Franchise Agreement Explained
There’s no denying that starting a new business venture is as scary as it is exciting. On the one hand, you’re fulfilling a lifelong dream to be your own boss; but on the other you feel like you’re drowning in complex paperwork and legal documentation.
Franchise Agreement UK
It’s true that when you become a franchisee many of the stress and concerns that come with starting a new business are removed from the equation, but this doesn’t mean that the whole process is completely plain sailing. The biggest worry that most franchisees have is understanding the franchise contract which you sign when you’ve decided on the right opportunity for you.
It’s not surprising that the lengthy, and often complicated, franchise agreement is daunting for entrepreneurs that are new to franchising. Longer doesn’t always mean better, but in the case of a franchise agreement, it usually does. A short franchise contract is unlikely to reflect the intricacies of the relationship between franchisor and franchisee and may result in problems further down the line.
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Key elements of the franchise agreement
It’s important that you consult an experienced franchise solicitor to help you understand the document before you sign, but in the meantime, here are some of the main parts of the franchise contract which you should familiarise yourself with:
At first glance the inclusion of three parties in a franchise agreement may seem strange. The reason behind this is that the contract involves a franchisor company, a franchisee company and an individual. Because many franchisees trade as a limited company it’s categorised as a separate legal entity. Obviously, the franchisor requires the franchisee to agree to a certain level of performance which the individual will be obliged to achieve, rather than the franchisee’s company.
Further reasoning for the individual being named in the franchise contract is that often a clause is added to restrict the franchisee from setting up a competitive business once the franchise agreement comes to an end. If the contract only refers to the franchisee’s company it wouldn’t prevent the individual introducing a business in competition with the franchisor.
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All franchise agreements are different, and this is also true of the length of time they are valid for. A franchisor takes several factors into account when setting the duration, including the profitability of the franchise, when the franchisee can expect to break even, followed by a period in which the franchisee can experience running a successful franchise.
Read more: Franchise Agreement Definition
After the initial term of the agreement, there is usually an option of renewal. This provides both the franchisor and the franchisee an opportunity to evaluate the success, or otherwise, of the franchise. Although simply because renewal is an option, it’s not guaranteed. The franchisor must be pleased with the performance of the franchisee, both from a financial perspective, as well as the franchisee’s ability to follow the franchise rules without any breaches occurring.
Providing the franchisor is happy, then the renewal discussions can take place. However, during the initial term of the contract it’s very likely that the franchise business will have experienced changes. This means that the renewal terms should be expected to be different to the original agreed conditions. In addition, a fee may be charged for the franchisee to renew the franchise agreement.
To become a franchisee, an initial fee must be paid to the franchisor. This franchise fee covers the costs of setting up the franchise, including recruitment and training of the franchisee as well as any professional fees and expenses incurred during completion of the franchise contract. The franchisor should not profit from the franchise fee.
Following the initial franchise fee, the franchisee will generally to pay regular royalty payments. These fees are usually worked out as a percentage of profits or as a flat fee. Some franchises may not even charge a royalty fee at all.
Another ongoing fee which the franchisee may be expected to make is contribution to a marketing pot. One of the main benefits of investing in a franchise is the power of the recognisable brand, and this is often achieved by nationwide promotional activity. The marketing activity, although extremely valuable to franchisees, tends to be pitched at a brand level, so additional local marketing should be carried out, which the franchisee funds.
Finally, as part of the agreement, the franchisee may be expected to purchase goods or services from suppliers stipulated by the franchisor. Many franchisors require this so that they can guarantee that the goods or services being offered to their customers is of good quality, consistent and meets with customer expectations. For the franchisee, this can restrict the ability to make cost savings by sourcing products or services elsewhere.
Read more: What’s the point of a Franchise Agreement?
Many entrepreneurs looking to become a franchisee often falsely believe that when they start a franchise that they will be granted an exclusive territory as part of the deal. However, this isn’t always the case.
From a franchising perspective ‘exclusive’ means that the franchisee will be protected from the franchisor opening another franchise, or granting the rights for another franchisee to start a franchise, within the agreed geographical area.
Despite the franchisee having this security, there will be conditions attached to the exclusivity. For example, if a franchisee is not achieving the agreed level of return for the franchisor, then they are within their rights to grant another franchisee the opportunity to open an additional unit in the same area.
When a franchisee decides that it’s time to move on, either by selling the franchise or through succession, they will be governed by the franchisor as to who the business can be transferred to. As the success of a franchise relies on the quality of the franchisees, the franchisor has full control over who takes over the business. Before the franchisee in situ can move on, the franchisor will apply the same rigorous recruitment criteria to the new franchisee to ensure consistency and quality for customers of the franchise.
Often a clause is added to a franchise contract giving the franchisor first refusal should the franchisee wish to sell the business. The franchisor can also profit from introducing a prospective buyer to the franchisee if they have not identified a suitable purchaser themselves, by charging commission.
The transfer of a franchise can be complicated and lengthy and an exit strategy should be given as much time and attention as the purchase of a franchise.
The Editorial Team, Point Franchise ©
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