You have adequate funds secured and are on your way to owning a franchise. Congratulations! Before you are handed the keys to your new business, you will need to sign a franchise agreement.
A franchise agreement is a legally binding contract between the franchisor and the franchisee. The agreement outlines the terms and conditions the franchisee must adhere to, as well as the obligations of both the franchisee and franchisor.
The franchise agreement and the Franchise Disclosure Document (FDD) are often confused, but do not be fooled; they are not the same! The Franchise Disclosure Document contains details about a company, and is intended for serious franchise candidates. The FDD includes important information such as franchise fees, past litigation, financial statements, and more. While the FDD is a critical document to review before investing in a franchise, it is not a legally binding document like the franchise agreement.
There are four types of franchise agreements:
The single-unit franchise agreement: This agreement grants the franchisee the right to own and operate one franchise unit. This agreement is used most frequently for first-time franchisees.
The multi-unit franchise agreement: Grants the franchisee the right to own and operate more than one franchise unit. This agreement is not limited to one specific territory, and the locations may be spread out across several areas of a town or city.
The area development franchise agreement: This agreement is similar to a multi-unit franchise agreement, because the franchisee owns and operates multiple units. However, in addition, the franchisor gives the franchisee exclusive rights for development in a specified territory. Also, no other franchisees can open units within this territory throughout the duration of the contract term.
The master franchise agreement: This agreement allows the franchisee to sell franchises within their geographic area to other franchisees. The franchisee, essentially, becomes a franchisor.
There are several differences between a franchise agreement and a license. We go in depth about these in our blog post, What’s the Difference Between Licensing and Franchising?, but below is a brief overview of the basic differences.
With a franchise agreement, there is more support from the franchisor than there is from a licensor.
The licensor has a say in how intellectual property is used, but not how the licensee operates the business (as in a franchisee/franchisor relationship).
Licensees are not required to follow a step-by-step business plan, as franchisees are.
The term of a franchise agreement is a bit more flexible than a license, as it starts, typically, at five years with the option to extend. Whereas, a license can last 16 to 20 years.
Licensees can negotiate terms of the agreement, whereas the franchisee, in most cases, cannot.
Businesses can use their good track record and success to obtain a license, whereas, with a franchise, there is a more extensive selection process.
The components of a basic franchise agreement may vary depending on the franchise, but here are the ones you will typically find.
This section states that the franchisor is giving the franchisee a restricted, non-transferable, and non-exclusive license to use the logos, trademarks and system of operation for a given time period.
Opening Date and Territory Limits:
Details the territory in which the franchisee can operate, and provides a timeline for when the franchisee should find a location and solidify plans for their unit. This section may also explain any local restrictions surrounding the location or territory.
Fees and Purchases:
Includes details regarding the initial fee, franchise fees, royalty fees, and other additional costs that may need to be made by the franchisee; both, previous to opening and during operation. Another term that may be highlighted is the late fees that may be applied if payments to the franchisor are past-due.
Term and Renewal:
Details the time period of the agreement; from the signing of the franchise settlement to the expiration of the relationship. The term of the agreement, in most cases, must expire for a given time period after the initial term. If you choose to renew the term, it will automatically be for that same time period. If you choose to not renew, a written notice must be sent to the franchisor prior to the expiration of the, then, current term.
Sourcing and Design:
At the franchisee’s expense, they must complete construction or renovations to premises in a timely manner and to the franchisor’s satisfaction. The franchisee must also only use supplies and signage that conforms to the standards of the franchise, and must only be purchased from an approved supplier. This signage should exhibit only the Licensed Marks or advertising materials approved by the franchisor.
Advertising and Marketing:
Here, it is stated that the franchisee’s advertising and marketing obligations are outlined in the franchise settlement. Marketing materials and signage should only be displayed in the arrangement and manner approved by the franchisor. Any local advertisement is done at the expense of the franchisee, but should be in accordance with standards.
Operations, Training, and Counseling:
This section makes clear how the franchisee will operate the establishment using the system, and the franchisor’s rights to inspect facilities to ensure the franchisee is conforming and adhering to all terms in compliance with the system. Also, this section lays out the restrictions, limitations, and requirements involved in operating the business. The training portion explains who should manage the business, along with the required training for employees. When it comes to counseling, the franchisor must make themselves available to the franchisee for any counseling or advising they may need along the way.
