May 7, 2010
The Right Way to Let Franchisees Out Of Their Commitments
The Right Way to LetFranchisees Out Of Their Commitments By Cliff Ennico www.creators.com A lot of corporate executives who have been "downsized" in the recenteconomy downturn, especially those in their 40s and 50s, are looking tobuy franchises. Their thinking seems to go something like this: "my 401(k) has lost a ton of value, there aren't any safeinvestments out there right now, so why not use at least some of what'sleft 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, andthere's a 'structure' to running a franchise that's similar to what youhave in a corporate environment"; "franchises aren't forever - the typical franchise term isbetween 10and 20 years #150; but that's okay in my case since all I'm looking for isa 'bridge' until I can retire at age 65 or 70 #150; at that point I'll sellthe franchise to someone else and have some fun before I die."Still, the question had to be answered. I did it by talking about twowords - two simple words - that you should write down on a Post-itNotereg;, put it on your computer, your bathroom mirror or anywhereelse you will see them several times a day. Make them your dailymantra, for these are the words that will help you get through whatevereconomic troubles we have to live through the next few years. All well and good, but . . . what happens if the franchise doesn#146;t workout? Most franchise agreements do not allow franchisees to terminate therelationship before the franchise term has expired. The idea is that ifthings don't work out for whatever reason: it was your fault #150; you weren't a sufficient "fit" for thefranchise, or didn't give it the old college try; and you should sell your franchise to someone who can do a better jobwith the franchise territory than you did. That's okay if we're talking about an established franchise likeMcDonald'sreg; or Burger Kingreg; -- hey, if you own one of these andare having trouble making money, you must be on Mars somewhere. But the franchises most people are looking at nowadays are "earlystage" franchises #150; with fewer than 100 franchisees, and sometimes lessthan 50 #150; that are still testing their business models. If a franchiselike THAT doesn't work out, there's just as good a chance it's thefranchise's fault as it is yours, and the franchise should let you outof the deal. That's easier said than done, though. Not only do most early stagefranchises not give you an opportunity to get out of the franchise ifthings don't work out, they actually impose penalties #150; sometimes LARGEpenalties -- if you ask to be released early. For example, if thefranchise imposes a "minimum monthly royalty" requirement on theirfranchisees, the franchise will require you to prepay all monthlyminimum royalties for the balance of the franchise term, sometimes in asingle lump sum installment. Crunch the numbers: if you have a 10-year franchise term, your minimummonthly royalty is $500, and you elect to terminate the franchise atthe end of Year Three, that leaves seven years remaining on thefranchise term, or 84 months. Multiply that by $500, and it will costyou $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 #150; a very early stage programwith fewer than 30 franchisees nationwide #150; where the franchise gotthis right. Here's how this program works. When a franchisee signs up, she commits to a monthly royalty of 8% ofher gross sales, and signs a "promissory note" agreeing to pay thefranchisor a total of $200,000 in royalties (without interest) duringthe 10-year franchise term. As the franchisee pays royalties eachmonth, the amount paid is applied to reduce the note so that once hertotal royalty payments reach $200,000, the "promissory note" ceases toexist. 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 electsto 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 toone year and the franchisee doesn#146;t owe anything to the franchise. An approach like this one not only gives franchisees a choice of "exitstrategies" if the franchise doesn't work out, but it also demonstratesa little humility on the franchise's part #150; an acknowledgment thatnobody really knows whether the franchise model will work in alllocations, in all economic climates, and under all circumstances. Sadly, most franchises are not as enlightened as this one. If you areplanning to buy a franchise anytime soon, be sure you understandclearly what your "exit strategy" will be if things don't work out. Anddon't buy a franchise if there#146;s even the slightest doubt you can lastout the full franchise term. Cliff Ennico ( cennico@legalcareer.com )is a syndicated columnist, author and former host of the PBS televisionseries 'Money Hunt'. This column is no substitute for legal, tax orfinancial advice, which can be furnished only by a qualifiedprofessional licensed in your state. To find out more about CliffEnnico and other Creators Syndicate writers and cartoonists, visit ourWeb 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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