Research about every aspect of the franchise agreement must conduct every entrepreneur who considers starting a franchise. This contract is not very complex, but there are many contractual terms that are good to know before signing this type of cooperation. The franchising business concept is very profitable if you know the advantages and disadvantages that provide this system.
What is a franchise agreement is a question that a lot of people ask when they start investigating this business concept. In the US, there are more than 700,000 business units based on the franchise model of operation. This fact tells us that it is worth investing time and money in this type of business.
What is a Franchise Agreement
The franchise agreement is the basis of the ongoing relationship between the franchisor and the franchisee. The Franchise Disclosure Document includes a copy of all agreements that comprise the franchise offering. Typically we have single-unit and multi-unit franchising agreements.
Due to the growing number of companies from different sectors that are entering the franchise system and because of the specific activities of each franchisor, it is not possible to have a standard form of the franchise agreement that can be applied to all types of franchises.
However, it can be observed that there are certain specific provisions that we can find in every franchise agreement, no matter who the franchisor is. These requirements are the backbone around which the further content of the franchise agreement is usually built.
The franchise agreement usually begins with a preamble, which states the parties’ names, intentions, ideas, and values on which the cooperation between the two parties will be carried out. The goal of the preamble(the introductory part of a contract) is that reader(potential franchisee) better understand the contract’s content. After that, a franchise agreement will contain some of the basic terms that will be used in cooperation between the franchisor and franchisee.
Groups of franchise agreement provisions:
- Provisions relating to the conclusion of the contract
- Provisions describing the rights and obligations of the parties during the legal relationship
- Provisions that explain conditions and manner of termination of the contract.
For a franchise agreement to be made in a quality manner, all the steps that need to be taken should be foreseen in advance. Only after all terms of the contract are determined you, as a franchisee will know if this franchisor is the right choice for you.
The author of the franchise agreement must adhere to the appropriate order for writing an agreement. It must form a logical whole that allows the reader to better and easier understand the contract itself.
What Should the Franchise Agreement Contain
The franchise agreement must clearly set out the obligations and responsibilities of each party, as well as all other terms of this business relationship. Also, this agreement will clarify the rights of the franchisor and the franchisee. If one of the parties does not fulfill its obligations from the contract, it can be nullified.
Basic conditions contained in the franchise agreement:
- Rights granted to the franchisee
- The rights granted to franchisees related to the goods and services that are under the franchisor’s trademark
- Obligations of the franchisor
- Obligations of the franchisee
- Terms of payment for franchise fees
- Duration of the franchise agreement – It should allow each franchisee to return the funds he initially invested
- The basis for the franchise agreement renewal, i.e., the extension of the contract and related rights of the franchise owner
- Conditions under which franchisee can use the trademark, name, logo, or any other mark of the franchisee
- The right of the franchisee to adapt the franchise system to new or modified methods.
- Provisions related to the termination of the franchise agreement.
- Provisions how and when will be returned any tangible or intangible assets after the termination of the contract
The franchise agreement must be under the state’s laws in which it was signed, that is, with the Federal Trade Commission (FTC) rule and other relevant legal provisions of any given state. The franchise agreement obliges the franchise network members to work on preserving the franchise’s intellectual property rights and to help preserve the common identity and reputation of the network.
All contracts and all contracted actions, which regulate the relationship between the owner and the franchisee, will be written down and translated into the official language of the country where the franchisee works, and the franchisee will receive his contract immediately.
Although we can discuss the general rules related to franchise agreements compilation, each of these contracts is specific (it depends on the specifics of each franchise system and product). This contract must not be compiled according to a template based on a similar model. To know more about this topic, you will need specific knowledge about franchising.
Before signing a franchise agreement, seek the participation and assistance of legal franchising experts (franchise attorneys).
