Episode 28: What Most Entrepreneurs Miss Before Signing – Franchise FDD Secrets (With Franchise Attorney Kit Higgs)

Shari Currie Skjoldager (00:01.88)
Thank you for tuning in to another episode of the Franchise Sisters Franchise Business Radio Show powered by our company Franchise Intellect, insider knowledge for selecting and investing in a business. I’m Sheri Curry-Skoltaker, your host, and on today’s show we will be getting legal tips from Franchise Attorney Kit Higgs. Kit actually lives in my hometown, Cincinnati, Ohio, so that’s fun.

He founded his own legal practice called Kit Franchise Law in 2019, which focuses solely on franchise law. Kit’s vast franchise experience has included serving in executive leadership roles for several business development companies and franchise systems, including St. Gregory Development Group, Cycle Bar Franchising, Mama Mimi’s Local Bar and Fueled Collective.

And he counseled exponential fitness, which boasts 10 amazing boutique fitness brands with over 2,220 studios open in 48 states and 13 countries. right, Kit is an active member of the American Bar Association and International Franchise Association. When Kit is not behind the desk, he loves spending time with his wife, Fiona, and his son Finley and his dog, Baz. Welcome to the show.

Kit. Thank you. We love to have attorneys. We love your wisdom, your deep experience that we can share with our clients so they can feel more informed and ready to move forward with the franchise. So let’s start out with this basic interview question. Can you kick it off with providing a general overview of what the franchise disclosure document is, also known as the FDD?

Kit (01:25.737)
Thank you. Thank you. Happy to be here. Thank you for having me.

Kit (01:32.432)
Sure, the franchise disclosure document is a document that the FTC, the Federal Trade Commission, requires all franchisors in the United States

give out to franchisees so that they can make an informed decision before they buy. obviously, it’s a great document to look through. The items 1 through 23 are required by franchisors. And then they have to include also a copy of the franchise agreement, multi-unit development agreement, and any other contract you’re signing. But the purpose of the disclosure document, the name is in the title, or the purpose is in the title, it’s a disclosure document. It’s there to let you know about

lawsuits against the franchisor, your expenses, item 19, your perspective, your potential earnings. So you get a better understanding of the franchise system before you buy because this is unlike buying any other type of business. The franchisor does exert control over the system. And so because of that, the FTC steps in and says, all right, before you buy, you should know all these things. And so that’s in a nutshell what the FDD is there for.

Shari Currie Skjoldager (02:54.668)
Very nice, nice overview. All right, let’s dig in a little bit deeper. Let’s get into the expenses and the revenue. So I want to discuss a couple of specific items and all of them are important, but we know money and fees are pretty relevant to understand and understand thoroughly. So I’m kind of focusing in on item five, six, and seven. So we know the item seven is the estimated initial investment.

Kit (03:14.0)
All right.

Kit (03:21.206)
Yes.

Shari Currie Skjoldager (03:22.178)
Can you explain to our listeners what that actually represents?

Kit (03:25.408)
Sure. What you’ve got to emphasize there is it’s an estimate of your initial investments. So franchisors will typically take their franchisees expenses and operating costs to get open for the first three months and put that in this schedule, this item. And so when you look at item seven, if it’s an emerging franchisor and they don’t have a long history and they don’t have experience with having 10 franchisees operating for 10 years, then

They basically take their best estimate. They’ll take their location they’ve got, the pilot location they have, and then add on expenses, add on 30 % depending upon what city they’re in based upon cost of living, expenses, and all of that. So they will come up with an estimate. If they don’t have all this data from a lot of franchisees, they will come up with the estimate, the best estimate they’ve got for the expenses that it will cost you to get this business open and operating. The thing is, it’s an estimate. So if your expenses are more,

than the high number on item seven, that just doesn’t give you the automatic right to sue. And we had a franchisee at Cyclebar. He built out in San Francisco. And he ended up suing us. And one of his claims was an item seven claim. And he said, I built out in San Francisco. It was more expensive than building out in Cincinnati. Well, duh. Yes, it says it. It disclaims that in it. It said, these are based upon our expenses building out in Cincinnati. Yours may be higher. And we naturally did add some

Shari Currie Skjoldager (04:43.63)
Yeah.

Kit (04:52.058)
padding to that, but they thought it wasn’t acceptable and they sued us on it. They didn’t win. You know, it’s an estimate. It’s there to help you understand what your expenses could be. I always tell franchisees when they’re about to buy, talk to existing franchisees, ask them if they regret buying something or if they regret not buying something. Because you get maybe stars in your eyes and you think, all right, I’m going to buy this franchise and you know, I’m going to get the most amount of space. You know, they recommend that we get 1500 to 3000 square feet. I’m going to get the most space.

Shari Currie Skjoldager (04:56.813)
Yeah.

Shari Currie Skjoldager (05:01.208)
Yeah.

Kit (05:20.602)
so I can make the most amount of money. Doesn’t necessarily work out that way. So find out from franchisees that are operating right now if it’s a good idea to get more space or if they regret buying anything. Do you regret getting that extra piece of machinery? If they give the option to buy two starting out, two to five, don’t always go for five immediately, but talk to others. Find out what they say so you get a better understanding so you don’t make those mistakes that other people who are less informed do.

Shari Currie Skjoldager (05:24.462)
Mm.

Shari Currie Skjoldager (05:33.607)
No, that means.

Shari Currie Skjoldager (05:49.891)
That’s great advice.

And that’s why we have the validation step in the discovery process so that they can speak with franchisees to get more of what’s going on at the ground level. And what I like about the item seven is it line items out everything that they believe you’re going to need to invest in. That’s how they get to that estimated investment range, low and high, sometimes even higher, sounds like, to really understand what it’s going to take to get your doors open, which…

Kit (06:15.386)
Yes. Exactly who those who those payments are also going to be made to. A lot of times franchisees come in and think, the franchise or is charged me for this, this, this, this and this. man, they’re really killing them. Well, you find out item seven. No, actually, that money is actually getting paid to a third party vendor. You know, and so you’ve got to understand, all right, this money is going to the franchise or, this is going to a vendor. This is going to QuickBooks. This is going to Microsoft. You know, some of the basics. So.

