A franchise agreement is a legally-binding contract between the parties to a franchise relationship. In order to take ownership of a franchise as the franchisee, you sign a franchise agreement.
A franchise agreement protects both sides. It protects you as the franchisee and also protects the franchisor brand. When buying a franchise you will be making a large financial investment. A signed agreement gives you rights to help safeguard your investment in your business.
What is a Franchise Agreement?
A franchise agreement is the master legal document that sets forth the rights and obligations of the two main parties to a franchise: franchisor and franchisee.
In legal terms a franchise agreement is a license from the franchisor to the franchisee. A license simply means one party gives permission to another party to do something or use something of value. In the case of franchising agreements, this means:
- The franchisor licenses to the franchisee the right to use the franchisor’s intellectual property, systems and brand.
- The franchisee acquires the rights to open a business using the franchisor’s intellectual property, systems and brand, provided it meets certain conditions.
Although the definition of franchise agreement is simple enough, the documentation can be complex.
A typical franchise agreement is 25 to 30 pages long. After attaching all exhibits and addenda, the final agreement can be two or three times as long.
Key Franchise Agreement Points
Here are 20 things you must know about franchise agreements.
1. Disclosure
In the United States a franchise business falls under the Federal Trade Commission’s FTC Franchise Rule. This is a set of Federal regulations governing most franchises (with a few exemptions).
The FTC Rule imposes strict disclosure requirements on franchisors in the form of a Franchise Disclosure Document (FDD) that must be delivered to a prospective franchisee.
One of the required pieces of information in the Disclosure is a copy of the Franchise Agreement. The copy must be attached to the FDD and delivered a minimum of 14 days before entering into a binding contract. This gives you time to review and discuss the agreement with an attorney.
Beyond basic disclosure requirements, the Franchise Disclosure Document often contains detailed provisions regarding the franchisor’s background, financial performance representations, and the legal and financial obligations of the franchisee.
This includes insights into the franchisor’s litigation history, bankruptcy records, and initial investment estimates, providing comprehensive information for an informed decision.
2. Trademark and Intellectual Property
A franchise agreement grants to the franchisee the right to use the franchisor 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 also outlines the protection and limitations concerning these intellectual properties. As a franchisee, you must adhere to specific guidelines on how to use these properties to maintain brand consistency and legal compliance.
This section also usually explains the franchisor’s responsibility to defend its intellectual property against third-party claims.
3. Support and Training
The agreement will set forth the franchisor’s obligation to provide training and support services. This obligation is both prior to opening and during entire term of the franchise agreement.
This section often includes provisions for ongoing development and training programs to keep franchisees updated on new technologies, marketing strategies, and operational improvements. It may also outline the support provided in areas like marketing, technology, and operational consulting.
4. Advertising
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!
To ensure transparency and fairness, franchise agreements may include the following provisions related to marketing and advertising support:
- Clear description of the franchisor’s marketing support and resources provided to franchisees.
- Specification of the franchisor’s financial contributions to national or regional advertising campaigns.
- Explanation of any required local advertising contributions from franchisees, with a fixed or percentage-based amount.
- Details on the approval process for franchisee-created advertising materials and campaigns.
- Information on cooperative advertising programs and the franchisee’s eligibility to participate.
- Clauses outlining the use of the franchisor’s trademarks and branding in marketing efforts.
- Provisions for tracking advertising effectiveness and measuring return on investment.
- Requirements for reporting advertising expenditures and campaign results to the franchisor.
- Clarity on any restrictions or guidelines for online marketing and social media usage.
- Language addressing the resolution of advertising disputes between the franchisor and franchisees.
5. Long Term Duration
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 conditions for renewing. Often an initial 10-year term can be automatically renewed for a second 10-year term, unless either side gives notice of non-renewal.
The long duration also means that the franchisee must adapt to any changes in the franchisor’s system over time. This might include adopting new branding, technology upgrades, or operational changes. The agreement may contain clauses on how these changes are to be implemented and financed.
6. Signed and in Writing
Every franchise agreement should be in writing 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 trying to prove oral representations years later. A written document makes rights and obligations clear.
A written franchise agreement serves as a clear record of the terms agreed upon, which can be crucial in dispute resolution. It usually contains clauses outlining the process for handling disagreements, including mediation and arbitration procedures.
7. Territory
The agreement will outline whether the franchisee gets a protected or exclusive territory.
Territories are important to limit market saturation. An individual franchise business will have a harder time competing in a over-saturated area. Remember your significant investment in the opportunity. How would you like it if you paid hundreds of thousands of dollars to open a franchised outlet, only to discover that the franchisor allowed another franchise just a quarter mile away?
Subway is an example where much has been written about market over-saturation and its negative effects on franchisees.
The agreement might also address how territory rights are affected by changing market dynamics, such as the introduction of online sales channels or mobile services. This section ensures that the franchisee’s interests are protected as the business model evolves.
8. 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.
The agreement may include provisions for adjustments in fees based on various factors like inflation, performance metrics, or changes in market conditions. Understanding these variables is crucial for financial planning and long-term sustainability of the franchise.
9. Site Selection
Each franchisee selects its own 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.
The agreement might also cover terms under which a franchisee can relocate or expand their operations. This includes processes for franchisor approval, adherence to new location standards, and potential impact on existing franchisees in nearby territories.
10. Termination
The agreement outlines any conditions for terminating early. Usually the franchisor will have the greatest termination rights. In fact, 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.
The agreement typically outlines post-termination obligations, such as the de-identification of the business from the franchise brand, return or destruction of confidential information, and non-compete clauses to prevent the former franchisee from opening a similar business within a specified period.
11. 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.
Some franchise agreements may also detail any support or assistance the franchisor will provide post-termination. This could include guidance on business wind-down procedures, assistance with asset liquidation, or support in notifying customers about the closure or change in management.
