How to buy a franchise correctly

So, a franchise. We think many people know what stands behind this concept. In short, franchising is a business model in which the franchisor (business owner, trademark holder) provides, for a fee, the franchisee (user) with the right to use a set of exclusive rights owned by him, including a trademark.

The franchisor's benefit is obvious — At the expense of independent investors, he expands his business, increases awareness of his brand, and receives an additional increase in cash flow.

For franchisees, this scheme is very attractive for several reasons. Firstly, he buys a working successful solution, and secondly, there are significant savings on brand promotion and finding loyal customers.

Ideally, everything is like this.

Practice shows that the wrong choice of franchise, a frivolous approach to formalizing relations with the franchisor can provoke a disastrous outcome for the franchisee as the weaker party in these relations.

Before you start opening your own franchise business, you should ask yourself a simple question: Am I really ready to open a franchise business? Am I interested in this? Do I want to be controlled by someone? There may be many questions, here we have given the main ones that will help you understand your own real intentions.

In order not to get burned, you should clearly understand that franchising — this, firstly, is not always a guaranteed success, and secondly, — a business model in which the entrepreneur is very limited in his own independence.

In this case, the freedom of the franchisee will be limited due to control and pressure from the franchisor.  This will manifest itself in the need for strict compliance with various mandatory requirements established by the franchisor for the premises, its design, product range, suppliers, product quality, customer service procedures, etc. It is precisely because of the numerous mandatory requirements that the franchising model is not suitable for everyone.

About choosing a franchise

You should choose a franchise based on your own interests, goals, principles and preferences. The taste and color, as they say. The only thing you need to take into account is that franchises in different areas of business have their own nuances.

So, often, when selling clothing under a franchise, it is enough to pay only a lump sum fee (initial payment to the franchisor or entry cost), without subsequent payment of royalties (regular payments to the franchisor for the right to use a set of exclusive rights).

At first glance, the scheme looks very attractive.

True, you shouldn’t delude yourself too much: with this approach, the size of the lump-sum contribution is significantly higher than the size of the lump-sum contribution in a royalty payment scheme. Typically, in such cases, franchisors compensate for the lack of royalties by the franchisee’s obligation to purchase goods either from themselves or from persons specified by them.

In this case, the markup on the product for the franchisee will be higher than the average royalty (about 8%). And of course, a one-time payment of a lump sum fee without paying regular royalties to the franchisor leads to the fact that after the sale of the franchise, the franchisor loses interest in your business.

Therefore, you can’t hope to receive further support, advice and support from the franchisor.

About hygiene rules

Before directly “purchasing a franchise” It is worth remembering such basic hygiene rules as collecting information about the franchisor, his products, registered trademark, financial indicators of his activities, the average payback period of a business opened under his franchise, the franchise period, and of course, the cost of the franchise (lump sum and royalties ).

All this information can be obtained from the franchisor himself, but it is better not to limit yourself to just one source of information. It wouldn’t hurt to make your own inquiries on the Internet, read customer comments, contact other franchisees (their contacts can be requested from the franchisor or found on his company’s website), evaluate and analyze their reviews, compare them with information received from the franchisor, look at the financial statements, legal disputes.

A popular “trick” among franchisors is to provide potential franchisees with various business plans, opening plans, etc. We do not recommend choosing a franchise only on the basis of data from business plans, because they almost always contain a guarantee of success and high franchise rates. It is better to rely on information received from franchisees already working in this franchise, or on the results of your own planning and forecasting.

Next, I would like to focus on several, albeit formal, but important points, namely, on formalizing the relationship between the parties when “purchasing a franchise.”

It is worth immediately deciding that in Russian legislation the term “franchise”, “franchise agreement” not legally secured. Similar relations in our country are regulated by the norms of Chapter 54 of the Civil Code of the Russian Federation, which is dedicated to the commercial concession agreement. Commercial concession in Russia and franchising abroad, although very similar mechanisms, are not identical.

So, those who are at the stage of formalizing relations with the franchisor should remember Chapter 54 of the Civil Code of the Russian Federation.

This will distinguish between original franchise packages and pseudo-franchises.

Pseudo-franchises include those franchise offers in which the relations of the parties are formalized, for example, by a license agreement and a supply agreement concluded on its basis, a simple partnership agreement, a fee-based provision of services and any others, except a commercial concession agreement. Most often, the reluctance to enter into a commercial concession agreement is explained by its complexity (the result is a rather voluminous multi-page document), as well as the need to register the agreement with Rospatent.