Shari Currie Skjoldager (06:43.79)
Yeah, that’s all the systems. That makes sense. And then also what we see when it comes to money and fees. And people always want to know are there’s payments, also known as royalties, as well as maybe some other ones. But can you speak a little bit to royalties? What’s the common way in which?

Kit (06:44.025)
got to understand where that money is going to as well.

Shari Currie Skjoldager (07:06.542)
franchisors tend to represent their royalties. it more percent or is it more flat or a mix? Okay.

Kit (07:13.645)
more percentage-based. And then most will have a mandatory minimum that they’ll require you to pay as well. But I see royalties that range from, I’ve seen them as low as 3 % and as high as 30%. And it really depends on the franchise system that you’re buying in. When I go through the royalty section in my FDD legal reviews, I will typically have a prospective candidate say, this royalty is way high. This is higher than all these other brands I’ve looked at.

Shari Currie Skjoldager (07:25.976)
Wow.

Kit (07:41.698)
in what other areas? They’re comparing selling chicken sandwiches to doing garage floors. It’s completely different. And so you have to look at within that particular franchise niche and compare royalties. But also it really just depends on what you’re getting from the system. Are you getting a lot of support and advice and guidance? But the royalty is there to pay the franchise or to give you the right to use their trademarks and provide you continuous support.

But the flat fee is the most common that I see. Typically, it’s a flat fee, it doesn’t change, but some will actually be a graduated step down as you bring in more gross revenue. I really like those. So it starts off at 6%, let’s say, and then for income or gross sales between $0 and $500,000. And then once you hit sales of $500,000, your royalty goes down to 5.5%. And then it goes down incrementally.

Shari Currie Skjoldager (08:09.686)
Yeah.

Shari Currie Skjoldager (08:23.043)
Yeah.

Shari Currie Skjoldager (08:37.834)
Okay.

Kit (08:39.279)
So I really like those. don’t think of actually, I think occasionally I’ve seen one that goes up, but maybe once or twice. And really it was just in the franchise or can increase this by 3 % and they didn’t really say why. So I told my client, make sure you find out. Are they planning to increase the royalty? And when would they do that? But 99 % of the time, the royalty stays the exact same. Doesn’t change.

Shari Currie Skjoldager (09:06.393)
Exactly, and I agree with you. like those what I call scaling royalties where they go down based on operations in your production. It’s kind of a reward basis. Do we not see flat fee, flat based royalty anymore or what’s your opinion on flat based? Is that good or bad or what are your thoughts on that?

Kit (09:28.623)
So part of the job that I really find enjoyable is the way that different franchise systems take the general idea of franchising, which is you’ve got a good business concept and you find somebody locally to recruit employees and create the culture and also recruit the customers because they know the area better than a franchisor would. And so for that, they give the right to operate the system and they pay the franchisor a fee.

My job, what’s really interesting about it is to see how these different systems figure out a way to compensate themselves. The step down royalties, most of them again are static. A fixed flat fee royalty is something that is not often seen, but I just want to know more. Why did you decide to buck the system? Everybody’s doing percentage based royalties. Why did you decide to do flat based, flat fee? And how did you come up with that?

that fit those figures. I just want to know more about why they did that to get better insight into the franchise system and their mindset. So that’s really a question that I’d be asking there if I saw a flat fee.

Shari Currie Skjoldager (10:34.348)
Yeah, yup.

Shari Currie Skjoldager (10:38.542)
That makes sense. love how you really kind of push it back to the franchise where to want to understand more instead of make assumptions. That is the key. Do not make assumptions. Always ask. Get clarification points so then you can make a wise decision moving forward. And then with a course like you were saying as well, industry. Industry can sometimes drive this. We have senior care. We usually see that anywhere from 4.5 to 5.5. It doesn’t really move outside of that.

Kit (10:50.895)
Absolutely.

Kit (11:03.759)
Yep.

Shari Currie Skjoldager (11:06.184)
and then you get into more home service offerings, flooring and things like that, that can be minimum 6 % sometimes goes up to 10%. So it does seem like the industry drives it as well, what you were saying. as always, bottom line is go back to the franchise or ask the questions, understand why they chose this route and then you can determine if you agree with it or not.

Kit (11:28.992)
Absolutely.

Shari Currie Skjoldager (11:30.339)
And then also just sticking with that final point on royalties, you did mention, most often we see percent royalty versus a flat base rate for royalty. However, you mentioned minimum requirements. So that kind of is almost a mix of the two. That’s how I look at it. Can you explain to our listeners what minimum requirements look like and what’s kind of standard in that space?

Kit (11:47.679)
Yes.

Kit (11:57.751)
Sure. Well, the mandatory minimum royalties that franchisors will require you to pay is basically, say, all right, let’s say your royalty is 10 % just for ease, just simple math. It’s 10%. And during the first three months, you’re just getting your business off. You’re figuring it out. And so you’re launching this. And maybe you don’t have any sales in that first month. Maybe you sell a dollar. So you sell a dollar.

the first three months, and your royalty is 10%. So you would owe them 10 pennies as your royalty. A lot of franchisors say you’ve got that ramp up time, so you just owe them 10 pennies. Most franchisors say, all right, after a certain time frame, you have to pay us this mandatory minimum. We don’t want just 10 pennies. So you’ve got to pay us at least $250 or 10 % of your revenue. And that mandatory minimum typically kicks in.

three to six months after you actually open your doors. so franchisors will give you a leeway, give you some leeway and say, all right, yeah, the first couple of months, if you bring in a dollar, we’ll only get 10 cents. After that time though, you owe us, you know, $500, $1,000 a month, whatever those monthly minimums are. So, and you can find out from them why they came up with that certain level. I don’t have a problem with mandatory minimums. I think mandatory minimums are a good thing.

they can indicate to you you’re not doing something right. If you’re just doing the mandatory minimums, you’re at the bottom level. And maybe that’s an indication this is not working out. Maybe you need to go get retrained. You need to figure out what you’re doing wrong and get extra help from the franchise or that’s what they’re there for. But you may just decide, this isn’t right for me. And so the mandatory minimums are going to kind of be your first indication. You’re at the bottom of your class. You’re getting Ds and Fs. This isn’t necessarily working out.

