Franchising can be a fantastic way to own a business, but only if the agreement is both fair and transparent from the start. If you are considering entering into the complicated dynamic of a franchisee vs. franchisor, on one side or the other, you need to look out for certain red flags. These red flags can indicate major risks, imbalances, or potential long-term problems, which is why they need to be considered. 

What Is a Franchise Agreement?

For those unfamiliar, a franchise agreement is a legally binding contract between a franchisor (the company that owns the brand) and a franchisee (the person or entity that wants to operate a business using that brand).

It outlines the terms and conditions under which the franchisee can operate a business under the franchisor’s name, including the rights, responsibilities, and expectations for both parties.

Common elements included in a franchise agreement include:

1. Franchise Fee & Royalties: The amount the franchisee must pay upfront and on an ongoing basis
2. Territory Rights: Whether the franchisee gets an exclusive area to operate in or not
3. Brand Standards: Any rules for using logos, uniforms, marketing materials, and more
4. Training & Support: The help the franchisor will provide, if any, to get the business up and running
5. Duration & Renewal: How long the agreement lasts and how it can be renewed
6. Termination Terms: Any conditions under which the agreement can end early
7. Non-Compete Clauses: Limits on what the franchisee can do after leaving the business

Signing a franchise agreement is like entering into a business marriage. You are legally bound to the franchisor’s system for years. That’s why it’s crucial to identify the red flags early on.

Red Flag #1: Overreaching Territory Restrictions

Having a clearly defined territory to start your section of the franchise is important. This will help you avoid competition within the same brand. Specifically, keep an eye out for vague language or the franchisor retaining rights to open nearby locations. Push back on any territory language that makes it unclear where your business can operate in, as well as any language which seems to make competition unfair.

Red Flag #2: Excessive or Hidden Fees

As mentioned above, there are certain fees that come with a franchise agreement. The initial fee, royalty payments, and contributions to a broader brand marketing fund are all reasonably standard. If you notice any surprise fees, vague descriptions that sound like fees, or unreasonable and undefined percentages for fees, your eyebrows should be raised. A franchisee that is burdened by high and unanticipated monthly fees can quickly run itself into the ground. 

Red Flag #3: One-Sided Renewal and Termination Terms

Franchisors having full control over the renewal rights or termination terms for even minor infractions is a slippery slope. The warning signs of this are a lack of automatic renewal in the terms, extremely short renewal periods, or abhorrent penalties on termination. All terms should have balanced clauses that make the agreement fair for all parties, rather than leaning in favor of one or the other. 

Red Flag #4:  Limited Support or Training Commitments

When you partner up with a brand as a franchisee, it should be your hope to grow that brand. However, in return for this, the franchisor should be willing to provide you with a certain level of support. Franchisors who promise vague “ongoing support” with no specifics on training duration, quality, or provided resources should be questioned. Not having proper resources can impact your ability to run the business successfully and lead to your being unable to grow the brand. 

Red Flag #5: Overly Restrictive Non-Compete Clauses

Non-compete clauses in a franchise agreement, meant to prevent you from operating a competing brand while operating your franchise location, as well as a few years after termination, are quite standard. These clauses typically cover the type of business you can run, the geographic area you can run them in, the scope of activities you can perform, and the time duration. Red flags to look for when signing, though, should include geographic areas that are too broadly defined or a duration lasting longer than a few years after termination. 

Grow your franchise location effectively 

When signing a franchise agreement, you need to read that agreement thoroughly alongside a franchise attorney who can help. Don’t rush your review of the arrangement either. A franchise is a long-term commitment, and your review of the agreement should reflect this. Ensure that a contract works for you, rather than against you, anytime you consider signing one.