There are many different ways to start out as a business owner. You can be an independent contractor, a freelancer, or a retailer. And franchising is one of the popular ways for entrepreneurs to start a business.
The advantage of buying a franchise is gaining access to an established brand name and operating procedures that have already been proven in the market. This lessens the risk you take in trying to build your own brand.
If you're looking to franchise, you would need to do a lot of research to find the right business for you. And before you officially call the business your own, you'll need to complete a franchise agreement with the franchisor. In this article, we'll discuss what franchise agreements are and what they contain.
What Is a Franchise Agreement?
A franchise agreement is a legally binding contract that regulates the relationship between a franchisee and a franchisor. It outlines the franchisee and the franchisor's rights and obligations in the franchise relationship.
The franchise agreement details the franchisor's conditions and requirements that you, as the franchisee, would need to fulfill. The contract grants you the legal right to establish a business and to use the franchise system, trademarks, suppliers, etc., to sell products or services.
A franchise agreement protects you and the brand. The financial investment you need to buy a franchise involves a significant amount of money. And making sure you have a signed legal document is a way to secure your investment.
Types of Franchise Agreements
There are four types of franchise agreements:
- Single-unit franchise agreement: This agreement is mainly used for new franchise contracts. It grants the franchisee the right to own and operate one franchise unit.
- Multi-unit franchise agreement: It grants the franchisee the right to own and operate multiple franchise units. Typically, this agreement covers more than one location across several areas of a town or city.
- Area development franchise agreement: This franchise agreement grants the franchisee the right to own and operate multiple units. This type of agreement is commonly drafted to secure a location. The contract grants the franchisee exclusive right for development and forbids other franchisees from opening units in the area as long as the agreement is in place.
- Master franchise agreement: This agreement allows the franchisee to sell franchises within their geographic area to other franchisees.
Key Provisions Included in a Franchise Agreement
The terms, conditions, and standard operating procedures detailed in a franchise agreement vary from every industry and type of business. So, there is no standard form of franchise agreements. There is one rule though, both parties — the franchisee and the franchisor — are required to sign the contract.
Below are the fundamental provisions commonly included in a franchise agreement:
Location or territory
The agreement pinpoints the location where you will operate. It will also outline any exclusivity rights you may have. You may negotiate exclusivity within a certain ZIP code, neighborhood, or distance from your location to help reduce competition and increase your market base.
Operating Procedures
The franchise agreement will detail how you are expected to run your units.
Training and Ongoing Support
The agreement will outline the extent of the franchisor's obligation to provide training and support for you and your staff. The document will also state all ongoing administrative and technical support from the franchisor.
Franchise Fees
Buying a franchise generally involves paying an initial franchise fee for the right to use the franchisor's trademark, business model, and operations manual. This fee will be clearly expressed in the franchise agreement.
Royalties and Ongoing Fees
Owning a franchise business can also mean ongoing royalty payments to the franchisor. Royalty fees are usually a percentage of total sales or a set amount to be paid every month. This section of the agreement will clearly lay out the pay structure for royalties.
The contract will also cover any expenses and who's responsible for paying for them. For instance, it may state that the franchisee handles their employees' travel expenses when attending training given by the franchisor.
Terms of the Franchise
The Franchise agreement must include how long the contract is valid.
Use of Trademarks and Intellectual Property
This section of the document gives you permission to use trademarks and intellectual properties such as patents, logos, and trade names. The document will also outline how you can use the trademark, logo, signage, etc.
Marketing
The agreement will detail the franchisor's marketing plan and the fees you need to pay towards it. You should be given a system for marketing, posters or promotional aids, and instructions on how to run the franchise in keeping with the brand's look and feel.
Recordkeeping and Auditing
Some franchisors reserve the right to define the records that you need to maintain and the right to access and audit your records. This section will detail the franchisor's conditions and describe your obligations.
Renewal Rights, Termination, and Transfer of Franchise Agreement
The franchise agreement should describe how the franchisee can be renewed or ended.
Exit Strategies
This section of the agreement details the franchise's resale policy. Some franchisors allow you to sell your franchises at your discretion. Some contracts would include a buy back or right of first refusal clauses, allowing the franchisor to buy back the franchise at a predetermined rate or to match any potential buyer's offer.
Before You Sign
A franchise business in the United States is regulated under the Federal Trade Commission's FTC Franchise Rule. The FTC Rule imposes strict disclosure requirements for franchisors to deliver a Franchise Disclosure Document to a prospective franchisee. You and your attorney must review this document before any money is exchanged.
Franchise Disclosure Document (FDD)
The purpose of the document is to give potential franchisees relevant information about the franchising opportunity, including:
- Information about the franchisor
- Fee structure, financing information, and initial investment estimates
- The items to which a franchisee is entitled
- The location of the unit assigned to the franchisee
- A copy of the franchise agreement
- Risks and rewards, including a comparison of the franchise against other investments
By law, a copy of the Franchise Agreement must be attached to the FDD. And the franchisor is required to deliver both documents to the franchisee at least 14 days before the final signing. The FTC imposes the 14 day rule on both parties to allow them time to review and discuss all the disclosures with their legal counsel. After the review, if significant changes were made to the agreement, then the franchisor must give the franchisee at least seven days more to review the completed document before signing it.
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Owning a franchise has its benefits. You can take advantage of the franchisor's recognizable brand, decreasing the risks related to opening a brand new business. Essentially, you don't need to build your business from the ground up. And with your investment, you'll receive mentorship, proven strategies, guidelines, and systems to start and grow your business.
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Notice to the Reader
The content within this article is a general guide and may not apply to your specific situation. Always do more research and consult with a legal professional or franchise attorney to ensure you're making the best decisions for your business.