If you’re in the process of becoming a franchisee or curious about what it entails, then you should familiarize yourself with the ins and outs of a franchise agreement — and that starts with what it contains.
First, let’s review some basics: A franchise agreement is a legal contract between the franchisor and the franchisee. It outlines all the terms and conditions of the franchise relationship before it officially starts. Both parties must understand the terms of the agreement before signing — or else either side runs the risk of some serious consequences.
Read on for everything that should be included in a franchise agreement, so you’re prepared before it’s too late.
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Franchise fees and ongoing royalties
The franchise agreement should specify the initial franchise fee, which is the upfront payment to the franchisor for the right to use its trademark and business system. Think of it as the price you pay for not having to build a business system from scratch.
This fee might be paid in a lump sum or installments, and it typically covers the initial training and support the franchisor will provide.
The franchise agreement should also include the ongoing royalties that the franchisee is required to pay to the franchisor. Royalty fees are typically a percentage of revenue, and they can be flat or on a sliding scale. The royalty fees can be paid weekly, monthly or quarterly and cover the franchisor’s continued support, marketing and advertising.
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Territory and exclusivity
One of the benefits of franchising is the ability to expand into different areas, cities and even countries. To avoid conflicts between franchisees in the same area, the franchise agreement defines the territory in which the franchisee is authorized to operate the franchised business.
This could include a specific geographic area, a particular city or a specific address or location. It should also specify whether or not:
- The franchisee has the exclusive rights to operate the business within a territory
- Other franchisees can operate in the same area or nearby
- The franchisor can open additional franchises in the same territory
Operating standards and training
An important aspect of franchising is a uniform training and operating model. This can include product quality, customer service, advertising, training and more. The franchise agreement should specify the operating standards the franchisee must abide by to align the individual franchise with the integrity of the larger brand.
The franchise agreement should also specify what the franchisor will provide in terms of the type and amount of training and operating support. That said, franchisors must provide appropriate training to ensure the franchisee understands and effectively implements the franchise standards.
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Intellectual property rights
It might go without saying, but one of the reasons a franchisee embarks on a franchising journey is to use the franchisor’s trademarks, logos and other intellectual property. The franchisor grants the franchisee a license to use this intellectual property exclusively for the franchised business.
These stipulations should all be in the franchise agreement. The franchise agreement should also outline the restrictions on the franchisee’s use of intellectual property to protect the franchisor’s brand.
Term and renewal
The franchise agreement should specify the term of the franchise relationship. The term is the length of time that the franchisee is legally allowed to operate the business. Terms can range from several years to several decades, and they can vary from location to location. The franchisor has the right to offer a renewal option that allows the franchisee to renew the franchise agreement for another term.
The franchise agreement should contain the renewal conditions, such as meeting key performance metrics, paying all necessary fees or meeting other goals. The franchisor also has the right not to renew the agreement if the franchisee fails to meet the conditions for renewal.
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Termination and default
The franchise agreement should specify the conditions under which either party can terminate the franchise agreement to avoid having to wait until a term ends. Terminations can be due to contract breaches, insolvency, failure to meet performance standards or just by mutual agreement and should be defined in the franchise agreement.
The franchisor should also include a default clause in the franchise agreement to protect itself. Default clauses outline the remedies available to the franchisor in the event of contract breaches or early terminations.
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Financial disclosures and obligations
A breakdown of financial disclosures and obligations should be listed in the franchise agreement, such as initial investment costs, ongoing expenses and financial reporting requirements. The franchisee should have a clear understanding of the costs and financial obligations associated with the ongoing operations of a franchised business.
Advertising and marketing
Franchises typically run national advertising campaigns, so individual franchisees are not responsible for television commercials or other marketing strategies. But to pay for this, the franchisee is required to pay ongoing advertising and marketing fees to the brand’s national advertising fund, outlined in the franchise agreement.
There may be opportunities for franchisees to conduct their own advertising in their local territories, which can also be outlined in the agreement.
Key takeaways and what to do next
Franchisees should have a clear understanding of what a franchise agreement entails before signing the dotted line — and they should be wary if the contract is vague. To better understand the terms and conditions, franchisees should seek the advice of a franchise legal professional before moving forward.
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