Analysing the Franchise Agreement
So… you’ve seen a franchise that you’re really excited about. Experts in your chosen industry have confirmed that it is a profitable sector. You’ve written your business plan and are now ready to sign the franchise agreement. It is important, however, to know exactly what a franchise agreement is before signing anything. This article explores everything you need to know about a franchise agreement.
The franchise agreement is a legally binding contract that stipulates in detail, the responsibilities and expectations of the franchisor and franchisee.
Keep in mind that franchise agreements are generally written to be more advantageous for the franchisor. Once signed, you are legally obliged to uphold all the provisions of the agreement, so it is absolutely essential that your franchise solicitor reviews this contract and explains everything to you in plain English.
If any verbal promises were made to you, make sure they are written into the agreement before you sign it. After signing, the agreement governs your relationship with the franchisor and any disagreements or misunderstandings will be subject to the terms in the document.
The franchise agreement must be disclosed at least 5 days prior to signing any contract with the franchisor. This period is intended to prevent the prospective franchisee jumping in and signing the contract, before reviewing and considering the terms of the agreement.
Because it is a contract, it contains critical elements typically found in all business contracts, and some that are unique to franchises. Here are a few parts of the agreement that you and your solicitor should carefully scrutinise to ensure that you understand all the implications.
Who Is Signing the agreement?
First and foremost, be absolutely certain about the identity of the party with whom you are doing business. Is it the parent corporation signing the agreement or is it a master licence owner? Have you investigated the other party’s business track record and reputation? You must know the partner you are going to be working with for many years.
Duration of the Franchise Agreement
Next, be sure that the duration of the franchise agreement is clearly stipulated. How long does it last – five, ten, or twenty years? Is it renewable when the initial contract expires? If the contract is renewable, how much will you have to pay – a nominal fee or the full franchise fee?
The section detailing initial and ongoing fees should be thoroughly examined. These ongoing fees could be fixed or varied (varied fees are generally dependent on the percentage of revenue). Fees based on revenue can be a minimum fee or based on performance targets, and it will help you manage your franchise’s finances as you build your business. Most franchisors require a royalty (sometimes referred to as a management service fee) as well as a marketing fee.
Another factor that can impair your profit margin is advertising. Carefully examine your obligations to contribute towards advertising and marketing, and check what the franchisor will provide in return. Review this clause so you know just how much of the franchisor’s advertising budget will go towards promoting your business at national level and how much will go towards local advertising. Is promotional literature provided?
The logistics, duration, location, and costs of training should be described in the franchise agreement. Usually franchisees must pay their own travel and lodging expenses during training, and these can be prohibitive if the training period is prolonged. The franchisor’s ongoing training and support obligations should also be mentioned.
As a franchisee, you will need guidance on the procedures required for running the business. These should be outlined in the ‘operations manual’, which is basically your business management bible. Find out if you will be given a hard copy or if you must download it. How often is it updated? Is there an additional fee or deposit for receiving it?
Trade Dress Use
One aspect of the contract that is unique to franchise operations is ‘trade dress’. This broadly refers to the logo usage, the image and décor of the high street premises, and the clothing worn by employees. Some requirements about trade dress are very stringent, while others are less formal. Be certain you understand and can meet these guidelines. Who pays for the signage and special fixtures that are part of the trade dress? And how often must these features be replaced?
Hours of Operation
What are the hours you are expected to be open? Don’t commit to any rules about hours of business unless you are certain you can meet them. If you fail to meet them, the contract can be considered breached and your standing as a franchise owner might be jeopardised.
Procurement and Supplies
Another pivotal element of the franchise agreement is the question of supplies and products. Must you buy everything exclusively from the franchisor or are you allowed to use items obtained from other sources? Are you required to make a minimum purchase of goods? Does the franchisor mark up products sold to franchisees and what protections are in place to prevent unfair price increases? Know where your products are coming from, and what is a decent price to be paying for them. Buying from the franchisor often means a discount, so ensure that is written in as well.
All businesses rely on the people who do the work to achieve success. What are the policies regarding staffing? Are there defined methods for recruiting and training staff? What, if any, corporate human resources policies – e.g. sick time, holiday pay, bonuses – must be followed? These practices should be detailed in the operations manual, but be sure to double check.
What does the franchise agreement stipulate regarding the opening of your Franchise? Will other company representatives be there? Are there specific practices (such as trade dress use) that must be followed? How much of your initial fee goes toward a grand opening? What contributions can you expect from the franchisor towards public relations and advertising? Even though this is a one-time occasion, the way your business debuts can affect its long-term success. Know what you are expected to do, and how much help you’ll receive.
Selling or Transferring Your Franchise
How much control does the franchisor exert over selling or transferring your individual franchise business? Does the franchisor have approval rights regarding prospective buyers? What percentage of the sale is the franchisor entitled to, and when must it be paid? It is always wise to have a good exit plan before investing in anything, so know what your rights and obligations are in relation to selling the franchise business.
Termination of the Agreement
Under what conditions can the franchisor or the franchisee legally terminate the agreement before its expiration date? Be aware of your legal and financial rights in case the franchisor does not meet the agreement’s stipulations, and in return know the consequences you’ll have to face if you fail to live up to your obligations.
Death in Service and Other Contingencies
It sounds morbid, but you must plan for unexpected circumstances and the possibility of catastrophic events. If you should die, is your spouse or any other family member entitled to take over the business? If you and your spouse hold the business jointly, are there conditions about how divorce affects franchise ownership? How responsible are you for rebuilding if business is disrupted by a natural catastrophe, and how does this affect any mandatory fees that are normally due?
Does the agreement allow you to expand the business and/or purchase other franchises so that you can own multiple units instead of just one? Though such expansion may seem unthinkable during the stressful phase of obtaining your first franchise, once you’ve got one successful business up and running, you might want to grow beyond a single unit. Find out if that would be possible and what it would cost, so that you don’t run into any surprises if you decide to expand in the future.
Is your franchise an exclusive territory or does the franchisor reserve the right to open other branches nearby? Find out exactly what area it covers (e.g. postcode or region) and if you are only able to make sales in that territory. How is your territory determined by population numbers? Is it drawn up by geographical map, and if so, how detailed is that map? If you do not have an exclusive, defined territory, then make sure to stipulate what kind of direct competition there is.
Tips on Negotiating the Franchise Agreement
Some franchisors have unbending franchise agreements that all their franchisees must sign and then adhere to, while other franchisors may be more flexible about negotiating the agreement’s terms. But be warned – since franchises are built on proven systems and consistency, a franchisor that seems too eager to bend the rules may be a sign that the business is in trouble.
Items that are typically open for haggling include:
- Territory rules about exclusivity, future expansion or changes in size.
- Support and resources given to you for the grand opening.
- The training provided to you and possibly your staff.
- Rules about transferring the franchise to other franchisees.
- Schedules for fee payments.
‘Default right to cure’, which governs how much time you have to correct a problem that keeps your franchise from operating properly before you are in default of the contract and your status as a franchise owner is jeopardised.
- The start-up date for launching the business.
- Your liability limits regarding franchise performance.
Your solicitor and your accountant are the most familiar with your individual situation, so seek their advice about which franchise agreement terms you should accept.