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Franchising is a deeper, more complicated business relationship and agreement than licensing. A franchisor retains control over how its brand is used and how each franchise under its name is operated. There is a lot of interdependence between the franchisee and franchisor in a franchise relationship. The franchisor is the owner of a business. The franchisor sells the rights to their brand — including products and services, intellectual property, and more — to a franchisee, who will open up a separate branch under that brand’s name, which is essentially a duplicate of the original business.
Before digging into the actual wording, let’s look at the bigger picture. First, it’s key to remember that franchise agreements are binding legal documents. Get the advice of an attorney, preferably one specializing in franchise law. That does not mean you should abdicate your responsibility to know what you are signing. Question anything you are unclear on and anything out of sync with verbal promises or other written documents.As part of the franchise agreement, the franchisee will pay fees to the franchisor to open a franchise, use their brand, and for advice and business support. The franchisor loans its brand for a fee and provides training, as well as expertise, to the franchisee.
Go clear-eyed into the process. Remember that franchise agreements are drawn up by the franchisor, to grow their business while protecting their brand and reputation. Franchising is about replicating success. These agreements are structured for consistency—not custom tailored for the individual franchisee. While the viability of your business is important to the parent company, the protection of their brand and IP comes first.
- All the benefits of being a self-employed business owner without the risks of starting a new business. Franchises come with the bonus that they’re already a proven business model with a pre-established customer base. Purchasing a franchise is often much less risky than starting a business from scratch, and while there can be significant fees involved, they may amount to a smaller investment than if you were to build your own company from scratch.
- Franchising also has the benefit of a shared relationship. The franchisor gets to scale its business rapidly while minimizing some of the work, which is instead done by franchisees. Additionally, the franchisee works with the franchisor to manage the business and learn business skills that they may not know already.
- In comparison to licensing, one of the big pros of franchising is the depth of the relationship between the franchisee and the franchisor. The franchise agreement may be complicated, but it also provides a wide range of opportunities.
- One of the drawbacks for a franchisee is the loss of control. While it’s your business, most of the major business decisions will be made or at least must be approved by, the franchisor. While this support can be beneficial while learning the ropes of the business, it can also feel like being micromanaged by experienced business owners. However, this control is a pro for the franchisor, as they can still dictate how their brand is used.
- In comparison to a license, a franchise will seem much more expensive and complicated. Then there are the ongoing fees to keep in mind. This might seem exorbitant, but it’s important to remember that you’re getting access to an entire business. In comparison, a licensing agreement only gives you access to use specific trademarks in certain ways. So, a license will be cheaper and less complicated, but it also gives you access to a lot less.
- Because of this cost discrepancy, business owners will sometimes opt for licensing agreements instead of franchising agreements; however, these are not interchangeable and often do not work for the same types of businesses. Not to mention, you’re also putting yourself at legal risk by forming a licensing agreement for business operations that fall under the franchising category. If initial fees are prohibiting you from starting a franchise, you can also seek out franchise financing to help you fund these expenses.
- Trademark and Intellectual Property: A franchise agreement grants the franchisee the right to use the franchisor’s name, trademarks, service marks, logos, slogans, designs, and other branding indicia. The franchisor will also grant the right to use other intellectual property such as the operating manual and proprietary software systems. This contractual license is the foundation of the agreement. Without it, a franchisee would not be able to use intellectual property without infringing. The agreement will set forth the franchisor’s obligation to provide training and support services. This obligation is both before opening and during the entire term of the franchise agreement.
- Brand Awareness: The agreement should set forth the franchisor’s obligation to support franchisees with marketing and advertising. Unfortunately, some agreements impose more requirements on franchisees than on franchisors. In some franchises, the franchisee is required to spend a certain percentage for local advertising, but the franchisor is remarkably free of hard and fast obligations!
- Time Span: The franchise agreement will set forth the duration of the contract. Franchise agreements are long-term. A typical term is 10 years. Some are 20 years.A long-term agreement protects you as the franchisee as well as the franchisor. Franchise opportunities can be expensive, and you will want to protect your investment. Also included will be conditioned for renewal. Often an initial 10-year term can be automatically renewed for a second 10-year term unless either side gives notice of non-renewal.
- Every franchise agreement should be in writing and signed by both parties. Strangely enough, oral or handshake agreements in franchising exist — although they are rare. And it’s no surprise why they rarely occur. Think of the legal nightmare of trying to prove oral representations years later. A written document makes rights and obligations clear.
- Fees and Expenses: The franchise agreement outlines the costs of franchising ownership. All franchises charge fees. These include the initial franchise fee, as well as ongoing fees such as the monthly royalty fee, advertising or marketing fee, and any other fee.