Shari Currie Skjoldager (13:48.93)
you know that makes sense it’s the motivators what I’m hearing you say to really understand what’s going on makes sense. Some other ongoing fees we see often is technology and marketing. Marketing is oftentimes a little bit of a pushback I feel like depending on what they’re asking but what do you tend to see in regards to national and local level ongoing marketing fees?

Kit (13:55.545)
Yes.

Kit (14:14.143)
So the national marketing of the brand fund, I typically see 2%. So they typically require franchisees to contribute 2 % into the brand fund. And then they can increase it to 3 % upon 90 days notice. So that’s standard. What I like seeing when I get to the brand fund section is that the franchisor will contribute equally to the brand fund if they have affiliate locations they’re operating as well. I want to see fairness because they’re

The brand fund is there to, the whole purpose is to increase brand awareness of that franchise system. They can use it to improve their website. They could use it to buy a Superbowl commercial, but it’s benefiting everyone equally. Now, if it’s benefiting everyone equally and the franchisor owns 10 locations, well, those 10 should contribute too. And so I really like when I get into that section to see that the franchisor say, all right, we don’t have to, but we have been contributing to the brand fund on the same

know, same level as you all have.

Shari Currie Skjoldager (15:14.766)
And that makes sense and I’ve also seen and I would love for you to affirm or correct You know for more of those ground level ones sometimes they will even Put some of those marketing dollars into the local space because they’re still building their brand name Do you see that is that is that a an addendum you would have to put into the FDD and negotiate that or how would that work?

Kit (15:33.891)
Yes.

Kit (15:40.732)
No, typically franchisors, they hire really good lawyers to write these documents. And they will future proof the documents to allow for a variety of changes. And they’ll allow for some wiggle room there. And so when you first start off with a brand fund contribution, if you’re franchisee number one, you’re thinking, why am I contributing to a brand fund? Because this is just going to benefit me.

And then you get a second one involved and a third one involved. And now you’ve got 10 franchisees. Well, it’s only just going to benefit those 10. Most franchisers wait a certain period of time before they have 20 or 30 locations open. And then they launch the brand fund. And then from there, it may be spending money somewhat regionally. You know, they can do that. They don’t have to spend money just nationally. So the allocation of money, you want to look at the fine print there and just make sure, all right, they are going to be spending money.

on me, it’s going to trickle down to me somehow. You want to see that the franchisor says they’re not going to use it to solicit the sale of new franchisees. I’ve only seen that happen a couple of times where the franchisor says, we can use the brand fund for anything. We’ll use it to solicit sales of franchisees. I don’t like seeing that. I want it just to be used for marketing. You are creating this or you’re contributing to it, so you should get the benefit of

Shari Currie Skjoldager (17:01.869)
Yeah, focus completely on brand awareness and so people get familiar with the brand. Wow, I didn’t know that about the other side. And then also there are there’s some negotiation. Do you find there to be wiggle room in regards to that minimum royalty requirement? If it’s three months, do you think he can move it to six months or do they not really like that kind of pushback? Okay. Okay.

Kit (17:05.72)
Yes.

Kit (17:26.425)
They don’t really like that pushback on royalties and fees. I hope and I assume that they went through that with a financial analyst and really figured out the numbers they need to make this brand healthy and survivable and make sure that you’re still as profitable as possible. So it’s a calculation. So I don’t think they appreciate it when you go in and you tweak those numbers like that. I rarely find franchisors will allow you to change that.

In fact, I just did an FTD review right before this call and the franchisor did not have the mandatory minimum started on day one. And I said, that’s unusual. And I said, you can ask them to change it, but they’re going to say no. What I’d really have a discussion with them about is why, why didn’t you allow me to have six months of no mandatory minimum? Why didn’t you? Because that’s what most do. You know, it’s either three or six months. This one started immediately. So it’s not really about changing the royalty. It’s about understanding

why there’s a mandatory minimum that kicks in immediately.

Shari Currie Skjoldager (18:27.983)
Interesting and when you make those modifications, let’s say they are generous because you are the first franchisee So they say hey, let’s push out to six months. Definitely that doesn’t necessarily carry over to anybody else who comes through That’s a little bit more specific to the relationship of you with the franchise or in the situation that you’re in versus somebody who’s coming through 30 40 other franchisees behind you

Kit (18:50.415)
Absolutely. The franchisor can make tweaks to your franchise agreement and make modifications to those terms. Certainly. They just write up an amendment or an addendum. then if I were representing that prospective franchisee, I’d say, all right, great. Send it to me. I’ll review it in 10 minutes and say, it looks good. Because those amendments or addendums typically are two pages. But there’s really only one paragraph that says,

what you’re getting. The rest is legalese and boilerplate language. So you just look for that one paragraph. Yep, says this change. Your mandatory minimums don’t start for six months. Great. There you go. So very easy fix if the franchisor is willing to do it. But I’d certainly if you’re concerned about it, ask them. Have a discussion about it.

Shari Currie Skjoldager (19:36.534)
Always ask, I like it. Okay, let’s get out of expenses. Let’s get into revenue. Item 19, financial performance representation. I’m going to start out with this first question. Is it a red flag when a franchise award does not have an item 19 completed?

Kit (19:54.539)
No. No, it’s not an automatic Red Fly. No. No. So when I see Red Fly, because we had the same discussion when CycleBar first launched, because we had a business that we had created, but nobody was operating under the CycleBar name. They were operating under previous names. We combined these two businesses together to create CycleBar. So we didn’t have a track record.

Shari Currie Skjoldager (19:55.983)
Great. Okay, tell me why.

Kit (20:20.111)
of a business operating under the cycle bar name. We had a track record of businesses doing the exact same thing, but they weren’t using our trademarks and they weren’t using the specific system. So we wrestled with whether or not we should include an item 19 in the first year, because if we had numbers that maybe were somewhat misrepresentative, if they seemed like it was, you’re buying this business, but the item 19 shows the financials of a business that’s operating under different systems.

