Depending on the financials of the franchisor and the pre-opening costs to the franchisor, some registration states will require a franchisor to make choices when it comes to initial franchisee fees.
The state may require as a condition of registration that the franchisor agree to and amend their franchise agreement and franchise disclosure document to defer payment of initial franchisee fee until the franchisor’s opening obligations are met. Or, the franchisor may be permitted to escrow the funds. The state may permit the franchise fee be impounded. Alternatively, the state may permit the franchisor to obtain a surety bond.
When given these choices, which should a franchisor choose? Well, often the simplest and inexpensive choice is deferral of initial franchise fees. With deferral there is no escrow account, escrow agent, or agreement. The payment of the initial franchisee fee is delayed until the franchisor’s obligations for opening are met. On the down side there are risks. What if after opening, the franchisee has spent all his/her money and does not pay the initial franchisee fee? What if the franchisee just refuses to pay? You can always sue for breach of contract, but is that what you want to do right after the franchise opens?
The other options may be equally unfavorable. A surety bond costs money and you have to get the bond in the state of the registration, which may not be the state in which the franchisor lives or operates.
Escrow agreements, as we stated above, require an escrow bank to act as agent, a separate account for the signing of an escrow agreement, which requires the state commissioner’s say so before the funds can be released. You can find a copy of the Maryland’s template agreement at: http://www.oag.state.md.us/Securities/Forms/escrowagreement1.pdf.
At the end of the day none of the alternatives are desirable, but you see why most franchisors choose deferral. It is cheapest and easiest. However, if you are concerned about the franchisee not paying, your system requires a considerable initial fee for startup, or you are just worried about franchisees attending training, learning your secrets, and running, you may want to consider another one of the alternatives.
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Trademarking and Franchise Law