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Three mistakes when buying a franchise

Three mistakes when buying a franchise: legal advice

From the realities of modern business methods, we can come to an unequivocal conclusion that franchising is a necessary condition for popularizing and promoting the product both in the domestic market and abroad.

And it's not surprising! After all, franchising provides benefits to both the owner of the product and its user at the same time. Thus, by entering into a franchise agreement, the product owner gets the opportunity to grow, and not only in terms of financial performance, but also in scaling the business, covering other market sectors, sales channels, increasing awareness and demand for the product in the market.

And what is the benefit of franchising directly for the user of the product? The same - franchising deprives the user of the product of those risks and losses that businessmen usually experience when starting from scratch. In addition, franchising provides an opportunity for the user to sell a product that already has a name and demand in the market. Additionally, the user of the product receives constant support from a team of experienced professionals who will ensure the prompt launch of the business and its further functioning without errors.

However, when purchasing a franchise, users of the product make mistakes that overshadow all the benefits that franchising provides them and can put their business at risk.
Thanks to the qualified expertise in supporting the entrepreneurial business activities of participants in the HoReCa and Retail sectors, the MK Legal Service team of lawyers has prepared an analysis of three typical mistakes when buying a franchise.

Mistake No. 1. "Penalties of the franchise agreement or Financial trap"

Both the owner and the user of the product must understand that the franchise agreement not only fixes their contractual relationship, but is also a strategy for achieving their goals, which each of them must strictly adhere to. And it is important from the very beginning to build a strategy that will lead them to business development. Usually, the conditions of this strategy are set by the owner of the product, based on his own commercial experience, as well as having the confidence that the "success" of the product is achievable only if it complies with the already established system and methods of doing business.

And, as a rule, compliance with this compliance is seen in depriving the product user of the right to independently make management decisions and implement their own business methods. This happens when the terms of the franchise agreement prohibit the user from independently choosing suppliers, equipment, premises, design; to form the pricing policy of the product; to establish requirements for personnel, implement methods and means of management, operational accounting, and make other decisions necessary for the implementation of the product. To ensure such compliance, the franchise agreement contains exorbitant penalties that tie the hands of the product user. For many years of experience of the MK Legal Service team, there have been cases where fines reached 200,000 thousand hryvnias for a single violation of certain terms of the franchise agreement.

Here are the TOP-5 conditions, for non-fulfillment of which, product owners apply penalties:

  1. Non-compliance with payment deadlines, especially the lump sum and royalties;
  2. Non-observance of deadlines for submission of management and financial reports;
  3. Failure to comply with the obligation to cooperate with an exhaustive list of suppliers, contractors and other persons whose services or goods are necessary for the realization of the product;
  4. Failure to fulfill the product owner's marketing concepts, especially in cases of introducing new "unfavorable" conditions for programs and loyalty systems, certificates, bonuses, discounts, promotions, etc. for the user;
  5. Disclosure of commercial information.

To avoid such a mistake, the team of MK Legal Service lawyers always reminds the product owner of his duty to professionally support the user, without providing a large number of excessive obligations and "financial traps" for their non-fulfillment.

Mistake No. 2. "Failed location"

Being a participant in the HoReCa and Retail sectors is a long-term perspective. And regardless of the object, whether it is a restaurant or a store, the business needs space, and not every location will meet all the requirements that are usually applied to such objects.

Of course, the premises must correspond to the format of the object's: in the HoReCa and Retail spheres, when choosing a premises, special attention is paid to its compliance with fire safety requirements, technical possibilities to install equipment, hoods, grease traps, advertising signage, and provide sufficient electrical power. Otherwise, the user will have to bear the costs of bringing the premises into such compliance.

And finding a place is just the beginning! There are many factors that the user of the product must consider when choosing a space, and even more factors when drawing up a lease agreement.

Here are the TOP-3 recommendations when concluding a lease agreement:

  1. The term of the lease must be at least three years with a preemptive right to conclude a new lease;
  2. Mandatory determination of the prospects for rent growth;
  3. Prohibition of unilateral refusal of the lessor from the lease agreement;

As already mentioned, the lease agreement must be consistent with a long-term perspective. How many cases are there when the owner of a successful establishment was forced to cease operations due to another rent increase? It is for these reasons that the lease agreement must be concluded for a long term with the provision for a gradual increase in the rent during its validity.

The lease agreement may provide for gradual increases of the rent in a fixed monetary unit or provide for an annual automatic increase of the rent in a percentage ratio.
Undoubtedly, this will prevent unilateral changes in the rent by the landlord in the future.

Mistake No. 3. "Unprotected brand"

In the HoReCa and Retail spheres, all participants have been gaining commercial experience and business reputation for many years due to consumer loyalty to the brand. At first glance, the brand is a designation, a certain combination of words, numbers and colors, but the brand itself is the economic component of franchising.

With this in mind, it should be noted that under the franchise agreement, the owner does not transfer the product, but the rights to its use, manufacture and sale according to the technology or recipe developed by the product owner. The owner's rights to the product are also objects of intellectual property that require legal protection.

Thus, before concluding a franchise agreement, the user of the product must make sure that its owner has sufficient scope of rights to the brand and has properly ensured its legal protection.

The established provisions of the Civil Code of Ukraine provide the conditions for granting and determine the scope of legal protection of a brand. Protection of brand rights is granted only after its state registration. The owner and user of the brand have the exclusive right to prohibit any other person from using the brand and any sign that is clearly identical to the brand.

At the same time, in accordance with the provisions of the Law of Ukraine "On the Protection of Rights to Marks for Goods and Services", the brand owner may transfer to any person the exclusive property rights to the brand in whole or in part and only on the basis of an agreement.

Therefore, guided by the provisions of the legislation governing the legal protection of intellectual property objects, the MK Legal Service team always separates the franchise agreement and the license agreement on the transfer of brand rights.

The user can independently verify the availability of legal protection of the brand using the publicly available web resource of the State Enterprise "Ukrainian Institute of Intellectual Property" (Ukrpatent).

Another mistake can lead to the violation of the rights of third parties’ intellectual property rights and the impossibility of further use of the brand.
From the above analysis, it can be concluded that the franchising process contains a sufficient number of legal aspects, which cannot be ignored! Otherwise, the listed mistakes are inevitable.

MK Legal Service is the leader of the Ukrainian market in legal support of HoReCa and Retail sector participants, which will help you not only avoid typical mistakes when buying a franchise, but also give you legal confidence in scaling your own business.

Maksym Kurochko, managing partner of MK Legal Service, lawyer
Serhiy Gusev, head of HoReCa and Retail support practice, lawyer