Well, then why are you including it? If these are two different business systems, why include it? So emerging franchisers wrestle with that all the time. Should I include it or not? If you don’t include it, some people say that’s a red flag. well, they’re not showing their financials. And there was a brand that I reviewed a couple of months ago. It’s been in operation for 15 years. So it’s an established brand and they don’t disclose financials. They just say, all right, talk to our franchisees, find out from them.

Because it is item 19 and item seven are the number one areas where franchisees if they have filed a lawsuit against the franchise or you’re always going to ledge item 17 or I’m sorry, item 19 violations and item seven always. So if the franchise or is very cautious that they’ve been sued before in other areas and they just don’t want to deal with it. Maybe they don’t include an item 19. It certainly it certainly raises some eyebrows and antenna.

Shari Currie Skjoldager (21:34.286)
Okay.

Kit (21:48.591)
thinking why did they not include this information? Why did they decide to make that decision? And if you talk to them and find out, oh, it’s because x, y, and z, if that’s a good answer to you, then move forward. Talk to a franchisee. Validate those numbers with them. You should do that anyway.

Shari Currie Skjoldager (22:07.724)
Yeah, and it’s funny with those more mature brands. I’m 19. Was it even that popular five, 10 years ago? It just started getting really hot. It takes a lot of time for the franchisors to gather that data, scrub it to make sure it’s accurate because now they’re liable for putting correct data in there. And so there is a little bit of angst to put it in there.

Kit (22:31.024)
And sometimes I’ll review an item 19 and think, why did they disclose this number? They’ll just disclose. was one where they disclosed they took all their aggregate franchisees gross sales and they had 20 of them that had varying territory sizes and they were multi-unit operators and they just combined all their gross sales together and said, combined our system brings in this amount of money. This is what it brought in last year and that was it. Like, wait a second, hold on.

I can’t figure out what one individual business did, let alone figure out their expenses to find out. So item 19 actually created more questions. And I thought, all right, well, they included this information. Now it’s actually kind of a red flag here. Like, why did they include this information that has no relevance almost to me? I can’t use it. So I’ve seen some really bad ones.

Shari Currie Skjoldager (23:11.724)
Yeah, I…

Shari Currie Skjoldager (23:15.566)
Yeah, I agree with you. I’ve seen that in FDDs too where they do an aggregate and I’m not a fan of that either but maybe it’s a way of checking the box. I don’t know. Just to kind of get something in there.

Kit (23:27.459)
Yeah, that’s really sometimes franchisers just check the box. And I don’t like I don’t like seeing that. I want to see them give you as much information as possible. I want them to be as forward and honest. That’s how you know, it’s a business partnership.

Shari Currie Skjoldager (23:30.872)
Yeah.

Shari Currie Skjoldager (23:41.615)
And the good news is that they don’t have item 19 because it can be challenging sometimes especially if you have a bunch of what I would call more owner operator models so a lot of people just kind of funneling a lot of expenses through their P &L which is standard. You have a step in the process that allows you to dig in more thoroughly anyway.

to really understand your return on investment much more than the item 19, even if it does have a little bit more detail in it, but potentially give you. So just know that you can get to that data. It just might not be through the FDD. Okay. Alternative way. So for those people that do have an item 19, do you see a more of a standard way of presenting? Is there any way that…

Kit (24:14.927)
Exactly, exactly, find an alternative way to get it.

Shari Currie Skjoldager (24:25.166)
Like you said aggregate that might be more of a red flag versus a standard way that is more reasonable And no you can’t necessarily expect an EBITDA in there But you can certainly get to high level numbers to get you started before you start validating

Kit (24:38.819)
Yes, I always like seeing a beta in there, of course. But I mean, just starting out and just looking at item 19, is it easy to understand? I want to look at this and not have to have a PhD in math from MIT. I want to be able to just actually look at this and say, that makes sense. And this is why they’re including that information. Sometimes it’s very apparent when they talk about first year results, essentially, and then they talk about

Franchisees who’ve been in operation for three years or more, they emphasize, all right, these are their gross sales, and these are a beta number. So they’re really kind of pushing you to understand that the ramp up time may take a bit. It may take you three years. So when you see multi-years, and they’re really stressing that, multi-units, maybe they’re saying, all right, well, kind of pushing you along. One, you’re going to get some money, but if you buy three, this is really where the sweet spot is.

And so sometimes you can glean that information from the information presented and see, all right, they’re kind of pushing me in this direction, letting me know that, yes, I need to actually stick it out for three years, or maybe I should own multiples in this instance. So those are other issues that I see in item 19s.

Shari Currie Skjoldager (25:48.238)
That’s very good point. And I have read item 19s as well, thinking the same thing based on exactly what you said. this requires multi-unit to get to a certain number. Or this is going to take a little bit of time to ramp up, which is perfectly fine. It’s just going in with eyes wide open, which is what we want everybody to do. All right, let’s move on. Item 12.

Territory definition. What can you share about item 12 like maybe brick and mortar versus service based? How do they figure out territories?

Kit (26:18.864)
So that was one of the questions that I first had when I was writing these. And so we hired a really good law firm to help us write the initial franchise agreement and franchise disclosure document. I had questions about that. So you’ve got territory. Typically, it’s defined in a mile radius around a pin dropping at your specific location. Typically, it’s a two to three mile radius. But sometimes I’ve seen drive time, seen 10 minute drive time.

So you’ll get a territory based upon a 10 minute drive around your territory. And so they will make that your protected area where they will not allow another franchisee to operate in it. And that’s based upon where they think you’re going to get customers from. The average customer drives 10 minutes. So your territory is going to be 10 minutes. But if you’re in more of an urban dense territory, they may have it defined by blocks. You get three of

10 block radius, because if you’re in Manhattan, it’s quite different than if you’re in Cincinnati, Ohio. You’re going have a different size territory. Those are typically pegged, though, at population size, too, 100,000, 200,000 people. Sometimes I see them get more granular. For one that’s teaching infants how to swim, they will have included in their population 20,000 kids age nine and under in the territory.

So it really kind of depends on what the franchisor is selling ultimately to the customer, how they define their territories. So I’ve seen a wide variety.

