Reviewing the Franchise Agreement Before You Buy a Franchise
The franchise agreement is the legal agreement that creates a franchisor-franchisee relationship between you and a franchisor. When you buy a franchise, it’s the franchise agreement that will govern and determine your rights and obligations as a franchisee.
The time to review the franchise agreement is before you commit to a franchisor, before you pay any franchise fees, and before you sign any agreements. During the franchise sales process, the franchise agreement will be attached as an exhibit to the franchisor’s FDD and the FDD itself will summarize key franchise agreement provisions, including franchise fees, royalties, ongoing fees, territory rights, renewal terms, personal guarantees, and other critical rights related to your franchise investment.
Before signing a franchise agreement, it’s always recommended that you review the agreement with an experienced franchise attorney. In many instances, your attorney can enhance and better protect your legal rights as a franchisee through a franchise agreement addendum, which your attorney may negotiate before you sign your franchise agreement.
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 franchisor’s trademarks, operations manual, training, and ongoing 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, initial fees may also include pre-opening fees that a franchisee may be required to pay to the franchisor for items such as opening inventory and software licenses.
The franchise agreement will define the ongoing fees that a franchisee will be required to pay to the franchisor throughout the term of the franchise agreement. Typical ongoing fees include:
- Royalty Fees - Royalty fees are paid to a franchisor on an ongoing and recurring basis. Royalty fees are typically paid weekly or monthly and are most commonly calculated as a fixed percentage of a franchisee’s 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 and fixed dollar amount royalty.
- Technology and Support Fees – Technology and support fees relate to any ongoing fee that a franchisee is required to pay to a franchisor to maintain access to the franchisor’s technology systems, or 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 based on a fixed percentage of the franchisee's gross revenue. Brand development fund fees are typically utilized to establish a generalized fund for the franchisor to cover costs associated with producing marketing materials and 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 franchisee’s 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 the franchisee's establishment of the franchised location or outlet, ongoing 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 to 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 rights franchisees have in curing any alleged breach, renewal rights, and rights respecting a franchisee’s transfer or sale of the franchised business.
State Franchise Relationship Laws
As a prospective franchisee, or even as a current franchisee, it is important to also know that many states have enacted franchise relationship laws that may provide you with legal protections that exist outside the language contained in the franchise agreement. Franchise relationship laws are designed to create more balance in the relationship between franchisor and franchisee, and in many states, franchisees are afforded additional rights when dealing with their franchisor.
When evaluating your rights as a franchisee, it’s important to review your franchise agreement with an experienced lawyer and to discuss and evaluate whether or not your state has enacted franchise relationship laws to provide you with additional protections.