appendices, including acknowledgement and a personal guaranty to be signed by the franchisee.

This is a critical document and it will be tempting to skim over it as it is the same material that is in the UFOC. Do not skim! Not only the franchisee but also you will be bound by this contract.

Prove Receipt

Legally, a prospective franchisee must receive the Uniform Franchise Offering Circular (UFOC) at least 10 days prior to signing the Franchise Agreement and/or making payment to the franchisor. This is part of the Franchise Rule, and it is not negotiable.

Item 23 in the UFOC is for receipt. It notes that there are two copies of a “Receipt of this Offering Circular, including all Exhibits” document attached to the UFOC as an exhibit. One of the copies must be signed and dated by the prospective franchisee and delivered to you. This should be done upon receipt of the UFOC.

Make sure the prospective franchisee is aware of this provision and that they do return the signed receipt to you before you proceed with the Franchise Agreement and eventual sale.

Submit Financials

Whether you decide to share unit financial statements or not, you are required to submit financial statements for your franchise offering company. This is most likely a separate holding company, not the company under which you operate the business you are franchising.

Item 21 of the Uniform Franchise Offering Circular (UFOC) is a listing of your financial statements. You will indicate whether they are audited and who prepared them. If they are un-audited and internally prepared, you will indicate that. The minimum required statement is an un-audited Summary Balance Sheet.

If audits are necessary (based on requirements of the state in which you are selling the franchise) the minimum required statements are a Balance Sheet, Statement of Changes in Stockholders’ Equity, Statement of Income and Statement of Cash Flows. Misrepresenting financial statements could result in the Franchise Agreement being voided.

Name Outlets

Your existing franchisees are the best source of information for a prospective franchisee. You should encourage prospective franchisees to contact them. You should also encourage all franchisees in your system to be both candid and encouraging when interviewed by prospective franchisees. If they cannot be positive or encouraging, you should know the reason why and work to correct it.

Item 20 of the Uniform Franchise Offering Circular (UFOC) is a list of franchise outlets. It will be a resource for prospective franchisees and it contains information on franchises in operation, transferred, terminated, not renewed, reacquired and others that left the system. Here you will also list company owned units and project the number of units you expect to open in the current year.

Hypothesize Earnings

The prospective franchisee will ask about earnings and profit. Legally, you cannot guarantee any level of earnings. If you do, and the franchisee does not achieve that level, there are going to be legal battles. It is, however, a fair question and Item 19 of the Uniform Franchise Offering Circular (UFOC) gives you a place to address it.

First, you want to emphasize that you do not furnish or authorize your salespeople to furnish ANY oral or written information concerning the actual or potential sales, costs, income or profits of a store. Further, you note that actual results vary from unit to unit and that you cannot estimate the results of any particular franchise. You clearly state that you will not be bound by allegations of any unauthorized representation as to earnings, sales, profits or prospects or changes of success.

You may, however, give a prospective franchisee actual operating results of a unit they may be interested in purchasing. For new franchise units, you may suggest the potential franchisee contact existing franchisees and ask them candid earnings questions.

Outline Options

Hopefully you’ve picked a great franchisee and the franchise business is operating profitably and all is well. If, however, something unforeseen happens and the franchisee needs to be terminated or transferred, you need to have written, binding policies. In fact, you need standard policies for the length of the term of a franchise and for renewing or extending terms for successful franchises. If you don’t have these policies, you may find yourself on the expensive end of a lawsuit.

Item 17 of the Uniform Franchise Offering Circular (UFOC) lists provisions of the Franchise Agreement that pertain to renewal, termination, transfer and dispute resolution. You must describe these procedures in detail. Specifically, include provisions for:

• Length of the term of the franchise
• Renewal or extension of the term
• Requirements to renew or extend
• Termination by franchisee
• Termination by franchisor, without cause
• Termination by franchisor, with cause
• Cause defined and defaults that can be cured
• Cause defined and defaults that cannot be cured
• Franchisee obligations upon termination / non-renewal
• Assignment of contract by franchisor
• Transfer by franchisee
• Franchisor approval of franchisee transfer
• Conditions for franchisor approval of transfer
• Franchisor right of first refusal to acquire franchisee business
• Franchisor option to purchase franchisee business
• Franchisee death or disability
• Non-competition covenants during the term of the franchise
• Non-competition covenants after the franchise is terminated or expires
• Modification of the Franchise Agreement
• Integration / merger clause
• Dispute resolution by arbitration or mediation
• Choice of forum
• Choice of law

Restrict Franchisee Sales

You definitely want your franchisee to sell any products or services related to the business. But you do not want them to sell unrelated products and services at the business site implying endorsement by the franchise system. You also do not want the franchisee to sell unsafe or untested products, even if they do relate to the business.

