Why Are Franchise Agreements Important?
Franchise agreements are vital if you’re planning to purchase any type of franchise. This legally binding contract is formed between both parties in the franchise relationship and offers protection to both sides.
When you buy a franchise you’re making a significant financial investment, and having an official, signed agreement will give you rights and help you to safeguard that investment.
The franchise agreement represents the legal master document setting forth the obligations and rights of both the franchisee and the franchisor. Legally speaking, it’s a licence from a franchisor giving permission to the franchisee to use their intellectual property, brand, and systems when opening their business.
Typically, franchise agreements are around 25 – 30 pages in length (sometimes even longer) and there’s no “one size fits all” franchise agreement. Each franchise creates unique contract documentation, although most agreements will contain similar provisions, albeit with different wording.
Four Kinds of Franchise Agreement Exist
The direct/single-unit franchise – this is the most frequently seen and most traditional franchising format. The franchisee is given the right to set up and run a single franchise, investing their own money and applying their own hands-on management skills.
The multi-unit franchise – this agreement grants an entity the obligation and right to set up and operate a specified number of franchised unit locations in a certain time period. The franchisee needs to have sufficient managerial and financial capacity to develop several units themselves.
The area development franchise – this arrangement is quite similar to a multi-unit franchise except that the agreement involves opening a specified number of unit locations in a specified time period and within a clearly defined area.
The master franchise – this agreement gives a master franchisee the right to open and run multiple locations in a specific continent, region, or country, usually with the right to recruit more franchisees within that geographical area.
Understanding the Key Elements of the Agreement
Although all franchise agreements are different, there are common elements that are generally found in all of them. Some of the most frequently seen include:
Usage of the trademark
Franchise agreements will grant franchisees the right of use of the franchisor’s trademarks, name, logos, service marks, designs, slogans, and other types of branding. The franchisor also grants the franchisee the rights to use their other intellectual property like proprietary software systems and operating manuals.
This section of the agreement specifies how long the contract will last and whether there is a right of renewal for the franchisee. The terms will also outline whether or not the franchisor is permitted to buy the franchise before the expiry term of the agreement.
Obligations And duties
The duties and obligations of both the franchisor and franchisee will be laid out in the agreement. This will include the franchisor’s duty to provide suitable training for the franchisee while the franchisee’s obligations to attend training and to keep and submit appropriate records will also be outlined here.
Minimum performance standards
Of course, the franchisor needs to protect the reputation of their brand, therefore there will be clauses about minimum performance standards that franchisees must meet. Failure to meet the required standards could result in a breach of contract and legal action being taken against the franchisee.
Restrictions on services and products
If any restrictions are to be placed on the services or goods offered by the franchisee, they will be detailed in the agreement. Elements such as the required quality standards of goods, the suppliers and advertising that have been approved for use, the pricing structure and the hours of business operation will all be clearly stated.
A franchise agreement must outline if a franchisee gets an exclusive or protected territory, as territories are vital in order to limit any market saturation. Individual franchise businesses have a difficult time trying to compete if an area is over-saturated, so ensuring that there is provision for this in the agreement is vital so your investment can be protected.
If the agreement outlines a specific territory, it’s important to check which areas are covered and whether they’re determined by postcode or another method. If there is no territory clearly defined, it’s important to ask how avoiding direct competition can be avoided.
Costs and fees
A franchise agreement must outline all the costs associated with ownership of the franchise. Every franchise charges fees including an initial fee together with ongoing fees like monthly royalties, marketing or advertising fees, and potentially other costs.
It’s also important to check the agreement to find out whether those ongoing fees are fixed or whether they are calculated as a percentage of your revenue. That is something that is essential for managing your cash flow later, as well as for forecasting.
An agreement may also include interest and late fees, and franchisees who end up falling behind may find it difficult to catch back up if interest and late fees pile up. The agreement should cover required expenses too as well as who has responsibility for paying them.
As an example, franchisees may have the responsibility of funding the cost of training as well as the travel costs of any employees attending that training.
A franchise agreement should outline the obligation of the franchisor to support their franchisees in terms of advertising and marketing. There are some agreements that impose far more requirements on the franchisee than on the franchisor and this is something that must be examined before you sign the agreement.
For example, some franchises require the franchisee to spend a specific percentage on local advertising while the franchisor has minimal obligations in this regard. McDonald’s is one such franchise that requires every franchisee to spend 4.5% of their sales on advertising.
Reviewing this clause is essential to be aware of the percentage of the franchisor’s marketing budget goes towards promoting the business nationally and how much goes towards advertising locally.
The agreement should also point out whether or not promotional literature will be supplied by the franchisor to the franchisee or whether they will be expected to provide it themselves.
Franchise agreements include requirements for franchisees to maintain a certain amount of insurance coverage during their franchise term.
There will almost certainly be indemnification clauses too, requiring the franchisee to indemnify the franchisor against costs, claims, expenses, and damages that may arise from the activities of the franchisee.
Renewal, termination, and transfers
The agreement will certainly outline any conditions that apply to the early termination of the contract. Typically, franchisors have greater termination rights, and in many cases, there are no rights in the contract for franchisees to terminate the agreement early.
There are several potential causes for the contract being terminated including failure to pay the franchise fee, failing to carry out essential repairs to the premises, or filing for bankruptcy. In the agreement, there will also be specified conditions (if any apply) under which a default can be “cured”.
Also added into the agreement will be provisions for what happens if the agreement terminates early or expires. In the document it will outline what both parties need to do in order to unwind their business relationship.
The franchise agreement will also outline any applicable rights for the franchisee to transfer their ownership interest to another buyer. In some cases, the franchisor will have the “right of first refusal”, or the first opportunity to purchase the business should the franchisee take the decision to sell up. Also, franchisors will usually have the right of approval of any new buyer.
Since franchise agreements have an end date, there will also be specifics contained in them about how and when they are renewed.
Taking the Next Steps to Business Ownership
There is a lot of key information contained in a franchise agreement, so it’s imperative that you take the time to read it in full and to make sure that you understand precisely what your rights and obligations are, as well as those of the franchisor themselves.
It’s usually wise to take some independent legal advice when you receive your franchise agreement to ensure that everything is clear and that there are no unfair clauses contained within it.
An experienced legal professional will be able to explain all of the important provisions contained within the agreement and will have the experience and knowledge to raise with you any especially one-sided or harsh provisions that are uncommon within the industry.
Taking this professional advice will help to reassure you that you are making a well-informed decision and won’t have any unwelcome surprises at a later date that could prove to be costly and challenging.
Now that you know more about franchise agreements and their importance, we’d like to wish you every success on your exciting new business journey. You can find out more about the franchise options available to you and get the answers to any questions that you may have by contacting us.