A franchise territory is the area within which a franchisee is authorized to establish and operate a franchised business. The scope and size of a franchise territory is determined by the franchise agreement, and the levels of protection afforded to a franchisee within the designated territory will vary from franchisor to franchisor. Franchisors use many different terms when referring to franchise territories, such as “operating territory,” “operating area,” “exclusive territory,” “exclusive area,” “designated area,” and “area of responsibility.”
If you are buying a franchise, evaluating your franchise territory and the protections granted to you is a critical task. Although your franchise agreement will designate your franchise territory and the level of protection you are granted within FDD Item 12, your franchisor is required to disclose the scope, size, and level of protection it will afford you within your franchise territory.
How to Evaluate Your Franchise Territory?
The level of protection that you may or may not be granted within your franchise agreement varies from franchisor to franchisor, and many times depends on the industry and type of business. Some franchise systems offer exclusive territories where other franchisees are not authorized to operate or sell, while other systems offer you the ability to operate and sell within a territory but without protection from other franchisees. In other instances, the territory protections fall in between: some forms of territory exclusivity come with specific exceptions for certain venues or forms of commerce, such as the Internet.
Below, we summarize important factors to consider when evaluating and, potentially, negotiating the scope, size, and protections associated with your franchise territory:
- Fixed location businesses versus mobile businesses – When evaluating your territory rights, the first step is to understand the franchised business and whether or not you will be selling goods or services from a fixed location or on a mobile basis. Examples of fixed location franchises include traditional retail businesses, such as restaurants, gyms, and other retail stores; and service-based businesses, such as spas and tutoring services that operate from a center. Examples of mobile franchise businesses include the many service-based businesses where franchisees go out and provide their services on-site at their customer’s location, or deliver products to the customer. Examples of mobile franchised businesses include home-service businesses and businesses that maintain a physical retail presence but rely on customer deliveries for items such as gift baskets.
For fixed location franchises, the “territory question” comes down to whether or not the franchisor will you grant you territory protection surrounding your retail location. For example, does the franchise agreement state that the franchisor will not grant franchises within a set radius surrounding your retail store?
For mobile franchises, the “territory question” comes down to whether or not the franchisor will give you a defined territory wherein you and ONLY you will be permitted to service customers. For example, does the franchise agreement state that the franchisor will not allow other franchisees to service customers within your designated operating area?
- Protection versus no protection – Franchisors vary dramatically as to whether or not they offer their franchisees exclusive territory protection, and even within franchise systems that offer territory protection, there is great variation as to the type of protection and whether or not the protection is contingent on the franchisee’s performance or sales. If a franchisor does not offer territory protection, for a fixed location business, this means the franchisor can grant and authorize another franchisee to open another retail outlet next door, or more realistically, a few blocks away. For mobile businesses, this means the franchisor could authorize other nearby franchisees to service customers located within your territory.
- Are there exceptions to territory protection? – Many times, franchisors possess a legitimate interest in “carving-out” exceptions to territory protections that they grant to you as a franchisee. When buying a franchise, you need to review these carve-outs and evaluate how they may impact your business. Examples of common exceptions to territory protections include:
- Captive Markets such as malls, stadiums, college campuses, government institutions, airports, amusement parks, and other venues that draw large captive audiences within your franchise territory;
- Web and Alternative Distribution Models such as the Internet, websites, catalogs (to the extent people still use catalogs), and direct-to-consumer channels of distribution where the franchisor may deliver products and, possibly, services directly to consumers even if they are located within your franchise territory;
- Private Label rights that permit the franchisor to sell a competing product or service under a trademark and name that is different from the trademark and name of the franchised business;
- National Accounts permitting the franchisor to directly service facilities and locations that are part of a large national corporation, even if the account being serviced is located within your franchise territory; and
- Performance Contingencies that condition your territory rights on performance criteria, such as minimum sales or gross revenue obligations.
- Start with the FDD – Under the franchise laws, franchisors are required to provide detailed disclosures about the territory protections that they may or may not offer in FDD Item 12. Don’t just rely on Item 12; but it’s a great place to get started.