This is an essential document that every franchisee will sign. It specifies the rights and responsibilities of the franchisor, who owns the business, and the franchisee who is buying into the business.
What’s in the agreement?
A franchise agreement in some ways is like a licence agreement; however it is more prescriptive about a franchisee’s conduct, following the system, using the franchisor’s intellectual property and brand, and the sale of the franchise business.
Here are the key elements that franchisees need to consider when reviewing the franchise agreement. Each agreement will be different, but there are some commonalities.
The franchise term
Typically a franchise term will be for three to five years but it could be longer. It’s important to know whether there is an option to renew the term and to see how many franchisees choose to do so.
The initial franchise fee is what franchisees pay the franchisor for the right to use the brand, the processes and procedures, and support. The initial franchise is usually fixed, but not always.
Ongoing franchise fees are a standard inclusion in a franchise agreement, most commonly these are the franchise or royalty fee (sometimes called a service fee), and the marketing levy.
The royalty is the ongoing fee usually paid for the use of the brand systems and intellectual property. How this is calculated will be explained in the franchise agreement.
The marketing levy is often charged as a percentage of gross revenue and this must go into a separate dedicated franchisor’s marketing fund which serves to support national promotions and campaigns.
The geographical borders that franchisees will be operating their business within are defined by elements such as demographics, market size, and population density. A territory can often be shown as a series of postcodes or by a map of the region in the agreement. However, many systems now only give rights to operate from a specific location.
The franchise agreement will indicate whether franchisees must use specific approved suppliers for essential goods or whether they can source their supplies from a company of their choice.
A franchisee must follow the rules covering the use of the franchisor’s intellectual property, including the use of branding and any logos or other material.
Franchisees may be required to meet a minimum performance level, attend national conference or state meetings, share financial data with the franchisor – all these essentials will be outlined in the agreement.
It will also indicate whether the franchisor requires the franchisee to be an owner-operator or whether the franchisee can engage a manager to operate the business.
The franchisor’s obligations will also be specified in the agreement but usually, these are expressed as things the franchisor MAY do, not that they MUST do those things. ◊
The agreement will set out the notice period the franchisee has to give the franchisor, the renewal fee to be paid and any other conditions of renewal.
Terminating an agreement
The franchise agreement sets out the rules and process for termination. The franchisor has to give the franchisee notice in writing, six months before the expiry date, of whether they intend to renew the franchise. Franchisees have the right to request early termination at any time during the franchise term.
The franchise agreement will outline the termination rights and processes. For instance, it may be that following the sale of the business the franchisee may have to pay the franchisor a fixed fee or a percentage of the sale price.
Under certain extreme circumstances (abandonment of the business, insolvency or fraud, for example) the franchisor can give the franchisee not less than seven-days’ notice with the opportunity to dispute or rectify any breach or to activate the mediation process.
These are the most obvious things to look out for, but of course there’s a lot to a franchise agreement. It’s such a crucial document and franchisees need to read it to understand their rights and obligations.
If there is also a lease involved, find out whether the franchise term and the lease term can be aligned. That makes it a whole lot easier to manage when it comes to renewals.
Potential franchisees should carefully check and understand the supply arrangements to see what occurs in times of short supply.
Franchise buyers will be asked to sign a non-disclosure agreement before getting a copy of the franchise agreement, as the information is confidential.
A franchisor actually has to give a potential franchisee at least 14 days to get legal and financial advice before they are able to sign the documents or pay non-refundable money and neither the franchisee or franchisor can waive or reduce that period.