Shari Currie Skjoldager (27:53.519)
Yeah, absolutely. I agree with you. And in the whole radius and the 10 minutes away, do you feel like that leans more if you’re doing brick and mortar versus population based or income level? I’ve seen that number of single homes in the area. That’s maybe more specific to service based businesses and determine what your territory is. Do you think that’s Okay.

Kit (28:20.57)
Yes, yes. And when I’m looking at territory too, besides this the basic definition of your size of your territory, franchisees are going to splice and dice that a lot of different ways. I want to find out what’s the extra territory or the other extra territory issues or rights. What about if there’s a territory next to me that’s open? Can I solicit customers from that?

What if a customer reaches out from there to contacts me? Can I service them? What happens when a franchisee buys that territory? I mean, all the different things that happen with it. So it’s not just in your territory, it’s what happens outside of that as well.

Shari Currie Skjoldager (28:59.118)
Absolutely. And that kind of leads into the next question, which is understanding what protected territory means, what does exclusive territory means, and just what does that look like and what do you consider a red flag versus not a red flag when it’s in there?

Kit (29:17.495)
Yeah, so I’ve definitely had a bunch of clients say, when we get to this section, when they see the word exclusive or non-exclusive, they see, oh, this is a non-exclusive territory. They’re thinking, all right, well, hold on. I thought I had some protections here. You do. The next paragraph will say, your territory is non-exclusive. However, provided you’re not in default, we will protect your territory. We will not allow another franchisee to go into it or operate out of it.

Most franchise systems will say non-exclusive. I’ve only seen a few where they’ll actually say exclusive and I think that’s a mistake. Because there are certain instances where the franchisor can service a customer in your territory. Typically the franchisor is going to reserve the right to sell things online. They call it alternative channels of distribution. They’re typically going to reserve that right for themselves only. So they’re going to sell things online. Well, if they sell something to a customer in your territory, well…

That’s competing against you. So therefore, your territory is non-exclusive. And then for national accounts, they can offer you the right to service a national account, provided you’re not default. But you could be in default. They could say, we don’t want to have you service this national account, so we’re going to do it. Well, if they go into your territory and service a customer, that’s competing against you. Again, another reason why they say it’s non-exclusive. So they will protect it, but they will put guardrails around that and say, all right, if

Shari Currie Skjoldager (30:16.834)
Mmm.

Kit (30:42.319)
So long as you’re operating according to our standards, we will protect it. And even if population changes, typically they’ll say, your territory is not gonna change. It’s not gonna go up or down if you’re in a city that all of a sudden just blows up like Asheville or Austin, it’s really popular.

Shari Currie Skjoldager (31:01.218)
That’s very interesting. so we often hear the territory is protected, but it’s more guardrail protection kind of, think that’s how you put it. And that, you know, performance is needed and certain guardrails need to be put in place to maintain the reputation of the brand, especially if they’re offering national accounts. Cause when they’re offering national accounts and you’re new to that territory, that

maybe their national counselor in, they may say, let us service them for now. You build up, you get fully informed and you feel good about your business and we’ll slowly bring it over your way. But initially, we want to make sure that we are meeting the demands that all of our national counselor are being met well, so they remain secure throughout the nation.

And then also, I think what I heard you say is just from an operator perspective, they want to make similar. You’re just trying to make sure everybody’s being served the way they need to be served in order for that brand name recognition to stay strong across the nation.

Kit (32:10.557)
Yeah, and just also prevent infighting with other franchisees. You’ve got a lot of issues with franchisees sharing employees. If they’re next to each other, could have a really a star employee get poached by another franchisee. So there’ll be protections put in place there. I’ve seen them say, all right, if you poach an employee from another one and they went through training a year ago, you have to then reimburse the franchisee that

that hired them later on for the training expenses. And so they will allow you to hire somebody from another franchisee, but you have to pay for their training. So, you know, they come up with these different ways to really protect your territory, not just for customers, but also your employees and just, it’s your home turf.

Shari Currie Skjoldager (32:41.059)
Wow.

Shari Currie Skjoldager (32:56.556)
Yeah, I like that. And I like how you also brought, I never thought about that piece, by the way, I also like how you brought up, see what territories around you are still available. And you might not want to invest in them yet, but that doesn’t mean you can’t serve them and just really understanding what your options are within your own territory first, but any neighboring territories that have not been sold yet, what it looks like before the sale and what it looks like after the sale is very important to understand. Very good.

Kit (33:24.139)
Absolutely, yes.

Shari Currie Skjoldager (33:26.658)
All right, let’s get into some more, maybe more complicated stuff. And those are clauses that can sometimes create discomfort with anybody who’s going through the franchise discovery process and reviewing the FDD. All right, the first one I’d like you to find clarification on if you can, is a well-known common clause called liquidated damages. What is it? Is it always in there? Why is it always in there? And why should we not be afraid of it?

Kit (33:55.858)
Sure. So a majority of franchise agreements have it in there. I don’t have a specific number of the ones that I’ve reviewed, but it’s more common than not.

Shari Currie Skjoldager (33:59.287)
Okay.

Kit (34:05.283)
and, and, it’s, the most common issue that franchisees bring up. they are freaked out by it. And what the liquidated damages provisions allow allows for is, is allows for the franchise or to pursue you for damages based upon your failure to own the franchise or operate it for 10 years. Now, in theory, basically the, the franchise or has come up with a way to figure out how to compensate themselves through royalties and brand fund contributions.

Shari Currie Skjoldager (34:13.166)
Thank you.

