What are franchisees’ most common reasons for getting out of a franchise agreement?

1. The franchise location is performing poorly

There are many factors that could lead to financial distress for a franchisee and lead them to seek to exit the franchise system.

• Unrealistic expectations: Franchisees may have entered the relationship without fully understanding the potential risks involved.
• Withheld information: Franchisees may discover that the franchisor failed to disclose crucial information that influenced their decision to invest. In such cases, franchisees may have a rescission claim.
• Misrepresented earnings potential: Franchisees may find that the franchisor provided misleading information regarding the potential profitability of the franchise. This may warrant a misrepresentation claim.
• Financial burden: Excessive royalty fees or other franchise-related costs can place significant financial strain on franchisees.
• Unfavourable location: The location of the franchise may not be conducive to attracting customers and generating revenue.

Whatever the reason, franchisees often seek an exit strategy when concerns about the franchise’s financial viability increase, putting them at risk of bankruptcy or insolvency.

2. The franchise system may be unsound and shows signs of failure

While many franchise systems are legitimate and successful, there are instances where franchise systems prove to be untested or lack the necessary means to support franchisees effectively.

Some signs of an unsound or failing system include:

• Ineffective marketing plans: The franchise’s marketing strategies may fail to generate the desired results or may be inadequate.
• Disappointing products or services: The franchise may offer products or services that do not meet customers’ expectations or fail to appeal to the target market.
• Struggling franchisees: When other franchisees within the system struggle or face difficulties in meeting their royalty payments, it may indicate a failing franchise system.
• Lack of sufficient capital: Franchise systems should have enough liquid capital or reserves to operate effectively, especially during challenging times.

3. A business dispute with the franchisor

Franchise agreements can give rise to disputes if one party believes that the other is acting in bad faith, breaching the agreement, or failing to fulfill their obligations.

The following are areas where business disputes often arise between franchisees and franchisors about their contractual obligations under the franchise agreement:

• Changes to the franchise agreement (e.g., in a renewal)
• Required renovations or upgrades
• Failure to adhere to the requirements of the franchise system
• Failure to meet annual performance standards, where applicable
• Inadequate marketing support
• Disputes over exclusive territories, such as competition from other franchisees or company-owned locations
• Unpaid royalties

4. The franchisor does not provide adequate or ongoing training, support, or communications

Franchisees rely on the franchisor for guidance, communication, and support.  It can be frustrating for a franchisee if the franchisor is not living up to its obligations under the franchise agreement.

If the franchise system has complex operating procedures or proprietary methods, adequate training is critical to the franchisee’s success.

If the franchisor does not provide the necessary training, it can negatively impact the franchisee’s business performance.  A franchisee in this situation often tries to seek independence by exiting the franchise system.

5. The franchisor is not able to adapt or pivot to market changes and disruptions

New technologies, economic downturns and changes in consumer preferences can affect the profitability of a franchise business.

Franchisors should be monitoring the market for factors that could negatively impact their franchise system and adapting their products or services and business model to stay competitive.

It may be that the franchisor is not innovative or able to adapt its business model quickly enough to respond to the changes or disruptions.

This was the case during the recent pandemic closures when many franchisees struggled because they were forced to shut down and the franchisors were slow to adapt.

For some franchisees, a franchisor’s failure to stay on top of market changes and disruptions may signal that it is time to move on and explore alternative business models or industries.

6. The franchisor’s changes to the operating manual and imposition of operational constraints

Franchise systems typically have standardized operating procedures and guidelines outlined in the operating manual.

Sometimes the franchisor can update the operating standards in a way that conflicts with the terms of the franchise agreement.

Other times, these standards and procedures may be too restrictive and cause the franchisee to feel constrained in the operation of the franchised business.  A franchisee in this scenario may start looking for the flexibility of running an independent business.

Conclusion

Every situation is fact-specific.  A franchisee’s decision to exit a franchise system may be influenced by a unique combination of factors and circumstances.

Exiting a franchise system typically requires careful consideration and adherence to contractual obligations, and often results in complex and costly litigation.

Before leaving a franchise system or purporting to terminate a franchise agreement, franchisees should seek advice from an experienced franchise lawyer to review the terms of their franchise agreement and assess the potential implications of terminating it.

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This article is provided for general information purposes only and is not intended to provide legal advice.  Prospective franchisees should obtain legal advice from an experienced franchise lawyer.