In Item 16 of the Uniform Franchise Offering Circular (UFOC) you can stipulate exactly what can and cannot be sold by your franchisee. You can further spell out where the franchisee can sell your products and services. It should be only at their franchise location. They should be prohibited from directly market to customers outside their territory.

Of course, you can also make provisions for allowances. You can set up a process for reviewing new products and services and for requesting marketing allowances.

Mandate Participation In Operations

Who do you want running your franchise businesses? There’s a wide range of commitment between a manager and an owner. Owners have a vested interest in seeing the business succeed. Managers may, or may not, depending on how the business is structured and what the reward system is.

One of the things you, as the franchisor, can do is specify who has to participate in the actual operation of the business, and to what extent. Item 15 of the Uniform Franchise Offering Circular (UFOC) allows you to state whom the principal operator must be and whether his effort in the active management and operation of the business is full or part-time.

You can also require that any managers other than the principal have to complete your training program and be approved by you. While these are important considerations, be careful you do not specify so much that you’ll be spending all your time reviewing and approving managerial changes at the franchisee’s business.

Use Trademarks Correctly

You spent a great deal of time and money getting your business name and logo trademarked. You want your franchisee to use it, and to use it appropriately. In Item 13 of the Uniform Franchise Offering Circular (UFOC) you will list your principal trademarks. You will also confirm whether there are legal limits or problems associated with the trademarks.

You will specify exactly how the franchisee is to use your trademark. It should only be used in connection with operation of the franchise. It should never be used in connection with any products or services you do not authorize. This is important. Your image is tied to your trademark and you do not want it tarnished by misuse.

You also want your franchisee to know that you will defend your trademark and prosecute infringers, if necessary. This is your responsibility, not theirs. You do not want your franchisees settling or compromising legal situations regarding your trademark.

Negotiate Territory

It will be difficult to sell your first franchise. You are a newcomer in your industry and there are likely established franchisors competing for franchisee leads. One of the things you can offer your first few franchisees is expanded territory. As acknowledgment that they’re making a leap of faith going with you, you can offer more to them than you would to franchisees further down the road. You cannot manipulate the price of your franchise, but you can define a territory in multiple ways.

Expanded territory is a powerful inducement. But before you offer it make sure you talk to your attorney and find out just how much negotiating room you have.

Designate Territory

You must establish geographic territories for your franchisees based on the population and demographics of the area. Territories may be designated by zip codes, geographic areas (cities, townships or counties) or be the designation of streets or natural borders.

Territories are critical to the franchisee because they must operate within their boundaries and they may not operate outside the boundaries in a territory belonging to another franchisee. Territory is a large selling point for a franchisee. They want the largest possible exclusive territory and you want to limit the size of the territory in order to sell more of them.

In Item 12 of the Uniform Franchise Offering Circular (UFOC) you are required to define: territory obligations and restrictions, exclusivity and rights, minimum sales requirements and franchisee options. Work with your attorney to make the descriptions as complete as possible without specifying geographic boundaries. These designations may not be standard across the country, and you want as much leeway as you can have in determining fair territories. You may want to specify that a territory must have a minimum number of households with x% of income to support a franchise business. The criteria will be specific to your industry.

Train Extensively

You'll require the franchisee to attend specific training sessions. The critical session is the pre-opening training that is detailed in Item 11 of the Uniform Franchise Offering Circular (UFOC).

This is the most important training you’ll ever provide. Part of the purpose of the program is to create a strong allegiance to the company and lay the groundwork for a successful future relationship. Never again in the relationship will you have the franchisee captive like you do in the training program. During this time you have a chance to mold the franchisee. So make sure that you’re training for exceptional, not minimum requirements.

Most of the training will take place at the Corporate site. Before the franchisee visits, make sure you have all training-related tasks completed. These include: creating the curriculum, hiring trainers (unless you do it yourself), establishing testing procedures to verify that you’ve communicated the information, and setting an exit strategy for franchisees who don’t successfully complete the training. Will you refund the franchise fees to these candidates?

Training may take between 3 – 5 days to complete. It includes both classroom training and on-the-job training. It should encompass everything from an overview of your philosophy and standards to hands-on product/service use. There may be multiple instructors and you may want to specify further training to be completed at home, before the grand opening. One example of further training is CPR certification.

