Not the most glamorous words out there. They’re actually a bit daunting. However, while on the trek to starting a franchise, these concepts will make up your roadmap.
Franchises are a unique kind of small business. In this business model, a franchisee will use the procedures, intellectual property, and business plan provided by a franchisor. So in these situations, the contents of a contract rule your business operations.
This contract is called a franchise agreement.
What is a franchise agreement?
The franchise agreement might seem over the top with legal jargon, but understanding it will add momentum to your small business venture.
Franchise agreement definition
A franchise agreement is a legal contract between a franchisor and a franchisee that outlines the terms and conditions of the business deal, as well as the obligations of both parties. In the United States, all franchise agreements are handled at the state level.
Essentially, it’s a contract that governs the franchisee-franchisor relationship.
Contracts exist to legally oblige people to perform specific acts. In the world of franchising, the franchise agreement is put in place to ensure that a franchisee is operating correctly under a certain brand.
It’s a common mistake to believe that a franchise is the business itself. However, the franchise is actually the type of license you get to operate as a small business owner using a franchisee’s branding, business plan, etc.
Every business needs a license to operate, but not every license is a franchise.
What makes a license a franchise?
A franchise is a special type of license that has three requirements to be considered as such.
The franchisee’s business is connected to the franchisor’s brand. Put simply, there is only one brand involved.
The franchisor provides assistance to the franchisee in business operations. This is generally limited to brand standards and does not affect the way the franchisee operates their business on a day to day basis.
The franchisee pays the franchisor a fee for the right to conduct business activities using their brand.
Elements of a franchise agreement
Most franchise agreements will include, but are not limited to, the following elements.
Overview of the relationship: The people involved in the contract, ownership of the intellectual property, as well as the agreement that the franchisee will operate the business according to the standards of the franchisor.
Duration of the franchise agreement: The course of the franchisor-franchisee relationship.
Initial and continuing fees: Franchisees will pay an initial fee to become apart of the relationship, and then continue to pay fees to maintain their position.
Location and territory: The definition of a franchise’s territory can differ in each agreement. Either way, a territory must be established. Franchisors must define their rights within a franchisee’s territory.
There are two main types of franchise territories: exclusive and non-exclusive. When a franchise is sold with an exclusive territory, it means that the franchisor cannot sell other franchises to people in that particular area. It is exclusive to that franchisee. When the agreement states that the franchise is sold in a non-exclusive territory, the franchisor can sell other franchises to people within that area.
Site selection and development: While franchisees will typically find the site for their location on their own, it still needs to be approved by the franchisor. They will approve the location and the standards of design that the franchisee will move forward with.
Training and support: Any training the franchisor will offer to the franchisee before they start the franchise, and anything that will continue throughout the relationship. These training programs can be required or simply recommended.
Use of intellectual property: This includes trademarks, patents, and manuals. What will be offered to the franchisee, how they are expected to use it, and the rights of the franchisor to change it by updating the franchisor’s manual.
Insurance: The franchisor will go over the insurance requirements of the franchisee before the location opens and for the duration of the relationship.
Record keeping and right to audit those records: The franchisor will lay out the records the franchisee is required to keep, the software they should use, as well as the right to access and audit that information.
Quality control: The franchisor will specify quality control requirements for the franchisee to ensure the goods and services are being offered as expected.
Transfers: Requirements of the franchisee should they transfer their interest in the franchise.
Advertising: Franchisors will debrief franchisees on the advertising efforts, and potentially how much they must contribute.
Expiration or termination obligations: Steps the franchisee will take if the relationship expires or if they are terminated due to a breach of the franchise agreement.
Right of first refusal: The franchisor has the right to purchase the assets associated with the business before the franchisee offers them to an outside party.
Indemnification: A promise from the franchisee that they will reimburse the franchisor should they encounter any loss as a result of their own wrongdoing or negligence. This part of the contract exists because the franchisor is not responsible for the day to day operations of the business, so they shouldn’t be held accountable.
Non-competition agreement: Prevents the franchisee from opening any business that could compete with the franchise. There are two parts to it: in-term and post-term. The in-term period refers to the time period that the franchise agreement is active. The post-term part covers the time after a franchise agreement is expired or terminated.
Dispute resolution: The methods the franchisor uses to resolve disputes with the franchisee. Common dispute resolution methods include mediation and arbitration.
Miscellaneous: All other legal issues that were not elaborated on above, including, but not limited to, successor rights, termination, resale rights, sources of supply, governing law, etc.
As a franchisee, you can’t start operating your business without facing the legal aspect: the franchise agreement. Although it might seem like another tedious hurdle to jump in the franchise acquirement process, it actually provides you with solid information that can help you become an efficient, compliant, and successful franchisee.
That can be a lot to handle to a first time franchisee. Don't let this discourage you. Before this, franchisees will receive the franchise disclosure document that goes over all of this information as well.
Mary Clare Novak is a Content Marketing Specialist at G2 in Chicago, where she is currently exploring topics related to sales and customer relationship management. In her free time, you can find her doing a crossword puzzle, listening to cover bands, or eating fish tacos. (she/her/hers)