It is known that franchise agreements in the US are well legally covered, which we can thank for the legal tradition and the long history of the franchise system in this territory. In the US, where franchising has a long tradition and is well developed, it would be difficult to imagine the successful start and subsequent operation of the franchise system without the mediation of reputable legal experts.
Types of Franchise Agreements
The types of franchise agreements are divided according to the number of units and the rights for representation in a certain area, that is, the territory. In this way, the business structure is precisely defined, and each user of this agreement knows his rights and obligations. The franchise business model work in such a way that everything must be clear from the start.
Types of franchise agreements:
- Single Unit franchise agreement
- Multi-unit franchise agreements
What is a Single Unit Franchise Agreement
The basic agreement that is included in almost all Franchise Disclosure Documents is the single unit franchise agreement. This type of contract is most used in this industry because it is simple for both parties. In it will be outlined all the terms and costs that franchisee must pay.
Single-unit franchise agreement outline:
- Initial fees
- Other fees(royalties, marketing, software)
- Sales restrictions
- Renewal terms
- Transfer restrictions
Initial Fees will depend on some of the factors that every franchisor will look for. First, the initial fee should cover the franchisor’s initial costs of selling the franchise, providing initial training, and assisting the franchisee in the launch of the business. Initial fees are not profit centers for the franchisor. The franchise system makes its profit from ongoing royalties.
Also, when determining how much it will charge the initial fee aside from the fact to looking its own costs, the franchisor will also look at what the competition is charging. Because of this fact, costs of initial franchise fees are quite similar for franchises that are on the same level. Except for this initial fee in the franchise agreement, there will also be some other fees usually paid on a monthly basis.
Fees that must be paid monthly:
- Royalties – This fee range usually from 4 to 12 %, it depends on the franchisor
- Marketing Fees – Franchisors frequently handle regional and national advertising, and they commonly collect marketing fees from franchisees to cover some or all of the costs.
- Services – Some of the franchisors have fees for onsite assistance or training requested by the franchisee.
Sales restrictions that franchise agreement can include.
The franchise agreement requires that the franchisee sell only those goods and services that the franchisor approves. You, as a franchisee, can not sell some of your own products because every franchise must have the same products and the same quality of service. If you don’t like these sales restrictions, that for you can be a good option to buy some license.
In our article franchise vs. license, we explained the difference between these two business models. The license can be good for the people who want to have in offer some of the branded products, but at the same time, they want to develop some of their own products.
What is a Multi-unit Franchise Agreement
Many franchisors offer both unit franchises and multi-unit franchises. Multi-unit franchises come in a few basic varieties. A multi-unit franchise agreement will contain a development schedule that will contain the number of units that the franchisee is required to open or sell over a specified period of time.
Multi-unit agreements help a franchisor to grow a franchise system more quickly and with less effort than it will be possible with selling individual unit franchises.
The most basic multi-unit area development agreement requires the developer to open an agreed number of franchises in a defined territory over a specified period of time. By working with a multi-unit franchise business model, a franchisor will simplify its business because it will reduce the number of franchisees and grow the number of units.
Types of multi-unit franchise agreements:
- Area representative agrement
- Master Franchise agreement
Area representatives (often called area developers) commonly act as sales representatives for the franchisor within a defined territory. The area representative acts as a finder of prospective franchisees. The franchise agreement is signed by the franchisee and the franchisor, and the area representative is the ”bridge” between these two parties.
The area representative will typically receive a portion of the initial franchise fee and the ongoing royalty from the franchisor. Area representatives also perform services for unit franchisees on behalf of the franchisor within the territory.
For example, the area rep may assist unit franchisees in finding and developing appropriate sites for the franchise units. The area rep may also train unit franchisees and provide ongoing support. In many systems, the area representative must own at least one unit franchise because, in this way, he will be familiar with how that particular franchise works.
Master Franchising Agreement
The master franchise business model is commonly used in international franchising. The U.S. franchisor grants to the master franchise all company rights for the particular country. That company finds and helps franchisees to open and starts new franchises in the country under their jurisdiction.
