Question: Afranchise arrangement appeals to many prospective businesspersons for several reasons. Entrepreneurs who purchase franchises can operate independently and without the risks associated with products that have never before been marketed. Additionally, the franchisee can usually rely on the assistance and guidance of a management network that is regional or national in scope and has been in place for some time. Franchisees do face potential problems, however. Generally, to avoid possibly significant economic and legal difficulties, it is imperative that you obtain all relevant details about the business and that you have an attorney evaluate the franchise contract for possible pitfalls.

The Franchise Fee Virtually all franchise contracts require a franchise fee payable up front or in installments. This fee often ranges between $10,000 and $50,000. For nationally known franchises, such as McDonald's, the fee may be $500,000 or more. To calculate the true cost of the franchise, however, you must also include the fees that are paid once the franchise opens for business. For example, as a franchisee, you would probably pay 2 to 8 percent of your gross sales as royalties to the franchisor (for the use of the franchisor's trademark, for example). Another 1 to 2 percent of gross sales might go to the franchisor to cover advertising costs. Although your business would benefit from the advertising, the cost of that advertising might exceed the benefits you would realize. Electronic Encroachment and Termination Provisions Even when the franchise contract gives the franchisee exclusive territorial rights, a problem that many franchisees do not anticipate is the adverse effects on their businesses of so-called electronic encroachment. For example, suppose that a franchise contract gives the franchisee exclusive rights to operate a franchise in a certain territory. Nothing in the contract, though, indicates what will happen if the franchisor sells its products to customers located within the franchisee's territory via telemarketing, mail-order catalogues, or online services over the Internet. As a prospective franchisee, you should make sure that your franchise contract covers such contingencies and protects you against any losses you might incur if you face these types of competition in your area. A major economic consequence, usually of a negative nature, will occur if the franchisor can or does terminate your franchise agreement. Before you sign a franchise contract, make sure that the contract provisions regarding termination are reasonable, clearly specified, and provide you with adequate notice and sufficient time to wind up business.

BUSINESS ORGANIZATIONS 718 UNIT SIX CHECKLIST FOR THE FRANCHISEE

1 Find out all you can about the franchisor: How long has the franchisor been in business? How profitable is the business? Is there a healthy market for the product?

2 Obtain the most recent financial statement from the franchisor and a complete description of the business.

3 Obtain a clear and complete statement of all fees that you will be required to pay.

4 Determine whether the franchisor will help you find a suitable location, train management and employees, assist with promotion and advertising, and supply capital or credit.

5 Visit other franchisees in the same business. Ask them about their profitability and their experiences with the product, the market, and the franchisor.

6 Evaluate your training and experience in the business on which you are about to embark. Are they sufficient to ensure success as a franchisee?

7 Carefully examine the franchise contract provisions relating to termination of the franchise agreement. Are they specific enough to allow you to sue for breach of contract in the event the franchisor wrongfully terminates the contract? Find out how many franchises have been terminated in the past several years.

8 Will you have an exclusive geographic territory and, if so, for how many years? Does the franchisor have a right to engage in telemarketing, electronic marketing, and Internet or mail-order sales to customers within this territory?

9 Finally, the most important way to protect yourself is to have an attorney familiar with franchise law examine the contract before you sign it.