Buying a Franchise: The Franchise Agreement Review
The franchise agreement is the legal agreement that creates a franchise relationship between a franchisor and a franchisee. When an individual buys a franchise, the franchise agreement is the legal document that creates the franchise rights and obligations that allow the franchisee to establish and open a franchised outlet and defines the on-going relationship between franchisor and franchisee. Prior to offering or selling a franchise, franchisors must disclose their FDD to all prospective franchisees no less than 14 days prior to the signing of a franchise agreement. The FDD contains summarized information about the franchise agreement and a franchisees legal rights and obligations
Some of the legal rights contained in franchise agreements, include:
The Granting of Franchise Rights
The primary purpose of the franchise agreement is to grant and authorize a franchisee to establish and operate a franchised location or outlet. The franchise rights that are granted from the franchisor to the franchisee include a license to utilize the franchisors trademarks, operations manual, training and on-going support.
The franchise agreement defines the initial fees that franchisees are required to pay to the franchisor at the time the franchise agreement is signed. The most common initial fee is the initial franchise fee. However these initial fees may also include pre-opening fees that a franchisee may e required to pay a franchisor for items such as opening inventory and software licenses.
The franchise agreement will define the on-going fees that a franchisee will be required to pay to the franchisor throughout the terms of the franchise agreement. Typical on-going fees, include:
- Royalty Fees - Royalty fees are paid to a franchisor on an on-going and recurring basis. Royalty fees are typically paid weekly or monthly and are most commonly calculated as a fixed percentage of a franchisees gross sales. Royalty structures may also exist in the form of a fixed dollar amount royalty or as a hybrid of both a percentage based royalty or fixed dollar amount.
- Technology and Support Fees – Technology and support fees relate to any on-going fee that a franchisee is required to pay to a franchisor to maintain access to the franchisors technology systems or, even, as a general administrative fee that is charged by the franchisor to cover generalized expenses.
- Brand Development Fund Fees – Brand development fund fees are typically paid by franchisees on a recurring basis and, typically, are based on a fixed percentage of the franchisee's gross revenue. Brand development fund fees are typically utilized to establish a generalized fund that is utilized by the franchisor to cover costs associated with producing marketing materials, point of sale displays, maintaining websites and paying for public relations representation. Brand development fund fee are not used to pay for marketing expenses of franchisees or to promote a franchisees business.
- Other Fees – Every franchise system is different and the franchise agreement will include a number of other fees that a franchisee must pay to the franchisor.
The franchise agreement will define whether or not the franchisee has obtained territorial rights where the franchisor will not establish nor authorize other franchised locations. Territorial rights are typically based on geographic service locations or zip codes where the franchisor represents and promises that it will not permit other franchisees to operate. Some franchise systems do not offer or provide territorial rights and are therefore not restricted as to the locations and/or territories within which the franchisor may sell additional franchises.
Operational Rights and Obligations
The franchise agreement will define the legal rights and obligations between both franchisor and franchisee as to franchisee's establishment of the franchised location or outlet, on-going operational requirements, franchisor's support and training obligations and the franchisee's obligation to adhere to the franchisor's confidential operations manual and overall system requirements.
Non-Competes and Restrictive Covenants
The franchise agreement will contain non-competition covenants and obligations imposed on the franchisee during the franchisee's operation of the franchised business and after the franchisee either terminates or ceases top operate the franchised business. During the term of the franchise agreement, franchisees are typically restricted and prevented from operating a competing business anywhere in the United States. Following the termination or expiration of the franchise agreement, franchisees are typically prohibited from participating in a competing business for a designate number of years and relative to a designated territory.
Termination Rights, Renewal Rights, Cure Period and Other Legal Rights
The franchise agreement will define many other legal rights between franchisor and franchisee. These rights include when the franchise agreement may or may not be terminated, the right franchisees have in curing any alleged breach, renewal rights and rights respecting a franchisees transfer or sale of the franchised business.
As a prospective franchisee and, even, as a current franchisee, it is important to understand and know that many states have enacted franchise relationship laws. In many cases, state franchise relationship laws provide supplemental protections and rights to franchisees. These supplemental rights exist outside the franchise agreement and should always be evaluated when considering your options under a franchise agreement.