Nevertheless, it is in the interests of the franchisee to enter into a commercial concession agreement with the franchisor, and not any other. First of all, this is necessary to ensure the protection of the rights of the franchisee as the weaker party in the relationship.  Any franchisee is interested in the franchisor providing him with organizational and technical support, consulting, and support not only on paper, but also in reality.

This can only be achieved by concluding a commercial concession agreement, since it is this contractual structure that includes the transfer of technical and commercial documentation, other useful information, as well as instructing the user (franchisee) and his employees, among the mandatory responsibilities of the franchisor. Even if you have not clearly stated such obligations of the franchisor in the contract, you will be saved by the presence of relevant mandatory provisions in the law.

On the essential terms of the commercial concession agreement

It is necessary to clearly check that the subject of the agreement includes the grant of the right to use a trademark indicating the registration number and priority date, otherwise the agreement will be considered not concluded and Rospatent will refuse its registration.

Under the guise of a commercial concession agreement, it is sometimes proposed to conclude a “rights granting agreement”, according to which the franchisee is granted the right to use the technology developed by the franchisor, a commercial designation, “know-how” and other objects, except for the trademark.

Such an agreement will not be a commercial concession agreement in the form in which it is defined in the Civil Code of the Russian Federation. Subsequently, if the franchisor violates the terms of such an agreement, it will be difficult for the franchisee to receive all regular payments paid under the agreement. One of the options for returning funds is to try to qualify such an agreement as a commercial concession agreement, based on the common intentions of the parties. Next, recognize the agreement as invalid, namely, void (due to non-compliance with clause 2 of Article 1028 of the Civil Code of the Russian Federation - the condition for registering the agreement with Rospatent) and make demands for the application of the consequences of a void transaction. True, the court does not always share this position.

So, in one case, the court refused to invalidate the user's commercial concession agreement due to the fact that clause 2 of Art. 1028 of the Civil Code of the Russian Federation applies and is applicable only to a commercial concession agreement. Due to the fact that the disputed agreement was not such, regardless of its legal nature, it cannot be considered void due to lack of registration with Rospatent (Resolution of the Federal Antimonopoly Service of the Far Eastern District dated November 30, 2012 in case A51-4947/2012).

When granting the right to use a trademark under a commercial concession agreement, you should pay attention to the classes in respect of which the trademark is registered. It is necessary to check whether they correspond to the types of services for which the use of the trademark under a franchise is expected. If they do not comply, then the concluded agreement will not be qualified as a commercial concession agreement.

On limiting the rights of the parties

Important terms of a commercial concession agreement, which are worth paying special attention to and for violation of which serious measures of contractual liability are usually provided, are the terms of limitation of rights.

We are referring to the so-called non-competition clauses. The agreement may provide for the obligation of the franchisee not to compete with the franchisor in a certain territory and not to allow this from affiliated persons. Some contracts provide for a violation of this condition with a penalty of half the lump sum, so it is in the interests of the franchisee either not to violate the condition or to lobby for a smaller penalty to be stipulated in the contract. Franchisees must ensure that the contract contains a corresponding obligation of the franchisor not to grant rights under the contract to third parties in the territory assigned to the franchisee.

About the franchise period

The key feature of a franchise and a condition of the contract is the franchise term. Let us immediately note that the longer the period, the more attractive and profitable the franchise package is for the franchisee. Obviously, franchise offers for a period of one year should not, by definition, even be considered by franchisees. Most franchises have a term of five years. Taking into account the payback period and the amount of the franchisee's initial investment, franchises for a period of 10 years or more are a more profitable option.

Grounds for terminating the use of a franchise

It is advisable to provide in the contract the conditions for unilateral termination of the use of the franchise (termination of the contract). Formulating suitable grounds or circumstances, the existence of which will help neutralize the negative consequences of the activity, will only benefit both parties to the contract.

Conclusion

In conclusion, I would like to note once again that when opening a franchise business, you should be guided not only by the franchise indicators promised in business plans and guarantees of its success, but also by your experience, forecasts, and reviews of existing participants in the system. Correct and properly developed documentation of the relationship between the parties to the franchise will subsequently minimize the risks of the franchisee and largely guarantee the success of the franchise.