Kit (34:35.024)
in exchange for them giving you the rights to use their system. And they figure it out for typically their period is 10 years. So you’re typically going to operate your franchise for 10 years. You’re to be able to recover your investment costs, make some profit, and so is the franchisor. And so this is a mathematical equation they come up with. So they want you to operate for 10 years. Now, if there’s a problem in the relationship within those 10 years, and you have to leave, you’re not operating well. You get terminated. So liquidated damages is really

for termination for your default. So you’ve done something wrong. And so the franchisor will call it out and say, all right, we’re going to terminate you because you violated this section of the franchise agreement. And it’s something severe. This is their nuclear option. This is not as typical, you did this wrong. Now we’re going to sue you for liquidated damages. Now, if all else fails, this is the nuclear option. They can resort to this. And so if you terminate or get terminated early,

through your default, they can use that to then say, all right, since you got terminated in year three, you owe us for seven years of future royalties and brand fund contributions. Now that is a blanket liquidated damages clause with really no term or no set coverage or amount. But most liquidated damages clause that I see typically aren’t these unlimited where they say if you terminate on day one, you’d owe us for nine years of royalties.

they typically have a cap on it. It’s typically three years or two years. So if you violate the franchise agreement, you get terminated. They can sue you for the liquidated damages clause, and they can get the royalty funds and brand fund contributions that you had made over the previous 12 months. They take an average of that, and then they multiply it by two or three years. And then sometimes they have a set amount that they say it can’t go below. And liquidated damages clause, every time franchisees see it, not only is it somewhat confusing,

to somebody who’s never seen it before and you’re trying to do the calculations and you think, what’s this number going to be? Really, it’s again, it’s there as this nuclear option. Franchisors hopefully shouldn’t have to use it. It should hopefully bring you back into the fold and you hopefully will not do what they’re threatening you to, why they’re threatening you to use this liquidated damages clause. So typically it’s just used as a threat. I’ve actually never used it in court. I’ve threatened it.

Shari Currie Skjoldager (36:44.97)
Exactly.

Kit (37:00.484)
I’ve said, all right, if you keep on selling from this bootleg website you created, then we’re going to file suit against you. We’re going to pursue you for liquidated damages. I’m sorry. OK, I’m going to stop doing that. So really, it shouldn’t be a problem unless you’re doing something wrong. So if you plan on doing something wrong, well, yeah, then really look hard at the liquidated damages clause. But my job as the FTD review lawyer is to protect the franchisee. And so I will always say,

If there’s liquidated damages clause, talk to them about it. Find out why they have it in there, when they’ve used it, why they’ve used it. So you can feel more comfortable about it because most franchisors when you bring it up to them, they’re not going to say, all right, we’re going to get rid of it. They should hopefully tell you why they’ve got it and explain it so you feel comfortable. yes, that’s never going to be used against me. So I don’t need to be concerned about that. That’s the way that I always approached it too as general counsel. And I, in fact, never did use it. I threatened it.

I never used it. So it’s scary because they can go and try to get liquidated damages from you. But a lot of states say they’re invalid and a lot of arbitrators really don’t like it too. So it’s one of those clauses that it’s there for a reason. You’ve got to protect the franchise system. You know, if you’re selling drugs, you’re doing something really bad. They want to prevent that kind of harm from affecting all franchisees. So they need some sort of nuclear option to bring people into compliance.

That’s the liquidated damages clause. Again, it’s there for a reason. Most franchisors won’t remove it, but you can at least have a discussion on it about that and understand why it’s there.

Shari Currie Skjoldager (38:39.8)
I love, I love you, you always come back to ask the franchisor and I love the question that you said, have you ever had to use it? Because I’ve heard, I just had somebody reviewing something and I ended up talking to the franchisor a little bit, right Sherry, we don’t use that. It just has to be in the FDD. That was them though. Not always the case for everybody else. So investigate.

Kit (38:56.657)
Hup.

Kit (39:00.461)
Yes, a lot of times they’ll say, don’t know, our lawyers said to have it in there. They may not even understand it themselves.

Shari Currie Skjoldager (39:05.612)
What in the time it takes for it, it really worth the litigation process to get that money? Or is it just a good tool to realize, hey, we need to separate here. Let’s separate.

Kit (39:14.159)
Yeah. If you’re a franchisee and you fail, you’ve followed the system, you’ve gone through the right training, you do the marketing, you do everything the right way and you fail, the franchisor is not going to use the liquidated damages clause against you. That’s for bad actors. It’s not for somebody who makes a real good effort. So I always kept it in there just for the bad actors. Never had to use it.

Shari Currie Skjoldager (39:26.584)
They’re not going to come after you. I win, thanks.

Shari Currie Skjoldager (39:38.614)
Yeah, you have to keep it in there for the bad actors because there are bad actors out there that could really ruin your business. It’s almost not optional, I would think. Now that I think of it from that perspective. Okay, let’s move on to another one. Personal guarantee. That’s another scary one for people. Can you explain to our listeners what does that mean? Is it just the person buying into the business or do their spouse, do they also have to sign it? Just explain it.

Kit (39:54.98)
Yes. So I have never seen a franchise agreement that does not include a personal guarantee. So you will always sign a personal guarantee no matter what. And the personal guarantee is guaranteeing the obligations under the franchise agreement. The financial obligations, also the non-compete, non-disclosure.

Shari Currie Skjoldager (40:13.026)
Okay.

Kit (40:24.783)
They don’t want you harming the system by disclosing their trade secrets or competing against them or other franchisees. So the financial aspect is the easiest. All right. You you own 10 grand, you shut down. Well, they can come after you personally for the $10,000 that you owe them. It’s a personal guarantee. Now, a lot of franchisors will also say your spouse has to sign a guarantee too. And we required that at CycleBar as well. And the reason why we required the spouse to also sign a guarantee

wasn’t for the financial obligations because when you sign, you are putting your marital assets up there. You’re guaranteeing your marital assets. Now, if the spouse has separate assets, those can’t be touched. So spouses say, all right, well, if I’ve got separate, you know, if I were previously married and I’ve got separate assets, I want to keep them separate. That’s when typically the spousal guarantee discussion occurs, is the spouse has separate assets. If it’s all held jointly, there’s really no discussion about the spousal guarantee.

for the financial obligations. just, your spouse already signed up and they’re guaranteeing the obligations. But a lot of franchisers will say the spouse also signed a guarantee because they don’t want them learning about the business. And you go to bed talking about, my gosh, this is a terrible day of the franchise or it was a great day. They’re learning about the model. They’re learning about the system. They could literally learn this and go create a competing business. So they want to prevent the wife, husband, partner.

from going out and competing against the franchisor. So they typically also have them sign a guarantee, even though the wife or husband is not going to be involved at all. Sometimes the guarantee is just there as it notice, hey, wife or husband, your partner is buying this franchise and we want to make you aware that your assets are at risk because of the guarantee. So sometimes it’s just a notice. But I really like it to prevent the spouse from learning about the business and going after them.

