⏰ 8 min read
You've examined the FDD. You've researched the franchise opportunity. You've gone over the numbers and they all add up. Now it's time for the next step toward franchise ownership — signing the franchise agreement.
What is the Franchise Agreement?
The Franchise Agreement is a legally binding contract that stipulates in exacting detail the responsibilities and expectations for the franchisor and franchisee.
Once signed, you are legally obligated to uphold all the provisions of the Agreement, so it is absolutely essential that your lawyer review this contract and explain everything to you in plain English.
Before signing, compare the Franchise Agreement to the Franchise Disclosure Document (FDD) to make sure the franchise offering as outlined in the FDD matches what is in the Agreement. If any verbal promises were made to you, be certain these are written into the Agreement. You want to make sure you get everything in writing. Once signed, the Franchise Agreement governs your relationship with the franchisor, and any disagreements or misunderstandings will be subject to the terms in the Agreement, so it is imperative that everything in the Agreement is correct.
Elements of a Franchise Agreement
Because it is a legally binding contract, there are certain critical elements typically found in all business contracts and some that are unique to franchises. Here are some aspects of the contract that you and your lawyer should carefully scrutinize to be sure you understand all the implications.
Who is signing the contract? First and foremost, be absolutely certain about the identity of the party with whom you are doing business. Is it the franchise parent corporation signing the Agreement or is it a Master License franchise owner? Have you investigated the other party's business track record and reputation? You must know exactly who the other party is that you are going to partner with for many years.
Duration of the Agreement: Next, be sure that the duration of the Franchise Agreement is clearly stipulated. How long does it last — five, ten, or twenty years? Is it renewable when the initial contract expires? If the contract is renewable, how much will you have to pay? Is it a nominal fee or the full franchise fee?
Fees: The section detailing fees must be thoroughly examined. Most franchisors require a royalty, sometimes referred to as Management Service Fee (MFS), that is a percentage of gross sales. Check to see if you must pay a minimum MFS regardless of gross sales. Keep in mind that if you are expected to reach $100,000 in sales per month with a mandatory five percent fee of $5,000, that 5k will consume a much larger percentage of your profits if your sales fall short of $100,000. It is crucial that you understand all the terms related to minimum performance and royalty fees based on revenues.
Advertising: Another factor that can impair your profit margin is advertising. Carefully examine your obligations to contribute toward advertising and marketing and what the franchisor will provide in return. Review this clause so you know just how much of the franchisor's advertising budget will go toward promoting your business on the local and national levels. How is the advertising capital distributed? This should be clearly defined in the Franchise Agreement.
Training: This is another factor that can affect your success and can be costly. Again, the logistics, duration, location and expenses should be detailed in the Franchise Agreement. Usually franchisees must pay their own travel and lodging expenses for training, and these can be prohibitive if the training period is prolonged. Most franchisors will probably not impose a costly burden, but be sure you understand how much time and money for expenses you must commit out of your pocket for the training period.
Operations Manual: As a franchisee, you will need guidance on processes and procedures for running the business. These should be outlined in the Operations Manual, which is your business management guide. Find out if you will be given a hard copy or must download it, which is growing increasingly common in the digital age. How often is it updated? Is there an additional fee or deposit for receipt of the Operations Manual or for its loss?
Trade Dress: One aspect of the contract is unique to franchise operations, and that is "trade dress." This broadly refers to the logo usage, store image, and décor, even clothing worn by employees. Sometimes there are very stringent requirements about trade dress, while others are less formal. Be certain you understand and can meet these guidelines. And, again, who pays for any signage and special fixtures that are part of the trade dress? How often must these be replaced?
Hours of Operation: What are the hours of business you are expected to be open? Don't commit to any requirements about hours of operations unless you are certain you can meet this obligation. This is especially important if you are expecting to run a part-time business. If you fail to meet the hours requirement, the contract can be considered breached and your standing as a franchise owner in jeopardy.
Procurement and Supplies: Another pivotal element of the Franchise Agreement is the question of supplies and products. Must you buy everything exclusively from the franchisor? And if so, what protections are in place to ensure you are not gouged on prices? Are you allowed to use other items not obtained from the franchisor? Know where your product is coming from, and what is a fair price to be paying for those products.
Personnel Policies: All businesses rely on the people who do the work to achieve success. What are the policies regarding staffing? Are there defined methods for recruiting and training staff? What, if any, corporate human resources policies — i.e. sick time, vacation pay, bonuses etc. — must be followed? These should be detailed in the Operations Manual, but be sure to double check so that you fully understand all the franchisor's personnel practices.
Grand Opening: What does the Franchise Agreement stipulate regarding the opening of your business? How much help does the franchisor offer? Will other company representatives be there? Is there specific trade dress and practices that must be used? How much of your initial fee goes toward a "Grand Opening?" What contribution can you expect from the franchisor in regard to public relations, marketing and advertising? Even though this is a one-time occasion, the way your business debuts can affect its long term success. Know what you are expected to do and how much help you'll receive.
Selling or Transferring Your Franchise: How much control does the franchisor exert over selling or transferring your individual franchise business? Does the franchisor have approval/veto rights over prospective buyers? What percentage of the sale is the franchisor entitled to, and when must it be paid? Basically, this aspect of the contract dictates how, when, and under what conditions you can sell the business. It is always wise to have a good exit plan before investing in anything, so know what your rights and obligations are in regard to selling the franchise business.
Termination of the Agreement: Under what conditions can the franchisor or the franchisee legally terminate the agreement before its expiration date? Know your legal and financial rights in this area in case the franchisor does not meet the Agreement stipulations, and know what financial consequences you'll face if you fail to live up to your obligations.
Death and other contingencies: It sounds morbid, but one must plan for unexpected circumstances and the possibility of catastrophic events. If you should die, is your spouse or any other family member entitled to take over the business? If the business is held jointly by yourself and your spouse, are there stipulations about how divorce affects franchise ownership? What are you obligations to rebuild if business is disrupted by a natural catastrophe, and how does this affect any mandatory fees that are normally due?
Expansion Options: Does the Agreement include any possibilities for you expanding the business and/or purchasing other franchises so that you own multiple units instead of just one? Though it may seem unthinkable during this stressful phase of obtaining your first franchise, once you have one successful business up and running, you might want to grow beyond a single unit. Find out if that is possible and what it will cost so you don't run into any surprises if you want to expand.
Territory: Is your franchise an exclusive territory or does the franchisor reserve the right to open other locations nearby? How is your territory determined? By population numbers? Is it drawn up by geographical map, and if so, how detailed is that map?
Some Negotiation Tips
As noted earlier, some franchisors have rigid Franchise Agreements that all their franchisees must sign and adhere to. However, other franchisors may be more flexible about negotiating the terms in the Agreement. But be careful — since franchises are all about proven systems and consistency, a franchisor that seems too eager to bend the rules may be a sign that the business is in trouble.
Items that typically offer room for haggling include:
- Territory rules about exclusivity, future expansion or changes in size
- Grand opening support and resources provided to you
- The training provided to you and possibly your staff
- Rules about transferring the franchise to other franchisees
- Fee schedules and payments
- "Default cure" which governs how much time you have to correct a problem that keeps your franchise from operating properly before you are in default of the contract and your status as a franchisee owner jeopardized
- The start-up date when you are expected to launch the business
- How the price will be calculated for the franchisor to buy your business once you've reached the termination date
- Your liability limits regarding franchise performance
Your lawyer and your accountant are the most familiar with your individual situation, so seek their advice about which Franchise Agreement terms you should attempt to alter to make more favorable for you.
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