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Subject: |
The Right Way to Let Franchisees Out Of Their Commitments |
| Date: |
2009-01-26
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The Right Way to Let
Franchisees Out
Of Their Commitments
By Cliff Ennico
www.creators.com
A lot of corporate executives who have been "downsized" in the recent
economy downturn, especially those in their 40s and 50s, are looking to
buy franchises. Their thinking seems to go something like this:
- "my 401(k) has lost a ton of value, there aren't any safe
investments out there right now, so why not use at least some of what's
left in my 401(k) to provide an income stream and a future for myself?";
- "franchises are generally safer than standalone small businesses
- you get lots of hand-holding and support from the franchise, and
there's a 'structure' to running a franchise that's similar to what you
have in a corporate environment";
- "franchises aren't forever - the typical franchise term is
between 10
and 20 years – but that's okay in my case since all I'm looking for is
a 'bridge' until I can retire at age 65 or 70 – at that point I'll sell
the franchise to someone else and have some fun before I die."
Still, the question had to be answered. I did it by talking about two
words - two simple words - that you should write down on a Post-it
Note®, put it on your computer, your bathroom mirror or anywhere
else you will see them several times a day. Make them your daily
mantra, for these are the words that will help you get through whatever
economic troubles we have to live through the next few years.
All well and good, but . . . what happens if the franchise doesn’t work
out?
Most franchise agreements do not allow franchisees to terminate the
relationship before the franchise term has expired. The idea is that if
things don't work out for whatever reason:
- it was your fault – you weren't a sufficient "fit" for the
franchise, or didn't give it the old college try; and
- you should sell your franchise to someone who can do a better job
with the franchise territory than you did.
That's okay if we're talking about an established franchise like
McDonald's® or Burger King® -- hey, if you own one of these and
are having trouble making money, you must be on Mars somewhere.
But the franchises most people are looking at nowadays are "early
stage" franchises – with fewer than 100 franchisees, and sometimes less
than 50 – that are still testing their business models. If a franchise
like THAT doesn't work out, there's just as good a chance it's the
franchise's fault as it is yours, and the franchise should let you out
of the deal.
That's easier said than done, though. Not only do most early stage
franchises not give you an opportunity to get out of the franchise if
things don't work out, they actually impose penalties – sometimes LARGE
penalties -- if you ask to be released early. For example, if the
franchise imposes a "minimum monthly royalty" requirement on their
franchisees, the franchise will require you to prepay all monthly
minimum royalties for the balance of the franchise term, sometimes in a
single lump sum installment.
Crunch the numbers: if you have a 10-year franchise term, your minimum
monthly royalty is $500, and you elect to terminate the franchise at
the end of Year Three, that leaves seven years remaining on the
franchise term, or 84 months. Multiply that by $500, and it will cost
you $42,000 just to get out of the franchise and get on with your life
(the franchise will discount this amount to "present value," of course,
but the reduction won't be more than a couple thousand dollars).
I recently reviewed a franchise program – a very early stage program
with fewer than 30 franchisees nationwide – where the franchise got
this right. Here's how this program works.
When a franchisee signs up, she commits to a monthly royalty of 8% of
her gross sales, and signs a "promissory note" agreeing to pay the
franchisor a total of $200,000 in royalties (without interest) during
the 10-year franchise term. As the franchisee pays royalties each
month, the amount paid is applied to reduce the note so that once her
total royalty payments reach $200,000, the "promissory note" ceases to
exist.
If the franchisee wants to quit the franchise before the $200,000
"promissory note" is fully paid, she has two choices. She can either
(1) agree not to compete with the franchise for a three-year period, or
(2) refuse to sign the noncompete agreement. If she chooses to sign the
"noncompete", the $200,000 "promissory note" is forgiven. If she elects
to compete with the franchise, however, the balance due on the $200,000
"promissory note" becomes payable in monthly installments at 6%
interest per annum over a five-year period.
If the franchisee elects to quit the franchise after the $200,000
"promissory note" is paid in full, the noncompete period is reduced to
one year and the franchisee doesn’t owe anything to the franchise.
An approach like this one not only gives franchisees a choice of "exit
strategies" if the franchise doesn't work out, but it also demonstrates
a little humility on the franchise's part – an acknowledgment that
nobody really knows whether the franchise model will work in all
locations, in all economic climates, and under all circumstances.
Sadly, most franchises are not as enlightened as this one. If you are
planning to buy a franchise anytime soon, be sure you understand
clearly what your "exit strategy" will be if things don't work out. And
don't buy a franchise if there’s even the slightest doubt you can last
out the full franchise term.
Cliff Ennico (cennico@legalcareer.com)
is a syndicated columnist, author and former host of the PBS television
series 'Money Hunt'. This column is no substitute for legal, tax or
financial advice, which can be furnished only by a qualified
professional licensed in your state. To find out more about Cliff
Ennico and other Creators Syndicate writers and cartoonists, visit our
Web page at www.creators.com.
COPYRIGHT 2009 CLIFFORD R. ENNICO. DISTRIBUTED BY CREATORS SYNDICATE,
INC. Permission granted for use on DrLaura.com.
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