A Guide To Better Understand Franchise Agreements

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A franchise agreement is a legally binding contract through which a franchisor grants a franchisee permission to use certain intellectual property rights and proprietary information, such as trademarks, recipes, and business practices. This contract outlines how the franchisee will run their new business and what they can expect from the franchisor.

In the United States, a business becomes a franchise if it meets the Federal Trade Commission’s (FTC) criteria, known as the FTC Franchise Rule. There are three general prerequisites for a franchise agreement to be declared official under the FTC Franchise Rule:

  • The franchisor’s brand must be heavily associated with the franchisee’s business, meaning the franchisor and each of its franchisees must share a common brand.
  • The franchisor must exercise control or give substantial assistance in how the franchisee will use the franchisor’s brand to conduct business.
  • The franchisee must pay the franchisor a fee in exchange for the right to enter the relationship and conduct its business under the franchisor’s trademarks. The cost may be a one-time fee of at least $500 or a recurring fee, with certain exemptions allowed by law.

Franchise agreements give franchisees access to the franchisor’s trademarked business logo, products, and marketing expertise, all while safeguarding the franchisor’s intellectual property and guaranteeing uniformity in how each of its licensees operates under its brand.

Franchising allows larger companies to expand and thrive while also allowing individuals to start their own businesses with the guidance and support of a larger company that has a proven formula for success. Entrepreneurs are the most likely to employ a franchise arrangement. Most entrepreneurs opt for franchising because it allows them to expand without the danger of debt or the high cost of equity.

Individuals who want to try their hand at a business may also use a franchise agreement provided that they have the necessary funds to purchase the franchise. Everyone who is willing to understand the ins and outs of their chosen company is eligible for franchise agreements. However, it is still up to the franchisor’s judgment whether or not to grant someone the right to open and run a franchised site or outlet.

This article will define the terms and detail the provisions binding franchise agreements to help you better understand them.

The parties involved in a franchise agreement are the franchisor and the franchisee. While there may be third parties involved, such as franchising lawyers and insurance firms, the heart of every franchise agreement applies to the essential concepts outlined below.

  • Franchisor: Franchisors are entities or individuals who license and sell their franchise rights to a franchisee. They sell their licensing, branding, and intellectual property rights.
  • Franchisee: Franchisees are entities or individuals who purchase franchise rights from a franchisor. They are typically entrepreneurial small business owners that have experience in the industry.

The key elements of a franchise agreement generally include:

Territory

Every franchise agreement should designate a geographic territory in which the franchisee is permitted to operate, even if the area is confined to a single outlet. Within the territory, the franchisee is free to establish outlets and advertise on behalf of these outlets.

A grant of territory may either be exclusive or non-exclusive. Although not every franchise agreement offers exclusivity or even protected territory to the franchisee, the specifics of the territory must be outlined in detail.

Licensing

The heart of any franchise agreement is the non-exclusive transfer of intellectual property rights from the franchisor to the franchisee. The intellectual property of every franchise system is its most valuable asset, some of which will change as the system evolves. Franchise agreements specify what intellectual property is granted to the franchisee, how the franchisee can use it, and the franchisor’s rights to evolve the system through modifying the business’s operating manual.

Franchise Term

The grant of these rights should be limited to a specific duration. Franchise agreements normally last between five and 25 years, with 10 years being the average term. Renewal terms are frequently included in these agreements. While franchisees cannot terminate a franchise agreement before its expiration date, they can sell or transfer their interest to another party who wants to fulfill the contract.

Business Practices

Franchisors impose obligations on franchisees to use their business methods and meet their operational standards. The purpose of these requirements is to safeguard the reputation of the franchise. If the business performs inefficiently, delivers poor customer service, or fails to meet proper cleanliness standards, the economic value of the entire franchise could suffer.

Franchise Fees

Franchisors usually impose two types of fees on franchisees, such as standard franchise fees and royalties. Franchise fees often take the form of an upfront payment. Royalties are recurring payments based on sales volume for the use of intellectual property rights.

