Thinking about buying a franchise? Read this first

This content is sponsored by Shulman Rogers.

For many would-be entrepreneurs, buying a franchise feels like a smart shortcut.

The brand is built. The system is proven. The roadmap is already there.

But that sense of security can be misleading.

“People think they’re walking into a turnkey operation and everything will be fine,” said Paul O’Reilly, who specializes in business law and leads the Franchising Practice at Shulman Rogers. “They don’t understand the potential pitfalls in front of them.”

The result? Costly surprises. And, in some cases, financial distress that could have been avoided.

For The Legal Lowdown on WTOP,  O’Reilly shared valuable tips about how to go in with your eyes open and negotiate the best franchising agreement upfront.

Don’t get swept up in the pitch

Franchise deals often start with polished sales presentations and a sense of urgency.

“The salespeople are very good at their job convincing the franchisee that they really don’t need outside expertise,” O’Reilly said. They also provide the “best-case scenario” on the potential revenue, he added.

Buyers may be told that a franchise location is in high demand, creating pressure to move quickly.

“Once the sales team senses your excitement, it is all over for you,” he said. “It’s that type of pressure: ‘You need to sign now before you lose the deal.’ ”

What to do: Take a step back before deciding. “Walk away, take a deep breath, call a lawyer,” O’Reilly said. A short pause upfront to dispassionately evaluate the franchise agreement can prevent long-term regret.

A franchise is not a shortcut, it’s a business

Certainly, there are advantages. A franchise can simplify branding and systems, but it doesn’t remove responsibility.

“People tend to forget they’re running a business. They’re the boss,” O’Reilly said.

You are still responsible for:

• Hiring and payroll
• Taxes and compliance
• Rent and build-out
• Day-to-day operations

What to know: If something goes wrong, the burden falls on you, not the franchisor. “If you don’t understand the playing field, don’t get on the field until you’re ready,” O’Reilly advised.

Know your break-even point — exactly

One of the biggest blind spots for first-time franchisees is the money math. The most critical way to reduce risk and drive success is to fully evaluate costs, all the costs, O’Reilly said.

“Break down all your definite and potential costs on a spreadsheet, and find out what that bottom line is,” he said.

Your spreadsheet should include:

• Rent and utilities
• Payroll and staffing
• Loan payments
• Franchise fees and royalties
• Marketing contributions

The result can be eye-opening. “You might find that you have to make $50,000 or $80,000 a month just to break even,” O’Reilly said.

What to know: If you don’t know that break-even number and how long it takes to get to it, he added, “you shouldn’t be getting into the business.”

Hidden costs can add up fast

What’s in the franchising agreement and the disclosure document matters, but so does what isn’t clearly spelled out. Beyond your core cost structure, some of the biggest surprises come from these gray areas.

“Identify the costs that are not assessed but can be assessed,” O’Reilly said.

That gray area can be broad and will depend on the type of franchise:

• Mandatory training or retraining
• Software or system upgrades
• Store remodels or refreshes
• Extra operational support

“Refreshing your space may cost $60,000 or $100,000,” he noted. And sometimes franchisors require that you buy from a list of approved vendors.

What to do: Follow one rule to cover yourself, O’Reilly said. “If it’s not in writing, it doesn’t exist.”

The risk is personal not just professional

“You’re going to be personally guaranteeing the franchise agreement, the lease, the equipment,” O’Reilly said.

And what someone uses to guarantee that agreement can extend to:

• Personal savings
• Home equity
• Retirement accounts

“Some people have depleted their 401(k) and then they end up going bankrupt,” he said.

What to do: Before you sign, understand the fine print and also what failure could cost long term, not just upfront.

Support isn’t always what it seems

Make sure the agreement details exactly what support the franchisor provides, for what amount and for how long. “Often, people go in assuming that they’re getting a lot of support, and they really might not unless they pay for it,” O’Reilly said.

Even required fees may not translate into results. “You’re paying for marketing and, frankly, some franchises do nothing locally,” he said. “How will you drive foot traffic to your business?”

Plus, if a franchise fails to meet corporate standards, a franchisor might require a trainer to come in. And it’s typically the franchise owner who pays for that required training, O’Reilly said.

What to do: Review all the support details in the franchising agreement and understand all the compliance expectations. Then, ask questions. Ask for changes too. Many things are negotiable, O’Reilly pointed out.

Plan your exit before you enter

“What happens when you leave? That’s something people don’t really look at,” O’Reilly said. But planning the exit or renewal strategy should be part of the initial planning process too.

Contracts often include clauses that affect your exit:

• Limit your ability to sell
• Restrict transfers
• Allow buybacks below market value

“Often, if you’re successful but decide you want to get out, the franchisor won’t renew you. Or the metrics are often nowhere near the fair market value if the franchising agreement has a clause that corporate gets the right to buy back the franchise,” O’Reilly said.

What to do: Before you sign, make sure the franchisor has detailed what happens at the end of the agreement and that those terms are acceptable to you.

Build your team — early

People generally have the enthusiasm to become an entrepreneur, but not necessarily the full skill set. “You need a lawyer, you need a good CPA, you need someone who understands business,” O’Reilly said.

Most people wait too long before assembling their team of experts, he cautioned. In his conversations, he estimates that “80% have not been prepared” before they signed their agreements.

What to do: Do an assessment of your knowledge and the related business acumen you bring to the franchise. Then, hire employees or third-party contractors who can fill the gaps. (And add that to your cost spreadsheet.)

The bottom line

Franchising can be a powerful path if you do the work upfront.

“Think: Can I do this? Before signing any agreements, get educated as to your options,” O’Reilly said.

Because once you sign, the commitment is real and legal options can get expensive fast.

For more legal tips and advice, visit The Legal Lowdown on WTOP, presented by Shulman Rogers.