Protect Yourself: Form an Entity
By Jonathan Barber
If you’re buying into a franchise, you’re probably about to make one of the biggest investments of your life. You’re likely spending hundreds of thousands of dollars and taking a great leap of faith. Maybe you’re taking out a small business loan or rolling over your retirement funds.
Maybe you’re using your parents’ hard-earned money that you just inherited. Regardless of how much skin you’ve got in the game, you’re heavily invested in this new venture and there is a ton of risk involved. Forming an entity is one way to protect your personal assets and limit your risk.
Limit Your Liability
When John Smith signs a contract in his own name, John Smith is personally liable if things go south in that deal. However, if John Smith forms Smith Holdings, LLC, and signs a contract as Smith Holdings, LLC, he is generally not liable for the obligations of that contract. The limited liability company that John Smith formed is responsible for performing the terms within that contract. This scenario applies directly to franchising. Before you sign your franchise agreement, you could form a business entity such as a corporation or a limited liability company. Then, if you sign that franchise agreement on behalf of your entity, you have greatly limited your personal exposure.
Most franchise agreements require that the franchisee sign a personal guaranty. This isn’t a dealbreaker, it’s an industry standard. A personal guaranty will make you liable even if you sign the franchise agreement on behalf of an entity. Almost all franchisors require this, because they need to ensure their franchisees are all-in with the franchise. If a franchise doesn’t require franchisees to sign a personal guaranty, those franchisees could essentially walk away halfway through their terms with no consequences.
With an entity in place, however, you’re still largely protected. For instance, if a man slips and falls in your store, he most likely won’t be able to take your house and the clothes off your back if you have an entity in place. He could sue your entity for negligence, but as long as you didn’t do anything malicious, he will likely only be able to get to the entity’s assets. Likewise, if your entity enters into contracts with vendors or employees, those parties would really only have claims against your entity—not you individually. The “limited liability” aspect of corporations and LLCs literally limits the liability of an entity’s owner. Some states are different though, and you should consult with a business attorney within your state for further guidance.
By purchasing a franchise, you are putting your business and personal assets on the line, and it’s impossible to completely eliminate your risk. However, you can balance that level of risk against the potential reward your franchise offers. You can also limit your personal risk for non-franchise issues like personal injury and negligence by forming an entity—and the low cost of doing so is worth the personal protection.
Jonathan Barber exclusively practices franchise law as a partner at Barber Power Law Group in Charlotte, North Carolina. He has assisted hundreds of franchisees with their FDDs and buying into franchises all over the world. Barber also represents emerging and established franchisors.