Shari Currie Skjoldager (41:58.734)
Mm-hmm.

Kit (42:19.703)
If the spouse is not involved, really don’t think they should sign a guarantee. They have something called a spousal acknowledgement form sometimes where it says, all right, I’m not signing a guarantee, but the financial obligations, I’m really signing guaranteeing say, I’m not going to disclose trade secrets or compete against you because I’ll definitely be learning about the business just through osmosis.

Shari Currie Skjoldager (42:39.894)
makes complete sense. actually might have a situation where that’s happening so that makes a lot of sense. Thank you for that. Okay let’s talk about this happens more often than I’m surprised at how often it happens where somebody comes in and they want to get into a franchise but they don’t have the financial strength to do it so they look for investors who don’t want to operate it they’re busy doing other things but they’re happy to invest in it. We call them passive.

usually passive investors. How does that look on the franchise agreement? If I have my parent helping me buy the franchise, does my parent now have to sign the franchise agreement as well since they’re putting the money up?

Kit (43:19.804)
Yes, typically there’s a threshold of five or 10 percent. So if you own five or 10 percent, you have to sign a guarantee. so franchise or is may even increase at the 20 percent. They say as long as somebody owns below 20 percent, we don’t need to approve of them. But if you own five, 10, 15, 20 percent depends on the franchise or they’ll say you’ve got to sign a guarantee guaranteeing the financial obligations and also

signing a non-compete non-disclosure because you own a piece of this business. So it depends on the franchise or how much paperwork they want you to sign or your other owners to sign.

Shari Currie Skjoldager (43:58.99)
So if the investor is going to invest in the money and want to own a piece of it, then they have to disclosed to the FDD and they probably have to sign the franchise agreement and the franchisor will decide what percentage. If the investor doesn’t want to own any of the business, they’re just wanting to help their child or somebody who is asking for their money, do they have to sign the franchise agreement?

Kit (44:27.134)
So we faced that question early on with Psychobar. There was a very rich relative of this franchisee that was buying

Franchisee himself did not have the money and his uncle was putting this money up. And his uncle said, I don’t want to be in the guarantee though. We figured out a workaround there. We talk with them, we talk with a franchisee and figure out some assurances because we just wanted to make sure that our bills are going to be paid. And so it really depends on the franchise or that’s where they can get creative with their lawyers and come up with a good way. Because if you’re a good franchisee and you’ve got a little bit of a different situation,

Hopefully they can come up with a way to bring you in, get creative. All right, well, you know, maybe, maybe your rich parents are saying, we don’t want to be on the guaranteed and the franchise are saying, absolutely, they must be on the guaranteed. Well, have a conversation about it. You know, you both want, want the same thing. Essentially you want to end to this franchise. They want you in. So let’s, let’s figure out a workaround here. You know, they, have the ability to craft and I’ve seen really good, you know,

just tweaks to the franchise agreements where they do allow for certain circumstances. And that’s what good franchise lawyers do and good franchisers do. They figure out ways to allow good franchisees in and make exceptions.

Shari Currie Skjoldager (45:48.97)
I it. I like the bottom. Again, we come back to go to the franchisor, discuss your concerns and figure out a way to work together as a team to make this work.

Kit (45:56.312)
They’re. Yeah. Absolutely, their business partner, so don’t look at them as an adversary. A lot of my job is really explaining that there, you know, because you’ll get these these these clients that say, well, I want to buy this, but it’s so one sided, the franchise or just sounds like a jerk. They can do all this stuff to me. No, no, no, this is a business. You’re looking at the wrong way. This is a business partnership. They have to write it that way because the documents good for 10 years. They’ve got a future proof it and allow themselves.

Shari Currie Skjoldager (46:05.453)
Yeah.

Kit (46:24.527)
to adapt to market changes, competition, all of that. So if they had a static agreement, they would be handcuffed and the business would fail. So you want to see that they have the ability to pivot and modify their system.

Shari Currie Skjoldager (46:41.13)
sense. So that being said, you see, I know we talked a little bit about, you know, guarantors and things like that who can help you fund it, but do you, it’s my understanding that if the system is mature, the odds of making any addendums to the franchise agreement, FDD, is significantly reduced versus if it’s more ground level.

They have less than 15 franchisees. They might be willing to work with you in certain areas to help you onboard and get your business up and running. So do you have any specific areas that tend to be a little bit more negotiable for those less mature brands that are still trying to build up their franchise system?

Kit (47:27.407)
Well, actually, with making modifications and changes, you’d be surprised at which ones do. I’ve actually found that some of the more mature legacy brands, would think that they don’t change anything. Well, they also have established lawyers that know how these documents work. And they may say, all right, that little clause, it’s never used. Like, yes, we can tweak it. So you may have more of a legacy brand saying, oh, yeah, no, no, no. In reality, we never.

Shari Currie Skjoldager (47:32.812)
Okay.

Kit (47:56.628)
resort to this. So yes, we can make this modification. No big deal. it really, you know, I’ve seen franchisors change things in the first couple of years that they’ve launched. And then some that say we’re never going to change anything. So it does it does matter or it does depend upon a variety of situations. And I always tell my clients, look, if you want something, ask for it. Because there’s really no

set answer or rhyme or reason for why a franchisor would make any sort of modification to anything. They may say, we really need a franchisee to go in this territory. They may say they really like you. And they’re willing to make this little modification just for you one time. So it’s always ask, ask, ask. Now, some of the low hanging fruit areas, transfer fee, renewal fees, they’re typically $10,000 or

25 % of the then current franchise fee. So you can sometimes go back to them and say, all right, well, if I renew, I don’t want to have to pay. One renewal was 100 % of the franchise fee at the then current time. So there’s no discount. If you renewed 10 years from now, you didn’t get a discount on the franchise fee. I thought that was strange. because most of the time, franchisors say, if you want to renew, you only have to pay us $10,000. So some franchisors will change that right now. And they’ll say, all right, well,

Shari Currie Skjoldager (49:12.675)
Yeah.

