Buying a Franchise in Canada. Tony Wilson

ten ( 10 days of the date hereof, the Applicant understands that the deposit referred to in paragraph 3 hereof will be returned within a reasonable period of time to the Applicant with a reasonable set off for the Franchisor’s administrative expenses.

      6. The Applicant understands that the acceptance by the Franchisor of a deposit from the Applicant is no guarantee that the Applicant will be granted an Emma & Jeremy’s franchise, and that the Franchisor may reject this application for any reason whatsoever.

      DATED at the City of Toronto, in the Province of Ontario, this 5 day of October, 20—.

      ____________________________

      Applicant (Signature)

      ____________________________

       (Print Name)

      ____________________________

      Witness (Signature)

      ____________________________

       (Print Name)

      ________________________________________________________

      Emma & Jeremy’s Internet Café & Donut Emporium Ltd. hereby acknowledges the foregoing together with the receipt of the amount of the deposit referred to above and agrees to consider the Applicant as a candidate for an Emma & Jeremy’s franchise.

      DATED at the City of Toronto, in the Province of Ontario, this 5 day of October, 20—.

      Emma & Jeremy’s Internet Café & Donut Emporium Ltd.

      Per:________________________

       * * *

      Note that Sample 1 says the franchisee is in the province of Ontario. If this deposit agreement were actually entered with a franchisee for a location in the province of Ontario before the delivery of a disclosure document and the expiry of the 14-day cooling off period mandated under the Arthur Wishart Act (Franchise Disclosure), 2000, the statute would be breached and the franchisor may well have opened itself up to liability. Franchisors who grant franchises to franchisees in Ontario must not have the franchisee sign any agreement relating to the franchise, or take any money from the prospective franchisee prior to disclosure having been made in accordance with the Act and the expiry of the 14-day cooling off period.

      As noted earlier, in Alberta, a deposit agreement is permitted, but the deposit must be refundable, must only contain provisions respecting confidentiality, and must be for no more than 20 percent of the franchisor’s initial franchise fee. In the other common-law provinces, there are no similar requirements concerning deposits, so “buyer beware.”

      Note that the franchisor in this sample is entitled to retain some of the deposit monies to compensate it for administrative expenses (see paragraph 4 of Sample 1). If this happens in your deposit agreement, you need to ask yourself the following questions:

      • How much is the deposit?

      • When will the deposit be returned if the transaction fails to complete? (In Sample 1, the deposit agreement does not say.)

      • Will it take a year before the deposit is returned?

      Sometimes franchisors will legitimately want the right to deduct a portion of the deposit to pay for some of its expenses (e.g., location-related and design costs that have been incurred). That’s a business decision you must make. If you are going to agree to that, then fix a dollar amount that you can live with and you are prepared to agree is non-refundable. You should fix a time period in which the money will be returned (i.e., five days from written notice).

      What if the franchisor rejects the franchisee? Can it still retain part of the deposit monies to compensate it for its administrative expenses? (See paragraph 5 of Sample 1.) This is something else you should consider.

      Note as well this franchisor is seeking to prevent the franchisee from competing with it if the franchise agreement is not entered (see clause in 2.[f.] in Sample 1). Restrictive covenants are interpreted very strictly by Canadian courts, which see them as restraints of trade and will not enforce them unless they are “reasonable” in the circumstances. Regardless whether the franchisor has breached Ontario law by having the franchisee enter into the deposit agreement prior to delivery of the disclosure document or waiting the requisite 14-day cooling off period, and regardless of the fact that this may breach Alberta law by requiring a deposit that is more than 20 percent of the franchisor’s initial franchise fee, as this covenant lacks a time period and geographic boundaries for its restriction (i.e., one mile for one year), it will in all likelihood be unenforceable by the franchisor.

      Note also in Sample 1 that the number of days don’t match, which is a good indication that other things will be wrong as well.

      3. Are The Initial Fee and Other Costs in US or Canadian Dollars?

      For US franchisors (who may not have converted their US agreement and marketing material to a Canadian format), initial fees and other costs set out in the franchisor’s US FDD or in US-based pro forma financial statements will be in US, not Canadian dollars, and will be based on the franchisor’s US experience, not a Canadian one. Needless to say, those costs will be different in the US and won’t factor in the GST, PST, HST, Canadian tax rates, lease costs, labour costs, or other differing costs.

      A pro forma financial statement is a projection of what the franchisor thinks or expects the location to reflect in the first year (or the time period in the projection). It is little more than a projection, and like the weather, can be quite accurate or highly inaccurate. Actual financials are more reliable as they reflect actual performance over a period of time, rather than estimating performance. Accordingly, buying an existing operation from a franchisee or an outlet run by the franchisor itself as a corporate location (with actual financials to read) has its benefits. Also, you should inquire how the franchisor calculated its pro forma statements, especially if it has no operating locations of its own.

      If the franchisor has simply extrapolated US assumptions regarding anticipated Canadian sales (and costs of sales), this may also be unrealistic in Canada. The franchisor’s numbers may simply reflect the US experience. Taking the US population and dividing it by ten to deal with a Canadian population that is one-tenth the size of its southern neighbour is not always an accurate way to measure anticipated performance in Canada. Canada is a country in which our disposable income is less, our labour costs are higher, and our taxes are more than what they would be in the US. As a nation, we don’t seem to shop or eat out as often as Americans do, so pro forma financial statements that assume that a sample group of 200,000 Canadians will shop and eat out as often as a sample of 200,000 Americans may well be flawed. Mind you, this doesn’t mean you have to treat financial or pro forma financial statements based solely on US performance as if they were claims for weapons of mass destruction, but you should treat them with a healthy degree of skepticism and an ever so small grain of salt. Your accountant may be able to assist you with this. So might other franchisees, particularly in Canada.

      4. Royalties

      Franchise agreements will almost always contain some form of royalty, which is a monetary amount payable to the franchisor by you every week or every month, depending on the agreement. The continuing royalty keeps the franchisor financially able to administer the franchise system. Franchisors need royalties as much as franchisees need profit from sales.

      Although one often sees royalty rates of between 5 and 8 percent in the restaurant industry, this may not be appropriate in other industries. It may be wise to make inquiries of franchisees within different franchise systems in the same industry if the royalty rate is considered too high in the circumstances. Often, start-up franchisors have no scientific method to their selection of the initial franchise fee and royalty amounts;