Master franchising is far less common in the U.S. One reason is that the master franchisee and the franchisor are jointly liable for compliance with the franchise laws. The unit franchise disclosure document must include disclosures about both the franchisor and the master franchisee, including the audited financials of both the franchisor and the master franchisee.
Master franchising can also lead to quality control problems with subfranchisees because the franchisor does not have a direct contractual relationship with the subfranchisees.
Contractual Terms of Master Franchise Agreement
Due to the nature of the business and rights involved in it, the Master Franchise Agreement is the most complex document of all that we have mentioned before. A typical master franchise arrangement enables the master franchisee to develop the business in the territory under the franchisor’s brand name and trademark with permission to manufacture the products.
Master Franchise Agreement will govern:
• Permission and restrictions about the use of a trademark within the given territory
• Transfer of technical know-how concerning manufacturing, advertising, or marketing
• Financial returns to the franchisor, including franchising fees
• Appointment of sub-contractors to manufacture and sub-franchisee to sell the products at different locations within the territory
• Control over the sub-contractors and sub-franchisees through master franchisee
• Manufacturing process including approval of samples and quality control
• Provision of dedicated staff by the franchisee
• Appearance of the franchise stores and training of sales executives
• Annual market penetration targets
• Minimum stock purchase/import obligations
• Joint marketing, sharing of advertising cost and support by the franchisor
• Periodic reporting by the franchisee
• Duration, renewal, or termination of the arrangement
• Events of default, pre-termination notice to correct, termination, etc.
• Exit options, if any or both parties do not wish to continue
• Post-termination obligations including assignments of trade contacts; return/destruction of advertising material, liquidation of unsold inventory, raw material, and destruction of sub-standard products, if any
• Provisions governing confidentiality, warranty, intellectual property protection, and insurance
Renewing the Franchise Agreement
Usually, franchise agreements are signed for a period of 10 years, but in some cases, they are signed for 5 years. Most franchisors will renew your franchise agreements automatically- it is important that you as a franchisee are good at managing and that your unit is profitable.
Most franchisors don’t want to give franchisees a contractual right to continuing renewals. Franchisees typically have the right to renew as long as they comply with the franchise agreement. So in practice, a franchisor will renew every agreement if the franchisee is performing well.
Franchisors typically require the franchisee to sign the form of agreement that the franchisor is using for new franchisees at the time of renewal. That agreement may be very different than the one that the franchisee signed at the outset of the relationship. This allows a franchise system to change terms over time because, as we know, the market is a ”living being” and evolves every year.
Some franchisors charge a renewal fee, which may be 50% or 25% of the initial fee of a new franchise or some lower amount. Other franchisors don’t require any renewal fee at all.
Transfer restrictions(selling the franchise) are also common in franchise agreements. The franchisor wants to know that the owners of the franchise are of good character, that they have the requisite business experience, that they are adequately financed, and that they are not affiliated with a competing business.
This means that any sale of a franchise is a three-way transaction involving the buyer, the seller, and the franchisor. Where there is a lease, the transfer of the franchise also involves the landlord.
Every franchise has its own agreement- it depends on the nature of the business or service. if you are new to franchising, then you are aware that this business model is not so easy as it seems at first. First, you need to have investment funds, and after that, you must be able to fulfill all requirements before and after signing a franchise agreement.
Franchisors are very strict, and they don’t give franchise rights to persons who are not good at managing a business and who are not willing to work under the rules that particular franchises have. Also, if the obligations from the franchise agreement are not fulfilled, it is a high chance that this contract will be nullified. So, it is important that you are aware of how this business is functioning.
The franchise agreement is the most important document in the franchising business model; this must be a document under the law of the state where you conduct your business operations. Also, as we mentioned before, it is good to hire a franchise attorney before closing any deal. The attorney can give you legal advice that can be of great help to you.