Agreements can include late fees and interest. Franchisees who fall behind could find it that much harder to catch up once late fees and interest start piling up.
The contract should also cover any required expenses and who is responsible to pay them. For example, the franchisee may be responsible for paying for training, and for the travel expenses of employees to attend training.
- Location: Each franchise selects its site. However, the franchisor typically has the right to approve the location. You must follow the franchisor’s standards for developing the premises, including choice of furniture, fixtures, upholstery, landscaping, and signage that meet the franchisor’s standards. Some franchisors require the franchisee to use approved vendors and service providers. The franchisor will inspect the build-out for adherence to the franchise system standards.
- Termination: The agreement outlines any conditions for terminating early. Usually, the franchisor will have the greatest termination rights. Franchisees often have no contractual rights to terminate early.
Cause for termination generally includes failing to pay a franchise fee, filing bankruptcy, or failing to make needed repairs to premises. The franchise agreement will also specify the conditions, if any, under which you can “cure” a default. For example, you may be entitled to written notice and 14 days to remedy certain defaults.
- Obligations upon Termination: What happens when the franchise agreement expires or terminates early? The document will state what the parties must do to unwind the business relationship. Usually, this consists of a long list of specific obligations for the franchisee. These include the obligation to stop using the brand name, take down signs, return the operations manual, and pay all amounts due.
- Non-Competes: Franchise agreements often contain restrictive covenants limiting what franchisees can do. For example, you or an affiliated company may not be permitted to operate a competing business during the agreement term.
Agreements also typically contain non-competes that kick in after termination. For example, a provision could prohibit operating a competing business within 5 miles of your former location, for a period of three years following termination.
- Insurance and Indemnification: The franchise agreement will include the requirement for the franchisee to maintain certain insurance coverage throughout the term of the franchise. Expect indemnification clauses, as well. For example, the franchisee will probably be required to “indemnify, defend and hold harmless” the franchisor against any claims, costs, damages, and expenses arising out of the franchisee’s activities.
- Documentation: As the franchisee, you will be required to maintain accurate records and provide regular financial and operations reports. Since royalty payments are often a percentage of gross sales, reporting accurate sales numbers is especially important. The franchisor usually has the right to request additional information including tax returns and to audit your records. You could be charged an audit fee, also.
- Modifications: If the business is a restaurant or retail premises where consumers visit, franchisees will have substantial obligations to maintain the premises in good repair at their sole expense. The franchisor usually reserves the right to inspect the premises to make sure they are well maintained.
You may be required to renovate once every 5 to 10 years (or sooner if needed). Renovation might involve considerable expense, including replacing upholstery, furniture, or fixtures to meet the franchisor’s standards. Your ability to be creative could be severely curtailed. For example, you might not be able to even choose different paint colors without the franchisor’s approval.
- Transfer and Re-Sale: Franchise agreements will outline any rights to transfer the franchisee’s ownership interest in the franchise relationship to a buyer. Sometimes franchisors retain the right of first refusal, meaning they get the first chance to buy your business if you decide to sell.
Also, franchisors typically reserve the right to approve buyers. The franchisor may impose many requirements on a buyer, including the need to submit an application and pay the initial fee.
In practice, transfer rights are tricky and will require adept structuring if you go to sell. You will need to guard against the buyer backing out or going around you directly to the franchisor.
- No Industry Standard Agreement: There is no such thing as a standard franchise agreement for the entire industry. Every franchise brand creates its contract documentation. Most agreements contain common types of provisions, but they won’t be worded the same.
- Negotiating: Prospective franchisees often want to know if they can negotiate the franchising agreement. Technically the answer is yes. You should always try to negotiate. However, be prepared for the franchisor to refuse. The nature of a franchise system is such that the franchisor tries to keep all requirements uniform.
A franchise agreement is a contract of adhesion, meaning it’s created by one party with greater bargaining power using standard form provisions. However, sometimes franchisees can negotiate minor points such as an installment schedule for the initial franchise fee.
The more popular the franchise, the less likely you can successfully negotiate. A well-established franchisor has little incentive to make one-off concessions. However, if you are one of the first in a new franchise, you might have more negotiating leverage.
How we can help?
Regardless of whether you can negotiate terms, it’s still important for you to get a franchise lawyer to review the franchise agreement.
We can point out unusually harsh or one-sided provisions that are not common in the industry. We understand what to look for in the Franchise Disclosure Document, and can identify red flags. Also, we are well-versed in applicable laws that protect franchisees. Knowing key points before signing could save you from making a big mistake.