You have done your homework and determined that a franchise is a good fit for you. Perhaps you have also talked to other franchisees and looked at the franchise disclosure document (FDD). So far, everything sounds right. The logical thing to do now is to make things official by signing the franchise agreement finally.
Despite this, it is important to understand the legal and financial implications of this venture before you dive into it. While the legal terms can get confusing, it is in your best interest to read through the whole document before you commit to the franchisor.
When Is A License A Franchise?
A franchise is not exactly the business all by itself. Instead, it is a license type that meets these requirements:
- The business of the franchisee is associated with the brand of a single franchisor.
- The franchisor assists in the business operations of the franchisee, often limited to brand standard requirements.
- The franchisor receives a fee from the franchisee for conducting business under the brand.
A franchisee and franchisor must agree before the license is issued and made official.
What Is A Franchise Agreement?
A franchise agreement is a contract stipulating the expectations and responsibilities of both the franchisee and franchisor. This legally binding document should be carefully analyzed before committing to this venture.
It is also a good idea to ensure that verbal promises have been put into writing. Upon signing the franchise agreement, the document governs the relationship between the franchisor and franchisee. Misunderstandings and disagreements are going to be subject to what it says.
Check The Following Aspects Of The Agreement
Make sure to read the document thoroughly. A legal counsel can also offer assistance to ensure the fairness of the terms. In general, these aspects should be scrutinized to gain a better understanding of the agreement:
- Involved Parties
The most important thing to check is the identity of the other party. Check if the agreement will be signed by the parent corporation or the owner of a master license. Before signing, do your due diligence to ensure that the other party is reputable and trustworthy since franchisees will ideally work with the business for an extended period of time.
The contract should stipulate the duration of the agreement. On top of this, it should state whether the initial contract is renewable or not after expiration. If it is possible to renew it, the associated fees should be stated. Ask for clarification if it does not say whether it will be the full franchise fee or a discounted amount.
This section deserves a thorough examination as well. Many franchisors ask for royalty. It usually refers to a percentage of the net or gross sales or revenue, although it can also be a flat fee in some cases. It is imperative to learn the terms associated with royalty fees, revenue, and minimum performance.
Keep in mind that this is yet another factor that will impact the profit margin. It is wise to inspect your obligations to spend on advertising and marketing, as well as what the franchisor offers in return. This is important because it will affect the budget. The distribution of the advertising capital should be laid out in the agreement.
Another factor that will affect the success of the franchise is training. The duration, location, and logistics must all be detailed in the contract. Franchisees usually have to pay out of pocket for their living expenses, so this period might be costly. While most franchisors do generally not prolong training, it is good to learn about the cash flow and time management involved this process will require.
- Operations Manual
The franchisee will require guidance when it comes to the procedures and processes involved in running the business. The operations manual should outline them and serve as the bible of the company. It should be clear how often it gets updated and whether it will cost extra.
- Trade Dress
The “trade dress” is unique to this type of business. It basically encompasses the store image, décor, logo usage, and employee uniform. Some franchises are strict about these requirements, but some are not as formal.
It is essential to gain a complete understanding of these guidelines to ensure compliance in the future. The contract should also specify who pays for signages and other unique fixtures and their replacement frequency.
- Operation Hours
In the contract, the hours of operations should be indicated. The franchisee must only commit to these requirements if they are sure that the obligation can be accomplished. Failure to comply can result in a breach of contract. This will also lead to a bad reputation as a franchisee.
- Supplies And Procurement
Supplies and products are vital to any business. The contract should detail if the franchise owner bought them from the franchisor on an exclusive basis. It should also explain the protections in place to avoid price gouging. It is essential to be clear on the origin and the fair price of the products.
- Grand Opening
The contract should also specify stipulations about the opening of the location. It must indicate how much help the franchisor will provide and whether there will be company representatives present.
This should also include the practices and trade dress to be employed. Ideally, the document will also detail how much of the initial fee goes toward the event. It might be a one-time occasion, but it might affect the long-term success of the business.
- Personnel Policies
A store is only as good as the employees working there. The agreement must outline the staffing policies, including training and recruitment. It should also layout corporate human resources policies to be followed. The operations manual should detail all of these things too.
- Sale Or Transfer Of The Franchise
The agreement needs to explain the amount of control the franchisor has over the sale or transfer of the specific franchise business. It should indicate whether the franchisee needs approval from the franchisor and how big of a percentage of the sale, if any, will go to the parent company. This is important to ensure a seamless transition in case the option arises.
- Agreement Termination
This concerns the conditions under which the franchisee or franchisor can terminate the contract before the expiration date. It is vital to understand the financial and legal rights of the franchisee in case the franchisor does not meet the stipulations. Likewise, it is crucial to know the consequences if the franchisee does not meet the obligations.
- Expansion Options
The contract might discuss the possibility of the franchisee expanding the business or acquiring another unit. While this might not happen any time soon, this might happen when the franchise business has been successful. It is best to clarify this matter at the beginning to avoid surprises when the need arises.
- Death And Contingencies
No one wants to think about this, but it is imperative to plan for such circumstances. In case of death, the contract should clarify who is entitled to run and own the business. There might also be stipulations about divorce in case spouses jointly hold the business.
Lastly, there should be a focus on natural catastrophes and what the franchisee’s obligations should these events disrupt operations. The agreement must tackle how these contingencies will affect the mandatory dues.
This is another big factor that can impact the success of a franchise business. It must be clear whether or not the franchise is an exclusive territory. The franchisor might want the right to launch new locations nearby in the future. In any case, the territory must be determined clearly as it can affect the net profit.
Do not forget that franchise agreement are largely drawn up to protect the interests of the franchisor. Plenty of long-running franchisors already have established terms in the franchise agreements. However, franchisees can still negotiate some of the terms. It might be possible to discuss start-up dates, territory rules, grand opening assistance, and liability limits regarding performance.
It is in the best interest of a franchisee to read the franchise agreement before signing it. This will allow for a deep understanding of the expectations and obligations they must meet and follow. In general, the franchise industry runs on consistency and proven systems. However, there might be room for flexibility. Negotiation might allow you to run the business better, although there is no guarantee that the franchisor will bend to your terms.
As a general rule of thumb, do not sign anything you do not entirely understand. Seek assistance from your accountant and lawyer about the terms indicated. Therefore, they should be familiar with your situation and be in the best position to determine what stipulations can be altered to your benefit.