So, What is the Franchise Agreement?
Franchising allows you to capitalise on a proven business model without the risks of starting a business from scratch. Many new business owners enjoy a level of success they otherwise wouldn’t have if they had chosen the start-up route.
However, the success of the franchise industry hinges on stringent legal agreements which form the foundation of running a franchise business. In this guide, you will learn more about the key elements of a franchise agreement and some of the points you should pay attention to, before committing to a franchise and signing the agreement.
A franchisor assigns rights and liberties (to their business system and associated intellectual property) to a franchisee using a legal contract known as the franchise agreement.
The document forms the basis of the relationship between the two parties and details the terms of business, rights, and obligations each party must observe.
At its most basic, a franchise agreement is a licence that allows the franchisee to operate a business using the franchisor’s systems, intellectual property, and branding. The agreement then goes on to lay out the operating terms and conditions of the contract in great detail.
The franchisee agrees to abide by the rules of the agreement in their business operations and the franchisor agrees to offer support and other materials. The contract covers payment terms (initial fee and ongoing royalties), length of the franchise term, territory exclusivity, early exit terms (selling the business), performance standards plus many more.
Why is it Important?
Let’s consider why this document is important to the smooth running of a franchise.
Firstly, the franchise allows the mutually beneficial relationship between the franchisor and franchisee to happen.
Secondly, the contract lays out the obligations and responsibilities of each party throughout the duration of the franchise period and what happens at the end.
Thirdly, the signed document offers legal protection to each party and becomes the operating document that can be referred to in the event of a dispute.
Finally, you need to make sure that you understand every element of the agreement before signing it. You should seek legal advice to help you navigate the agreement and to identify any points you do not agree with. There is room to negotiate some of the elements, but established franchisors will try to keep their agreements uniform for all franchisees.
As you can see, the franchise agreement informs you of your obligations under the agreement and provides the guidelines within which you will run your business. Reviewing the document beforehand also gives you a chance to clarify and finalise any elements you don’t understand.
Next, we will dig a little deeper into some of the key elements you will come across when you are ready to embark on your journey as a franchise business owner.
The Key Components of the Franchise Agreement
Although there is no one-size-fits-all franchise agreement, there are key elements that you will find in almost every franchise agreement out there. Franchisors use the franchise agreement to retain control of the business process that drives the success of their business model.
Hence, you will find unique clauses when you read through different franchise agreements. Below you will find a selection of the most pertinent elements you can expect to find in many franchise agreements.
Use of trademarks and intellectual property rights
The franchise agreement involves the transfer of rights from the franchisor to the franchisee to use proprietary systems, software, and branding in conducting their business.
The agreement will detail how you will use intellectual property such as the trade name, copyrights, and trademarks. The franchisor will seek to protect these rights and ensure they are only used as intended, and you do not transfer these rights to the benefits of a third party.
Intellectual property rights not only protect the franchisor but you as a franchisee because these are the proprietary systems and methods you’ll rely on to successfully run your business. It is in your best interest to protect these rights.
Territory rights and location concerns
To reduce competition and avoid market saturation, most franchises operate on a territory rights basis. This means each franchisor, depending on the business model, is given an exclusive geographic area within which to operate. It could be a unique postcode area, town/city limits or large swathes of a county.
Ovenclean is a domestic oven cleaning franchise business operating in many parts of the UK. As part of the agreement, they offer their franchisees exclusive protected territory which allows the business to grow without competing against another franchisee.
Financial obligations (franchise fees, fees schedules and other payments)
Understanding your financial obligations to the franchisor in full from the onset informs you of the potential profitability you can expect from the business venture.
Many franchises have a minimum investment requirement to start the business, plus an ongoing franchise fee based on your gross income (anything from 5% to 10%).
In addition to the initial investment and ongoing franchise fee, most franchisors have a common marketing budget into which every franchisee contributes.
For example, the Burger King franchise requires each franchisor to contribute 5% of their total sales into the Marketing Fund in addition to the 5% royalty fee.
Although these fees may appear high, being part of the Burger King brand is an invaluable opportunity.
Minimum performance standards
The whole franchise business method has its foundation in standardisation of processes. Following a plan with a proven outcome ensures the repeatability of the process, hence nearly all fast-food outlets have a similar layout.
To ensure the success of the model and protect the brand and franchisees, every franchise sets minimum performance standards. These standards include financial, hygiene, food safety and compliance.
Subway has a restaurant excellence system which is responsible for ensuring their franchise restaurants meet the performance standards. Regular planned and unplanned audits/visits form part of their system to ensure restaurants adhere to their standards.
The business manual contains the standard operating procedure to ensure you meet the minimum performance standards so that you’re not running blind and trying to hit a moving target.
Non-compete clauses are something to look out for in franchise agreements. Although franchise agreements can be for between 10 and 20 years, circumstances may change and as a franchisee you may seek to terminate the agreement early.
Restrictive covenants often seek to protect the franchisor against direct competition from a former franchise who sets up a competing business after terminating an agreement. Typically, you cannot launch a competing business in the same territory within 12 months.
However, you should check your franchise agreement before you sign it so that you are aware of any restrictions you may face should you decide franchising is not for you further down the line.
This essential key element details the obligations and duties of the franchisor and franchisee under the agreement. It is important as a franchisor to protect your interest.
Additionally, you need to know what you are going to get for your initial investment and the ongoing royalty payments (all this is documented in the agreement). Finally, you need to know who is responsible for what (advertising, marketing, supply of goods and services etcetera.
Renewal, transfer, and termination
Another aspect you should be aware of is what happens when it’s time to renew the agreement. 10 or 20 years may seem a long time but if you’re running a successful business, you should be aware of the agreement renewal process.
Can you sell your business and what is the procedure for doing that? Franchisors will seek to protect their brand and intellectual property by seeking to secure the right of first refusal should you wish to exit the business and end the agreement through selling the business.
Also, under what circumstances can the franchisor terminate the agreement? Read and understand all these conditions to make sure you are comfortable with the implications prior to signing the agreement.
Beyond the Agreement and Setting Sail for Your New Business Journey
Once you have had the opportunity to go through the contents of your franchise agreement with the support of a specialist lawyer, what’s next?
If there are clauses which need clarification or negotiation, reach out to your franchisor, and have the discussion and propose amendments. While established franchisors are unlikely to budge on key elements of the agreement, you may get some room on other aspects such as payment schedules.
If you are joining a newly established franchise, there may be more room to negotiate other clauses so feel free to ask the questions.
We wish you all the best on your new journey as a franchise owner, and all the success that comes with it! If you’d like more support, or you want to clarify any misunderstandings, feel free to contact our team.