Review these Key Components of a Franchise Agreement Before Signing

Review these Key Components of a Franchise Agreement Before Signing

Sona Sulakian
 | 

While minorities lag in other business groups, over 30% of franchise businesses were owned by minorities and 30% by women in 2012, according to the U.S. Census Bureau.

 

A franchise is a business model in which a franchisor sells the right to use its brand to a franchisee for a fee called a royalty. Think of gas stations or fast food chains. All of the individual locations are owned by a business owner, who pays a fee to the owner of the brand name, like McDonald’s, for the right to sell products and services using the McDonald’s branch. The right often includes not only the trademark or logo, but also the franchisor’s expertise, process, and intellectual property in producing the product or service. 

 

The franchisor and franchisee are bound by a legally binding contract called a franchise agreement. This agreement sets out the terms and conditions that will govern the relationship between the two parties. In a way, a franchise agreement is like a licensing agreement for the branding rights. Franchisors like this model because the business can expand to new locations without shelling out large quantities of capital upfront. According to Statista, there were 773,603 franchise establishments in the U.S. in 2019. 

 

Here are some common provisions found in a franchise agreement:

  • Grant of Rights – Grants the franchisee the right to use the franchisor’s trademarks, logos, and other branded systems to operate the establishment
  • Relationship – Specifies that the franchisee is an independent contractor, and not an employee of the franchisor. This provision limits the franchisor’s liability in case your location gets into some legal or financial trouble. 
  • Schedule – Sets out the timeline with major deadlines for the franchise to begin operating
  • Costs and Fees – Lays out the upfront fees, as well as ongoing royalty fees and marketing or other expenses to be paid over the duration of relationship. Some agreements will allow for installment payments or financing. The agreement will likely require your establishment to have a certain amount of money on hand at all times to ensure that you can meet expenses. 
  • Territory and Boundaries Limits the region that the franchise establishment will be operating in, including whether the franchisee’s rights to the region are exclusive or shared with other locations
  • Supplies – Specifies who will be the supplier to the franchise 
  • Fit-Out – Details the expected costs in fitting-out the establishment 
  • Insurance – Sets out the required insurance 
  • Length of Franchise Agreement – States how long the agreement will last, usually 10 to 20 years with the option to renew
  • Renewal Rights and Termination Policies – Explains the process, duties, and rights of each party in terminating the contract, whether by not renewing at the end of the agreement or by terminating the contract earlier. This provision may state the consequences, including damages and liabilities, if you default or breach the agreement.
  • Quality Control – Gives the franchisor the right to monitor your location so that you’re maintaining a sufficient level of quality
  • Rules for Operating – Details the franchisor’s rules, including the hours of operation, employee wages, required equipment or software. This provision often limits products or services you may sell as well, e.g. you don’t expect to buy makeup at a McDonald’s location.
  • Training and Support – Details the training and ongoing support the franchisor will provide, which ensures that you understand how to operation your location according to the franchisors rules. This provision may include discounts on equipment or advertising. Clarify where and when training will occur and how much it will cost. 
  • Personal Guaranty – Most franchise agreement require the to-be-owner of the franchise establishment to be personally liable for the agreement. Make sure to scrutinize this clause because if your business can’t pay its debts, you will have to! 
  • Indemnification – Requires the franchisee to reimburse the franchisor for losses caused by the franchisee
  • Governing law and Arbitration – Specify what state’s laws and even which court will govern your agreement. May require arbitration, meaning you must resolve a dispute in a private arena not in the court system
 

However, the franchisor can’t just sign a franchise agreement, collect the royalty payments, and forget the franchisee exists. The franchisor has a duty to conduct due diligence on its franchisees, to make sure that the franchisee is meeting the quality standards expected by customers. You don’t want a dirty restaurant tarnishing the McDonald’s name, and customers expect that most McDonald’s locations will have a specific look, feel, and quality. 

 

Because franchisor’s are responsible for keeping the franchise afloat, or else all franchise locations will fail, franchisors often don’t really negotiate the franchise agreement. You should ask clarifying questions and push to negotiate clauses of concern to you, but franchisors may refuse to budget on important clauses.

 

Clauses you may be able to negotiate include waiving the personal guarantee or the franchisor’s right of first refusal if you decide to sell before your contract expires. Also, ask for a list of franchisee’s to call as references to vet the franchisor and manage your expectations going into the agreement. 

 

As with any contract, franchise agreements can be long and complicated, full of legal jargon. 
 

Although this article provides a good high level overview of a franchise agreement, you should study this document carefully with an experienced professional to minimize your risks and potential liabilities. An attorney will also help you assert your right to review certain documents and conduct due diligence on the franchisor before you sign a franchise agreement. LawChamps can connect you with an attorney.

 

This article is intended to convey generally useful information only and does not constitute legal advice. Any opinions expressed are solely those of the author, not LawChamps.

 
Sona Sulakian

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