Appeared in franchise Canada Magazine March/ April 2008 As a Tutorial
Deposits are often collected by franchisors prior to entering into a full franchise agreement. They are typically a percentage of the initial franchise fee or the full initial franchise fee amount. In the event a franchise agreement is entered into the deposit is credited towards amounts owing. Should the potential franchisee choose not to move forward with the franchise, the deposit may or may not be refunded. There will usually be a Deposit Agreement that is entered into at the time the deposit is made which defines how and if the deposit will be returned, provides timelines and typically addresses the issue of confidentiality.
The main purpose of the deposit, from the franchisor perspective, is to differentiate the serious candidates from casual enquiries to the franchise opportunity. Franchisors will often deal with hundreds of enquiries a month and simply cannot go into details or begin to work at finding locations or assist with bank financing with everyone. A deposit allows franchisors to properly allocate its resources and ensure that there is some compensation in the event that the prospective franchisee does not move forward. The franchisor is also concerned with confidentiality. The deposit agreement will often have clauses stating that the proprietary information provided shall be kept confidential and materials returned.
From a prospective franchisees perspective, deposits will often permit the potential franchisee to put a territory on hold while they do their due diligence, arrange financing, have documents reviewed by a lawyer or find an approved location. To spend time and money making arrangements to move forward with a franchise only to find that the territory that you wanted is no longer available or that you are not approved by the franchisor is not the best use of your resources. By paying a deposit the potential franchisee is showing that they are serious and ensuring that resources are being prudently spent. The franchisor will normally work with potential franchisees to remove conditions on the deposit agreement while holding the territory for a limited period of time.
Deposit can be refundable, partially refundable or non-refundable, depending upon the circumstances and primarily how much time the franchisor is spending working with the potential franchisee. The franchisor wants to be compensated for its efforts in, for example, reviewing locations or assisting with preparing a business plan. Franchisors should provide a deposit agreement that clarifies how and if the deposit is refunded. If the franchisor does not provide a deposit agreement, the potential franchisee should have one created so as to avoid confusion based on verbal discussions and memory. Be sure to read the deposit agreement carefully and have it reviewed by a lawyer so that there is clarity as to the terms and conditions.
Deposits are paid prior to entering into a franchise agreement. Provincial legislation has put in place certain laws to protect the public regarding franchise deposits. In Ontario franchisors cannot require a potential franchisee to pay a deposit or sign a deposit agreement until they have had 14 days to review the Disclosure Document. In Alberta, the franchisor can collect a deposit prior to the review of the disclosure and entering a franchise agreement but such deposit must be refundable, can only be for a maximum of 20% of the initial franchise fee and the deposit agreement must be limited to the issues of confidentiality, location and non-use of the franchisors information.
Deposits are in general held by the franchisor, or the franchisors commissioned salesperson, or consultant. In the event that the franchisor is new and not established there is a danger that the franchisor will spend the deposit funds prior to conditions being removed. Potential franchisees can protect themselves by having the deposit held in trust by a lawyer with an undertaking. An undertaking is an agreement with the lawyer which the lawyer must comply with or risk being disciplined by the law society, or worse, loosing his license. Holding deposits in trust are by and large not required if the franchisor is reputable and established.
Deposits are a great way to show that you are serious, provides some initial compensation to the franchisor for preliminary work and to reserve a territory for pootential franchisees. The deposit agreement protects the interests of both the franchisee and the franchisor.