Shari Currie Skjoldager (49:18.732)
Yeah.

Kit (49:23.054)
or remove the renewal fee. And then you think you’ve got a victory. That’s fine. They can also waive that fee later on in 10 years. When you want to renew, they can say, all right, well, you’ve been a really good franchisee, so we will waive fees. So they can waive it now. They can waive it later. It all depends on their philosophy. And so some of the things they may want to just leave for negotiation later on, transfer fees. If you’re a bad franchisee,

Shari Currie Skjoldager (49:40.13)
Very nice. Yeah.

Kit (49:50.191)
I’m going to waive the transfer fees. I want you to get out. I want you to have every incentive to get out. So I will lower the barrier and say, all right, that transfer fee, we will eat it because we want you out. We want that new buyer in. So transfer fees are also some things that can be negotiated later on. You can talk to them about it now, but they can say, well, look, we don’t know who you’re selling to. We don’t know the circumstances. We don’t know if you’re going to be a good operator. So why would we waive these fees that normally we’d be entitled to?

Shari Currie Skjoldager (49:53.202)
Hahaha

you

Kit (50:20.184)
So rights of first refusal, those are generally disfavored. All right, well, I’m going to this territory. There’s nobody around me. If somebody goes east of me, I want the first right. But it slows down the system there. Typically, that’s a of a handshake agreement on rights of first refusal for territory around you. But you can ask them about that. Delaying your opening, that’s a common one.

And that’s fairly simple for a franchisor to do is say, all right, well, you you could have a major life event coming up, your kid’s graduation, you can’t miss it. Therefore, you can’t go to training during that time, which means you can’t get open by their deadline and it screws everything up. So they may say, all right, you don’t have to go through training until this day or, you know, we can delay your opening. But don’t typically, I don’t see franchisors changing the development schedule. I get asked that all the time.

Shari Currie Skjoldager (51:14.572)
okay.

Kit (51:15.817)
They want me to get open within nine months. Yes, absolutely. They want you to get open with nine months. If you ask them right now to modify that, they’re going to say no, typically, because if they gave you 12 months, you’re going to take all 12 months. We’re naturally procrastinators. So they want you to see you making commercially reasonable efforts to get open during that nine month time frame. And then if you have a reason where you know that you’re not going to be open in time, ask them for the extension then.

Shari Currie Skjoldager (51:29.646)
We are. Yes.

Kit (51:45.124)
and they will grant it most likely. They’ll say, yeah, we’ll give you an extension. If it’s not in the business of terminating you, they want you to get open. So they don’t want you to go and modify the franchise agreement terms for development schedules right when you get started. They’ll give you modifications later on if you need it. and you know, I’ve had a couple franchisees clients ask me recently, within the last couple months, I want to change the royalty. Like get out of town. And I’ll tell them, look,

Shari Currie Skjoldager (52:02.606)
Makes sense.

Kit (52:14.071)
I know that I always tell you, you if you want to ask or you don’t get what you don’t ask for, but you could, if you’re asking for some things and you’re asking to make all these significant changes, the franchise system, well, then you’re making it more of yours and not the franchise or why are you buying their system? If you think you can run it better. And so if you ask a lot of these questions, let’s change the royalty, let’s change the term. I would flag you as a franchise or say, this is going to be somebody who’s going to be difficult to operate.

Shari Currie Skjoldager (52:43.33)
Yeah, might not be a good partner. Yes.

Kit (52:43.587)
They wanted to change everything. Yeah. And so I would flag it as, as, as the franchise or and say, I don’t think they understand how franchising works. You’ve got to follow the system. You’ve got to follow the model. That’s what you’re buying.

Shari Currie Skjoldager (52:55.82)
Yeah, we’re trying to find a middle ground where everybody lands. And if you’re taking, taking, taking, that’s kind of a red flag for the franchise. So I think you’re 100 % right there. So, okay, Kit, this has been awesome. Boy, you have shared some great information. Thank you so much. Is there anything that I missed that you really wanted to share with the listeners I didn’t ask?

Kit (53:10.361)
But I’m glad, glad to hear it.

Kit (53:17.935)
So no, no, I think we’re Yeah.

Shari Currie Skjoldager (53:20.236)
Wow, I think we covered quite a bit. I agree with you. All right, let’s wrap this up. At the Franchise Sisters, we always like to wrap our podcast up with a final question for our guest. And here’s the question. In closing, what tips would you give to budding entrepreneurs?

Kit (53:38.959)
All right, so if they’re buying, if these budding entrepreneurs are buying a franchise, always hire a franchise lawyer to do an FDD review. As number one, as part of your due diligence process, hire somebody that knows what they’re looking at. Don’t go and hire just a regular contract attorney. They’re going to make, it’s going to look ugly. Hire a franchise lawyer. It doesn’t have to be me. Hire somebody competent, but you better know what you’re getting into before you buy it. Because otherwise it’s too late and you’re signing blind. Why would you ever invest?

Shari Currie Skjoldager (53:45.133)
Yep.

Kit (54:08.451)
hundreds of thousands of dollars in the system when you don’t know what you’re investing in. Make sure you understand that.

Shari Currie Skjoldager (54:12.492)
Yep. % agree with you. 100 % agree with you. And the type of lawyer is critical. I have seen where someone says, I’ve got a friend of a friend who is a lawyer, and it didn’t work out because they didn’t understand franchise law. It took way longer. The way they charged him was not standard. So yeah, get a franchise attorney when you get an attorney. Absolutely.

Kit (54:27.183)
Absolutely.

Shari Currie Skjoldager (54:42.838)
Okay, I love it, Kit. So good to have you. All right. Obviously, thank you for being a guest on the show, Kit. And to our listeners, if you’re listening and considering franchise ownership, request a free Franchise Sisters consultation call. And we would also like to send you our ebook, Top 10 Questions to Consider Before Infesting in a Franchise. Our mission is to help you navigate the franchise selection process.

Kit (54:49.05)
Thank you.

Shari Currie Skjoldager (55:07.182)
through our client-centric align methodology and to put you in a position to make an informed decision with the help of our Investigate Before You Invest Toolkit. Thanks for tuning in as always. Fist pump.