12. 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.
The scope of non-compete clauses, including geographic and temporal limitations, should be carefully reviewed. These clauses can significantly impact your ability to engage in similar business ventures post-termination. Ensure that the restrictions are reasonable and enforceable in your jurisdiction.
13. Arbitration
Franchise agreements usually contain an arbitration clause requiring any dispute to go to arbitration. Instead of filing a lawsuit you might have to go before a body such as the American Arbitration Association.
The franchisor sometimes retains the right to file a lawsuit to obtain an injunction under certain conditions (such as to prevent the franchisee from revealing confidential information about the franchise system).
The agreement will specify the jurisdiction for filing any lawsuit. The choice of jurisdiction will be favorable to the franchisor.
It’s important to understand the arbitration process, including who will bear the costs. Arbitration can be less expensive than court litigation, but it may still involve significant legal fees. The agreement should clarify how arbitration costs and awards are handled.
14. 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.
The agreement might specify types of insurance coverage required, such as liability, property, and workers’ compensation insurance. It’s crucial to comprehend these requirements and ensure that your insurance policies meet the franchisor’s standards.
15. Records and Audits
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.
Maintaining accurate records isn’t just for royalty calculations; it’s also a matter of compliance with the franchisor’s operational standards. Regular audits by the franchisor ensure that franchisees adhere to the prescribed business practices, contributing to the overall brand reputation.
16. Physical Premises and Renovations
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.
In addition to meeting franchisor standards, renovations and maintenance must also comply with local building codes and regulations. This includes obtaining necessary permits and ensuring that any structural changes are legally compliant.
17. 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.
The agreement may address succession planning, outlining the process for transferring the franchise in the event of the franchisee’s retirement, incapacity, or death. This ensures business continuity and protects the franchisee’s investment.
18. No Industry Standard Agreement
There is no such thing as a standard franchise agreement for the entire industry. Every franchise brand creates its own contract documentation. Most agreements contain common types of provisions, but they won’t be worded exactly the same.
Each franchise may have unique clauses addressing specific business models or industry challenges. It’s vital to understand these unique elements and how they impact your operation within the specific franchise system.
19. 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 it’s possible for franchisees to 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.
Sometimes, a franchisor’s willingness to negotiate can be influenced by legal precedents or standard industry practices. An experienced franchise attorney can offer insights into what terms might be more flexible based on industry norms and legal standards.
20. Review with a Lawyer
Regardless of whether you are able to negotiate terms, it’s still important for you to get a franchise lawyer to review the franchise agreement and the FDD.
An experienced franchise lawyer can explain important provisions of the franchise agreement. A franchise lawyer may also be able to point out unusually harsh or one-sided provisions that are not common in the industry.
Besides understanding the franchise agreement, a lawyer can help ensure that your franchise operation complies with local, state, and federal laws. They can also assist in conducting due diligence on the franchisor, including reviewing their financial health and business track record.
An experienced attorney will understand what to look for in the Franchise Disclosure Document, and can identify red flags. Also, the attorney may know of common law and state laws that protect franchisees. Knowing key points before signing could save you from making a big mistake.
Read more: The Importance of Hiring a Franchise Attorney.
Franchise Agreement Summary
| Key Points in Franchise Agreement | Description |
|---|---|
| 1. Disclosure | Franchise falls under FTC’s Franchise Rule, requiring a Franchise Disclosure Document (FDD). |
| 2. Trademark and Intellectual Property | Franchisee granted rights to use franchisor’s name, trademarks, and intellectual property. |
| 3. Support and Training | Franchisor’s obligation to provide training and support services, both before and during the term. |
| 4. Advertising | Franchisor’s obligation to support franchisees with marketing and advertising. |
| 5. Long Term Duration | Franchise agreement’s duration, typically 10 to 20 years, with conditions for renewal. |
| 6. Signed and in Writing | Every franchise agreement should be in writing and signed by both parties. |
| 7. Territory | Outline of protected or exclusive territory granted to the franchisee. |
| 8. Fees and Expenses | Costs of franchising ownership, including initial and ongoing fees and expenses. |
| 9. Site Selection | Franchisee’s right to select a location, subject to franchisor’s approval and standards. |
| 10. Termination | Conditions and rights for early termination, usually favoring the franchisor. |
| 11. Obligations upon Termination | Requirements to unwind the business relationship after termination or expiration. |
| 12. Non-Competes | Restrictive covenants limiting franchisee’s competing activities during and after the term. |
| 13. Arbitration | Dispute resolution through arbitration, often with franchisor’s jurisdiction preference. |
| 14. Insurance and Indemnification | Franchisee’s obligation to maintain insurance coverage and indemnify the franchisor. |
| 15. Records and Audits | Requirements to maintain accurate records and provide regular reports and audits. |
| 16. Physical Premises and Renovations | Franchisee’s responsibility to maintain and renovate premises according to franchisor’s standards. |
| 17. Transfer and Re-Sale | Outline of rights to transfer franchise ownership and franchisor’s approval process for buyers. |
| 18. No Industry Standard Agreement | Franchise agreements vary between brands and may contain unique provisions. |
| 19. Negotiating | Prospects can attempt to negotiate minor points, but franchisors often maintain uniform requirements. |
| 20. Review with a Lawyer | Regardless of negotiation, consulting a franchise lawyer to review the agreement and FDD is crucial. |
Conclusion
The franchise agreement is a document with the rights and obligations of the parties outlined. The franchise relationship is not employer-employee. As the franchisee you operate a separate business in accordance with the franchise system. You are an independent business owner and the franchise agreement reflects this separation of interests.
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This article, “Franchise Agreement: 20 Important Things to Know” was first published on Small Business Trends