There’s a Lot to Know About the Legally Binding Franchise Agreement
A franchise agreement is a legally binding agreement between a franchisee and a franchisor. This agreement gives the franchise owner the license and right to utilize the franchisor’s trademarks, business systems, operations manual, and supply sources. The franchise agreement is disclosed in the franchise’s Franchise Disclosure Document, which must be given to a franchisee at least two weeks before a franchise is sold.
Legal obligations established in the franchise agreement include:
- A franchise owner’s development obligations. The franchisee is obligated to establish a franchised location(s) within a certain amount of time and is also responsible for the franchise’s daily operations.
- Various legal rights and jurisdiction. The agreement will define the state law that will govern its interpretation, as well as state the legal bodies that will possess exclusive jurisdiction in a dispute between the franchisor and franchisee.
- The granting of franchise rights and terms. The agreement grants the franchisee the right to establish and operate a location. Franchise rights are usually granted for ten years. But the terms may vary based on the type of business, the franchisee's initial investment, and the time needed to make a return on the investment.
- Rights regarding the franchise’s territory. Franchisees will usually be granted an operating territory where they are required and restricted to conduct business.
- The initial and on-going training that will be provided. The franchisor will provide initial training to the franchisee prior to a location's opening and will continue post-opening.
- The franchise’s operating procedures. The agreement will mandate that the franchisee must follow the franchisor’s systems and procedures. The franchisee will be required to offer and sell only those products and services allowed by the franchisor.
- Marketing fees and marketing obligations. The franchise agreement will also discuss marketing fees. The most common marketing fee is referred to as a “brand development fund.” The franchise agreement will establish whether or not a franchisee has to contribute to a brand development fund and other obligations they have to local marketing efforts.
- Restrictive covenants. In-term and post-termination restrictive covenants protect a franchise system’s confidentiality and prevent franchisees from establishing competing businesses. The “in-term” restrictive covenants prohibit the franchisee from establishing other businesses during the agreement’s term. The “post-termination” restrictive covenants apply after the agreement’s termination and prohibit the franchisee from operating a competing business for a designated time.
- The franchise owner's initial fees. The agreement will also define the initial fees the franchisee has to pay. The initial franchise fee is the primary fee paid when the agreement is signed.
- The franchise owner’s ongoing fees. Ongoing fees are defined in the agreement. A royalty fee is typically charged monthly or weekly and is calculated based on a fixed percentage of the franchisee’s gross sales. However, alternative structures exist that are based on a fixed dollar amount or other structures in the agreement.
A common question a potential franchisee may have is if these terms are negotiable. Good business relationships will always allow for the possibility of negotiation, but prospective franchisees should be prepared for rejection. Franchisors, who have the greater bargaining power in relation to franchisees, will want to keep things uniform and usually have defined terms that are consistent. The rigidity of these terms increases as the popularity of the franchise grows, so the likelihood of negotiation for a well-established franchise with multiple locations is generally low. Established franchisors have little incentive to make concessions. If negotiation is important to you, try to be one of the first to get in on a new franchise.
Franchise Attorneys and Consultants
Now that you know what a franchise agreement is and all it entails, you can probably see the value of a franchise attorney. A franchise attorney can read through the document and tell the prospective franchisee everything they need to know about the agreement. They can also look for red flags. Experienced attorneys can see if there are harsh or one-sided provisions in the document that are uncommon in the industry. They can also explain different laws and regulations that are specific to the state you want to do business in.
Another important person to contact when you're considering franchising is a franchise consultant. Although franchise consultants may not be experts in legal agreements, most have experience reviewing franchise agreements and can identify red flags.
A franchise consultant is a professional who connects entrepreneurs who want to open a franchise with franchisors who are looking for investors. The franchise consultant helps you determine if being a franchise owner is the right path for you based on your skills, goals, experience, financial situation, and more. Since they know the corporate culture, financial requirements, and the qualities of the ideal candidate of various franchise businesses, the consultant knows if purchasing a franchise will benefit you and the franchisor.
Since the consultant only gets paid a commission when prospective candidates buy a franchise, their advice is free to you. Take advantage of it! A quality franchise consultant should be ethical and have your best interests in mind. This means that they'll let you know if a specific franchise business isn’t a good fit for you.
Although franchise consultants may not be experts in legal agreements, most have experience reviewing franchise agreements, Franchise Disclosure Documents (FDD), and can identify red flags. For example, these red flags can include a franchisor firing a lot of franchise owners in the system; the franchisor being in a lot of legal trouble; and many franchise owners filing for bankruptcy. Think of the FDD as a consumer's guide to buying a franchise. If you have a serious chance of being a franchise owner, you’ll be invited to a franchisor’s discovery day.
During this event, franchisors and prospective candidates vet each other. As a prospective franchise owner, you can also ask questions to the members of the leadership team about what it’s really like to work for a specific franchise business. To make the most of your discovery day, be actively involved, ask questions, and take notes. After the event is over, take the time to rest and look over your notes before making your final decision to buy a business. If owning a franchise still sounds good to you after the validation process, then go for it and run your franchise business as best as you can.