Proprietary Marks and Intellectual Property:
Details the franchisor’s representation and responsibilities regarding use and ownership of Licensed Marks and intellectual property. The franchisor is, essentially, allowing a brief license to the franchisee by identifying confidential, trade-secret data, and restrictions on use of the data by the franchisee. In addition, this section mentions how long the franchisee will use the system and intellectual property, as well as the limitations on use of the materials.
States that the franchisee can and will not, without the franchisor’s consent, copy, duplicate, or reproduce confidential information and make it available to an unauthorized person(s). The franchisee must also comply with all data protection laws and refrain from action/inaction that could cause the franchisor or their affiliates to breach data protection laws.
Accounting and Reports:
At the franchisee’s expense, they must maintain and preserve complete and accurate books, records, and accounts in accordance with standard accounting principles enforced by law. The franchisee must also submit other forms and statements when asked for them by the franchisor. At any time, the franchisor can audit the franchisee’s financial documents.
Indemnification and Insurance:
The franchisee will refund the franchisor any loss, liabilities, and damages the business suffers as a result of their (the franchisee’s) actions. The franchisee must also notify the franchisor of any legal actions being made against them. In terms of insurance, the franchisee is solely responsible for obtaining and maintaining all insurance policies necessary to run the business. If the franchisee fails to do so, they can be charged premiums and fees and the franchisor will bring it upon themselves to find proper insurance.
Transferability of Interests:
The franchisee agrees that their rights and duties stated in the agreement are personal to them. And, that the franchisor has entered into the agreement in reliance on the business skill and character of the franchisee. Also details terms and conditions for transfer of ownership, with approval by the franchisor.
Default and Termination:
The franchisor may terminate the agreement if a breach of the agreement occurs. The franchisor may also terminate the agreement and any rights provided to the franchisee without giving them the opportunity to remedy the default. However, there are some cases where a remedy is allowed, and these are highlighted as well.
Details the franchisee’s obligations, which include but are not limited to: Ceasing to operate business and represent the franchise, ceasing to use intellectual property, turning over original copies of confidential information, payment of outstanding charges and fees, limitations on operating a similar business within a given period of time after termination, and the franchisor’s termination rights and the option for them to re-purchase the franchise.
If the business suffers physical damage, the agreement will not be terminated and the franchisee, at its own expense, will repair damages. If damages require closure, the franchisee must notify the franchisor immediately.
Compliance with Laws:
The franchisee must comply with all laws, and will obtain any and all necessary permits, certificates, and licenses for operation. The franchisee must also file, register, or report an agreement of payments to be made to appropriate government authorities. After the commencement of a material action, suit, or other proceeding that involves the business, the franchisee must notify the franchisor of such events that may adversely affect operations.
According to Richard L. Rosen, a franchise lawyer at The Richard Rosen Law Firm, the following are some red flags:
The franchisor should not discuss the franchise with you until fourteen days have passed since the Franchise Disclosure Document(FDD) was delivered to you.
The franchisor should encourage you to utilize the services of an experienced franchise attorney. If the franchisor tells you that ‘you don’t really need an attorney,’ beware: you do.
If the franchisor tries to give you any financial information that is not disclosed in the FDD, be on your guard, as doing so is illegal. Statements that should raise concern sound like:
Be on the alert if the franchisor tries to pressure you into signing the franchise agreement at “Discovery Day” or tells you that ‘There are several people that are ready to take the territory that you are interested in, so you need to sign the franchise agreement within the next three days.’
It is important, before you sign a franchise agreement, to review it with a lawyer. To learn more about working with a franchise lawyer, check out our blog post, Do You Need a Franchise Lawyer?.
Some franchisors are open to negotiating the franchise agreement, some are not. Most will not, as they are trying to protect the integrity of the franchise. They have a system in place, and they want to keep that system the way it is because it works best for them. Remember: If it is not the right fit, there are plenty of other franchises that may suit your needs better. However, according to Richard Rosen, some terms are negotiable. “Many franchisors will make modifications to the franchise agreement if the requests are reasonable,” he says, “If the franchisor is inflexible in this regard, it may be an indication of how the franchisee will be treated when issues arise during the franchise term, as is often the case.”
When looking for your future franchise, keep in mind these wise words from Richard Rosen, “Don’t fall in love with any deal. Be Patient, be smart, and have a knowledgeable franchise attorney represent you.”