Provide Negotiating Guidelines

One of your obligations to the franchisee is to provide site lease negotiation guidelines. It’s to your benefit to help the franchisee obtain the best possible lease. The lower the lease payments, the better the revenue opportunities. It may be the first time the franchisee has ever negotiated a lease. There’s a large intimidation factor in dealing with commercial brokers and it’s your job to prepare the franchisee ahead of time.

Items to consider in lease negotiations include:

• Verify owner and restrictions. Ask to see the owner’s title insurance policy and copies of existing mortgages, restrictions, easements, etc. Not only does this verify that you’re working with the proper owner, it also highlights any restrictions on the property that may be adverse to you.
• Review the entire lease. There is no such thing as a standard lease and you should have your attorney review it as you negotiate and before you sign. Leases can be 50 pages long and it’s tempting to skim over portions. Don’t.
• Negotiate directly with the holding company. The broker has his own agenda – not the least of it being his commission. The holding company has the ultimate say in the lease and is less likely to quibble over the things a property manager will.
• L eave out the emotions. Don’t go in heart-set on getting this specific site or you’ll under-negotiate. Remember, it isn’t the only property available.

Document Franchisor Obligations

Your obligations to your franchisee are a critical part of the Uniform Franchise Offering Circular (UFOC). Since this is a binding contract, it behooves you to go into a great deal of detail. You want to be fair, and you can always do more than you contract for, but you do not want to be in a situation where the franchisee can claim you have to do more because you didn’t say you wouldn’t do it. Use this section to your benefit. Begin it by stating “Except as listed below, we need not provide any assistance to you.” Then list, by category, what services you will provide.

Major categories include:

• Before opening
• During operation
• Advertising
• Computer systems
• Operations manual
• Site selection
• Time of opening
• Training

List Financing Options

You have to determine what financing options you’re going to offer to franchisees. You may offer direct, indirect or none. Whatever you’re offering, you’ll list it and the specific terms in Item 10 of the Uniform Franchise Offering Circular (UFOC). You may want to discuss your finance offerings with your accountant. You certainly want to fully understand the implications of offering financing. You will also have to specify if you guarantee any notes, leases or other obligations.

Document Franchisee Obligations

You’ve discussed general roles and responsibilities with your prospective franchisee. Item 9 of the Uniform Franchise Offering Circular (UFOC) formalizes the franchisee’s obligations. It also cross-references the items to the corresponding sections of the Franchise Agreement that will be the legal contract between you and your franchisee.

Franchisee obligations typically include:

• Site selection and acquisition/lease
• Pre-opening purchases/leases
• Site development and other pre-opening requirements
• Initial and ongoing training
• Opening
• Fees
• Compliance with standards and policies/operating manual
• Trademarks and proprietary information
• Restrictions on products/services offered
• Warranty and customer service requirements
• Territorial development and sales quotas
• Ongoing product/service purchases
• Maintenance, appearance and remodeling requirements
• Insurance
• Advertising
• Indemnification
• Owner’s participation/management/staffing
• Records and reports
• Inspections and audits
• Transfer
• Renewal
• Post-termination obligations
• Non-competition covenants
• Dispute resolution

Identify Purchasing Restrictions

To maintain consistency, quality and identity of your franchise products and services you have to restrict your franchisee’s purchasing options. You can list all purchasing obligations and restrictions in Item 8 of the Uniform Franchise Offering Circular (UFOC).

The franchisee will be expected to purchase products and services in accordance with your specifications and only from vendors you’ve approved. You may establish a process that allows a franchisee to submit a new vendor for your approval.

If there are any products or services that must be purchased directly from you or your affiliates, you have to list them. In addition to descriptions, specify whether the items are required or optional purchases. In addition to the equipment, signs, products and supplies, you will also demand that the franchisee purchase insurance coverage for their business. You will set the minimum standards for insurance coverage. If you have established purchasing or distribution cooperatives, you will list them and the products they provide.

Focus On The Goal

Your goal is not just to sell franchises. It is to sell them in a way that allows you to meet your commitments, stay in business and make a return on investment. You cannot do this if your initial fees and fee structure force your franchisees out of business. The financial health of your franchise structure depends on the profitability of your franchisees.

Sell Yourself

Don’t discount the value inherent in advertising fees. One of the greatest benefits of a franchise to the franchisee is the name recognition and advertising power of the franchisor or the network as a whole. If you don’t charge advertising fees in your initial offering, be sure to include a clause for the possibility of future fees.