Franchise agreements also typically include a number of side fees. Most franchise systems include a payment to an advertising or brand fund that is used by the franchisor to publicize the brand and for other contractually stated objectives.

Advertising

Franchisees must advertise their franchise in a manner that the franchisor approves. By expanding the public brand awareness of the franchise, the advertising benefits not only the franchisee but also the entire franchise. To protect the reputation of the franchise, many franchisors reserve the right to pre-approve any advertising efforts. Although some franchisors develop their own advertising strategies, franchisees are generally required to pay for advertising.

Training and Assistance

Franchisors generally provide a host of pre-opening and continuing support, including training, field and headquarters support, supply chain, and quality control. Employees of the franchisee may be required to attend training at the franchisor’s location or may be sent to actual franchises. This is done by franchisors to ensure that the staff of the franchisee understands how to follow the guidelines set by the franchisor.

Standards of Quality

Unless the franchisor gives permission, franchisees are not allowed to change or dilute the composition of the products. This is to keep the franchise’s reputation intact. If the company produces low-quality goods, it may reflect poorly on the entire franchise.

Confidentiality

Franchisees expressly warrant not to reveal any information related to the franchise or the franchisor’s business. This is to maintain the franchise system’s secrecy and to prevent franchisees from disclosing sensitive information to competitors.

Independent Contractor Relationship

Typical franchise agreements affirm that both parties are independent contractors, and not employees or agents. An important benefit traditionally enjoyed from this independent contractor relationship is the franchisor’s protection from liability to the franchisee’s employees, customers, and vendors.

See other legal documents that you may use to protect your rights

Buying a franchise is a convenient method to establish your own business without having to start from scratch. Franchising has many benefits but there are also a number of drawbacks to consider:

  • Franchising may be more expensive than you expect. You have to pay the initial deposit as well as continuing management service fees.
  • Typically, franchise agreements contain limitations on how you can run the business. You might not be able to adapt your product to the needs of your local market.
  • You may find that after some time, ongoing franchisor monitoring becomes intrusive.
  • Because other franchisees may harm the brand’s reputation, the recruitment procedure must be thorough.
  • All profits (a percentage of sales) are usually shared with the franchisor.
  • The inflexible nature of a franchise may limit your capacity to make adjustments to the business in response to market conditions.
  • It’s possible that the franchisor will go out of business.

Nevertheless, franchising can benefit you in more ways:

  • Franchising lowers the danger of business failure since your company is built on a proven concept.
  • Market share will have already been established for products and services. Therefore there will be no need for market testing.
  • You can franchise a well-known trademark and brand name. Any advertising or promotion by the franchise owner benefits you.
  • The franchisor provides you with support in the form of training, assistance in setting up the business, and a manual on how to run the business.
  • There is no need for prior experience because the franchisor’s training should ensure that you acquire the necessary abilities to operate the franchise.
  • Due to the pool of support from the franchisor and the network of other franchisees, a franchise allows a small firm to compete with major businesses more effectively than an individual small business.
  • In most cases, you have exclusive territory rights. In the same territory, the franchisor will not offer any other franchisees.
  • It may be simpler to finance the business. Banks are sometimes more willing to lend money to buy a reputable franchise.
  • You can benefit from connecting with and sharing ideas with other franchisees in the network, as well as receiving help from them.
  • Supplier relationships have already been established.

Franchising is about the consistent, sustainable replication of a company’s brand promise. Franchise agreements must detail the many business decisions that go into creating a franchise system. It’s complex and, in most cases, a contract of adhesion, meaning an agreement that is not readily subject to change.

Investing in a franchise is a commitment and you need to be certain that it’s right for you before committing yourself. Ask if you want to manage or operate a business or if you can see yourself happy with someone else setting the standards for your business. If that’s the case, then perhaps you should consider becoming a franchisee.