What is a Franchise Agreement?
The franchise agreement is a legal contract between a franchisor and a franchisee. They usually include franchise disclosure documents (FDDs) governed by the Federal Trade Commission’s FTC Franchise Rule. A franchise agreement outlines the rights and obligations of the franchisor and franchisee to license and sell the company’s intellectual property and licensing rights.
Businesses that can benefit from franchise agreements are:
- Convenience stores
- Fast food and chain restaurants
- Financial advisors
- Health care providers
- Health clubs
- Real estate companies
- Travel agencies
If you intend to license your company for use as a franchise, you need to have a franchise agreement in order to run your business legally and efficiently. If not, your franchise agreements could result in mistakes that can come back to haunt you in the future. Be sure to have a franchise agreement suitable for your particular situation and that you know how they work.
How Franchise Agreements Work
A franchisee simply purchases the right to run an organization under the franchisor’s established process, playbook, and brand. Franchises are a tested business model, and investors are eager to reap the rewards, particularly those with previous experience. The franchisor and franchisee must jointly agree on the standards and guidelines.
Here’s how a typical negotiation of a franchise agreement works:
- Step 1. Begin by meeting with the potential franchisor
- Step 2. Determine the proposed territory rights for the franchisee’s location
- Step 3. Establish the minimum standards for performance and associated penalties for missed goals
- Step 4. Decide how much you’re willing to accept in exchange for your service’s or product’s use
- Step 5. Develop the advertising standards as well as intellectual property rights by which the transaction is governed
- Step 6. Contact the franchising lawyers to assist you in translating your notes and discussions into a cohesive document
- Step 7. Revisit with the franchisor again to look over these terms and conditions.
- Step 8. Schedule a franchise agreement signing for both parties
- Step 9. Print copies for the franchisor and franchisee and distribute them
- Step 10. Place your franchise agreement in a safe location along with your other documents
Different types of Franchise Agreements
The franchise agreement’s fundamental principle defines how the franchisee and franchisor will work together. It also specifies what duties and responsibilities are to be respected by both parties. However, specific franchise agreement models may better suit certain situations than others.
There are seven kinds of franchise agreements, which include:
- Master franchise agreements
- Product distribution franchise agreements
- Job franchise agreements
- Conversion franchise agreements
- Investment franchise agreements
- Business format franchise agreements
- Area development agreements
In many cases, a master franchise agreement is sufficient. However, your requirements may differ based on your market, industry, and geographic location.
Essential Elements of a Franchise Agreement
The franchise agreements generally comprise the same elements irrespective of the type you use. However, there are some significant differences, especially when you require a highly specialized agreement. Therefore, seeking a customized option when drafting your contracts is always recommended.
The most important components of the franchise agreement typically comprise the following:
- Territory rights
- Minimum performance standards
- Franchisors services requirements
- Franchisee payments
- Trademark use
- Advertising standards
- Exclusivity clause
- Insurance requirements
Parties Involved in Franchise Agreement
The parties involved in a franchise agreement are the franchisor and franchisee. There may also be third parties, like insurance companies and franchising lawyers; the core of a franchise agreement applies the fundamental principles outlined below.
Franchisors are the companies or individuals that license or sell their franchise rights to a franchisee. They offer licensing, branding, and intellectual property rights to them. The company selling its rights is referred to as a franchise and can exist as a brick-and-mortar business, an online business, or both.
Franchisees are the companies or individuals who purchase franchise rights from s franchisor. They are usually small entrepreneurs with years of experience in the field. If you’re a franchisor, then you must choose franchisees that can adhere to the rules and guidelines you set up.
Common Provisions in the Franchise Agreement
Within your franchise agreement, some of the legal rights and obligations that will be established include:
- The Grant of Franchise Rights and Term. The franchisee is granted the right to set up and run a franchised location or outlet. The rights granted to franchisees include the license to use the franchisor’s trademarks, trade dress, and business system. The typical franchise rights are granted for a period of 10 years, but the duration may differ depending on the type of the company, the franchisee’s initial investment, and the length of time required for the franchisee to earn an adequate return on their initial franchise investment.
- Franchisee’s Development Obligations. The franchisee must set up the franchised location and the designated time frame within which the franchisee must establish and commence its day-to-day business activities.
- Initial and On-going training. The franchisor will provide the initial training to the franchisee prior to opening and any on-going training that may be provided or required by the Franchisor.
- Territorial Rights. The franchisee is granted some form of territorial protection wherein, for instance, the franchisor will not grant competing franchises. Most franchisees will receive an operating area in which they are required and restricted from carrying out the operations of their franchise business. The franchise agreement will specify the areas where franchisees can run the franchised business, who the franchisee is allowed to or cannot sell goods or services to, and any protection granted to the franchisee with respect to his or her territory.
- Operating Procedures. The franchise agreement will require that the franchisee follow the procedures and systems established by the franchisor. The Franchisee is required to sell only those products and services that are authorized by the franchisor and will mandate that the franchisee adheres to the rules and regulations contained in the franchisor’s confidential operations manual.
- The Initial Fees. A franchise agreement will specify the initial fees that must be paid by the franchisee to the franchisor. The most common initial fee is the initial franchise fee, which is the primary fee paid by the franchisee at the time of entering into the franchise agreement. Other initial fees may include upfront software license fees and initial inventory requirements, and purchases.
- Marketing Fees and Marketing Obligations. The franchise agreement will specify and mandate whether or not the franchisee is required to pay any marketing fees to the franchisor. The most common marketing fee charged by franchisors is typically called the “brand development fund” that a franchisee is required to contribute to. The franchise agreement will establish whether or not a franchisee must contribute to a brand development fund and other obligations that the franchisee is required to fulfill regarding the franchisee’s local marketing efforts.
- Restrictive Covenants and Non-Competes. To safeguard the confidentiality of the franchise system and stop franchisees from starting competing businesses, the franchise agreement must include post-termination and in-term restrictive covenants. These “in-term” clauses typically prevent the franchisee from starting, operating, or participating in any competing business during the period of the franchise agreement. The “post-termination” restrictive covenants will be in force when the franchise agreement is ended and will prohibit the franchisee from setting up or operating any other business during the specified time frame, which begins after the date that the franchise agreement was terminated.