When determining a reasonable fee consider the amount of money required for effective regional and national advertising programs and the funds required for the development of advertising materials and promotions. Also consider the franchisee’s necessary local expenditures in order to make an impact on his market.

It is not uncommon for new franchisors to require low or no contributions for advertising, until there is sufficient number of franchisees to warrant media campaigns funded by franchisee contributions.

Establish Other Fees

Your main source of ongoing income will be the other fees you charge your franchisees. These fees are typically: royalties, advertising contributions, grand opening advertising, minimum local advertising, license rights, maintenance and repairs, refurbishing or other extraordinary expenses, insurance, additional training, late charge and interest, transfer fee, renewal fee, audit expenses, indemnification and attorney fees.

You should look at the fees your competitors charge. But don’t just copy them! Use them as your starting point and change them to your circumstances. Consider the following issues when setting your fees:

• How much does it cost for you to deliver the services you intend to deliver to your franchisees?
• Are the fees high enough to allow you to pay these costs and still get the financial return you’re counting on?

If you set the fees too high, your franchise will not be marketable against the competition. If you set them too low, it may damage your ability to provide the services you’ve promised.

Determine Initial Franchise Fee

You will list the amount of the initial franchise fee payable at the time the franchisee signs the Franchise Agreement. You do not have to provide any detail for this fee.

This is an important fee and you should spend some time determining it. There are no legal guidelines or requirements for this fee. At a minimum, your fee should cover the costs of franchisee selection, training and pre-opening assistance..

Additionally, you should know the fee your competitors charge. You should set your fee in the mid-range of your competitors’ fees. If you have the highest fee, your integrity is questioned. You’re new to franchising – how can you possibly justify the highest industry fees? Conversely, if you have the lowest fee, your value is questioned. Do you have so little to offer in comparison? That combined with your relative newness in the market may lead your franchisee to pay a little bit more and go with someone established.

Other considerations include:

• The nature of the services offered by the franchisor
• The extent of these services
• The cost of the services to the franchisor
• The need for the franchising company to cover its overhead and possibly show a small profit
• The ability of the franchisee to pay
• The value of the trademark
• The attractiveness of the franchise – is it “hot”?
• The size of the territory being offered
• The term of the agreement

You will want to specify when this fee is considered fully earned. You want to avoid escrow and have it be considered earned at the time the Franchise Agreement is signed and therefore not refundable under any circumstances.

Caution: do not set the initial franchise fee so high that the franchisee cannot recover from it.

Acknowledge Litigation And Bankruptcy

You are required to disclose any litigation in the Uniform Franchise Offering Circular (UFOC). You must also disclose if any person described in the UFOC has been involved as a debtor in proceedings under the U.S. Bankruptcy Code. If there is no litigation or bankruptcy to disclose, you will state that accordingly. These are not items that can be left blank.

Describe Yourself

You will have to disclose a description of yourself in the Uniform Franchise Offering Circular (UFOC). The description requires:

• Your corporate name
• State in which you are incorporated
• Date of incorporation
• Principal business address
  
• Any names under which you legally do business
• List predecessors and affiliates and an explanation of what services or products your affiliates may offer to your franchisees.
• A detailed description of your business. At a minimum your business is the offer and sale of franchises. Include a description of the franchise.

Finally, you will also have to specify that there may be competition to the franchise, what regulations apply to the franchise and whether or not you operate businesses of the type to be operated by your franchisee.

Compile Initial Investment

You have to provide a detailed list of the initial investment costs for opening a new franchise location. Most likely you have these numbers available from when you started your business. Include costs for the period before opening through the initial three months of operations. In addition to the amount, you must specify the method of payment, when payment is due and who is to be paid.

Make sure that the summary is comprehensive, but note what isn’t included and that actual expenditures may vary depending on local conditions and other variables. Your lawyer should provide the verbiage and standard cost categories, you should be able to fill in the blanks.

Major categories of investment include:

• Initial franchise fee
• Grand opening advertising
• Real estate rental
• Construction, architectural fees and related items
• Fixtures, furniture, equipment and signage
• Program accessories
• Office equipment and supplies
• Opening inventory
• Insurance
• Miscellaneous travel and living expenses while training
• Legal, accounting and other miscellaneous pre-opening expenses
• Additional funds – three months

Extrapolate Business Experience

The Uniform Franchise Offering Circular (UFOC) requires disclosure of your business experience. This description is personal, not corporate. It should include at least the last seven years of experience in an abbreviated resume. This is not a lengthy description and it should concentrate on elements relevant to the franchise business. If there are multiple partners, then there will be a description of business experience for each person.