Franchise Agreements – The Key Considerations
If franchising is an expansion route you choose for your business there is one document that is of vital importance – a franchise agreement.
By precisely setting out the Do’s and Don'ts, in conjunction with your Operations Manual, it really does underpin the entire business. In effect it governs the franchisor/franchisee relationship. So, it must be relevant, unambiguous and comprehensive.
Obviously, you will therefore need to appoint a lawyer to prepare the agreement. But not any lawyer – you will need one who is experienced in franchising. There are many commercial lawyers who might claim they can put a franchise agreement together but invariably it is a mistake not to use a specialist – one who fully understands the protocols and nuances of good franchising, and who is able to practically interpret your business and the requirements you have.
Before appointing a lawyer to prepare the franchise agreement you must therefore have a very clear idea about the issues that the franchise agreement has to accommodate - you need to be quite certain about how you expect franchisees to operate the business. You must get it right, because, once the agreement is signed, you and the franchisee will be committed to respective obligations for 5, 10 or even 20 years.
If you have used a consultant to help design your franchise model, with a development plan and financial forecasts, its probable that most of the primary issues will have been decided. He/she may also recommend a franchise lawyer and will help you to brief that lawyer.
Some of the key points to consider are as follows:
- Entity of franchisees. A business can operate as a sole trader, a partnership or a limited company. You must decide what form of trading entity you want your franchisees to adopt.
- Rights to be granted. You must be absolutely precise about what rights you are granting to a franchisee. Is it to operate every aspect of your current business, or for a specific range of services or products that it offers? For example, some activities may be outside the scope of the agreement because of health & safety reasons or competency levels.
- Territory. The agreement will specify the precise area in which the franchisee is entitled to operate the franchise. You therefore must have decided the basis for your franchise territories – geography, size, demographics etc. The territory must have the capacity to allow each franchisee equal opportunity develop the business to a viable level, in accordance with a realistic sales forecast.
- Term of agreement. As indicated above, franchise agreements can have varying terms. 5 years is typical for owner-operator style franchises whereas high investment, premises based franchises may grant a franchise for 10 or 20 years. The key determinate will be the time required to generate a good return on investment after any borrowings have been repaid.
- Renewal of the agreement. It is usual for there to be a right to renew the agreement at the end of its first term. This may be dependent on there being no breaches of its terms and that all performance criteria are being met, within reason. You will however have to decide how many times you are prepared to renew – some franchisors insist on only one renewal. Also, do you want to charge a renewal fee? Some franchisors do, some don’t.
- Fees. The agreement must define all of the fees that are payable by the franchisee. This would include the initial franchise fee, the on-going management service fee, marketing fees and any additional payments for products or services.
- Respective obligations. Quite importantly, the agreement will detail the obligations that each party has to each other. For you this will cover the type and scope of support you are going to provide to franchisees. The obligations of franchisees will usually be considerably more comprehensive, covering every aspect of the business – marketing, operational, administration, accounting, reporting, staffing, training, premises/vehicles etc.
- Premises. If the business requires commercial premises then you must decide on how these are to be acquired. Do you want to own the head lease and sub let to franchisees, or prefer that the franchisee leases, or owns, the premises? There are pro’s and con’s to both and careful consideration is needed. The acquisition of equipment may raise the same issues.
- Selling the business. Usually, franchisees will have the right to sell the business. However, they may only sell to a candidate that the franchisor approves and on terms that the franchisor specifies. So, you need to have thought through and be clear about these terms. For example, do you want a right of first refusal to buy the business?
- Termination. Franchise agreements have a fixed term and so eventually will be terminated. This may be due to natural expiry, or it may be forced because the franchisee has breached the terms, either substantially or persistently without satisfactory remedy. Or, perhaps the franchisee has simply given up. Whatever the circumstances it is very important that the criteria and procedures for termination are clearly stated in the franchise agreement. Even more vital is that the agreement contains post termination provisions that seek to adequately protect your position, particularly with regard to use of the trademark, other intellectual property, customer data, etc.
Franchise agreements are typically unilateral in nature. That is to say, they are written entirely with the interests of you, the franchisor, in mind. You are granting the rights to operate a business you’ve made a success, so that’s how it should be. Also, usually franchise agreements are non-negotiable – you want every franchisee operating under precisely the same terms. Otherwise, you’ll have major problems!
However, it will be necessary to periodically review and modify your franchise agreement so that it adequately reflects the current requirements of the business and prevailing market conditions.
Getting the franchise agreement right is a must for any franchised business. So, investing in an experienced franchise consultant and a specialist franchise lawyer is essential if your aim is to build a robust, sustainable and viable network of franchisees.
Connect with Clive Smith
Franchise Intelligence Senior Franchising Consultant
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