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Franchise Business Basics: Understanding the Franchise Agreement

Since the terms, conditions and operating protocols can vary widely from one franchise system to another, the franchise agreement is not a standardized document. However, all will include similar fundamental provisions detailing the rights and obligations of each party. These typically fall into one of three categories: conditions related to franchise ownership, your financial obligations or operation of the franchise.

Franchise Ownership

Grant of Franchise – This section identifies each party to the contract and contains an overview of the relationship. It grants the franchisee the right to use the franchisor’s trademark, logo, service mark, system of operation and outlines the franchisee’s overall obligations to operate in accordance with the franchise brand’s standards.

Initial Term and Renewal – The length of the relationship, measured from the time the agreement is signed, is specified in this section. Any prerequisites for renewal of the contract as well as the cost are also outlined. Some franchisors offer a discount for renewals while others require the full franchise fee.

Resale and Termination Policies – This provision dictates conditions for selling the franchise business and defines how much control the franchisor has over the process. Some franchisors secure right of first refusal giving them the option to buy back the franchise to retain ownership. Or, they may have approval/veto rights over prospective buyers. The percent of sale the franchisor is entitled to and when it must be paid are also outlined.

The termination policy will specify the conditions under which the franchisor can terminate the agreement prior to the expiration date and fees due if the franchisee ends the relationship before the agreement expires.

Financial Obligations

Initial and Ongoing Fees – The most common initial fee is the franchise fee. This grants franchisees the right to use the franchisor’s trademark and operating system. Some franchisors allow this fee to be paid in installments and some may even offer in-house financing.

Many agreements also include a number of additional fees that may be paid to the franchisor prior to opening or throughout the term of the contract like software license costs and initial inventory. Royalties are the most typical ongoing fee. They are usually a fixed percentage of gross sales paid on a weekly or monthly basis, although some franchise systems use a flat fee structure.

Advertising Fees and Obligations – This section outlines the franchisor’s commitment to the type of promotional assistance they will provide on the local and national level. Most collect fees from each franchisee that are pooled together in a brand development fund used for general brand marketing. Individual franchisee obligations for local marketing efforts are also defined along with guidelines for logo and trade/service mark usage.

Operation Requirements

Site Selection and Development – The time period for establishing a location and opening the business will be specified. Franchisees are typically responsible for securing their own location and building it out in accordance with the franchisor’s standards. Franchisors must approve the location and final design prior to opening.

Territory – This section defines the franchisee’s designated territory where they are authorized to operate and who they may or may not sell products or services to. Territories can be determined in a variety of ways such as by population or geographical boundaries and help minimize competition in the area that can limit sales and impede success. Some agreements provide for an exclusive or protected territory meaning the franchisor will not grant a competing franchise business within the same area.

Training and Support – Franchisors provide training to ensure franchisees and their staff learn uniform business practices. This section will outline the location and extent of initial and ongoing training, seminars, meetings, etc. Ongoing support provided by field representatives and headquarters will also be defined in this section. This additional support can include things like supply chain guidance, quality control, discounts on equipment and supplies, advertising subsidies and administrative and technical support.

Business Operations – The operations manual for your franchise is your business management bible. It dictates how the business must be run. These details will also be included in the business operations section of the franchise agreement and can include things like hours of operation, specific items or services sold, rules around procurement and supplies, pay scale for employees, processes and operating procedures, quality control measures and more.

The franchise agreement is a key document to your franchise investment. If you want to start your own franchise, it’s imperative to take the time to understand each provision and how it will impact your business. Make sure all expectations (of you as the franchisee as well as those you expect from the franchisor) are covered in writing. Since the franchise agreement specifies the operation of every facet of the business, it’s also a good idea to have it reviewed by a franchise lawyer to flag any questionable conditions before signing.