What is a Franchise Agreement?
When running any B2C company and would want to license another company to operate using your trademark, a franchise agreement will help to protect you. Entering into a contractual agreement with the franchisee will ensure your business’s legal rights are protected. This overview will take you through everything you need to know about a franchising contract.
Quick Takeaways
Don’t have time to read the full article? Here’s a quick summary:
- A franchise agreement is a contractual agreement between a franchisor and a franchisee that defines the rights and obligations of both parties.
- The franchisor licenses the franchisee to use their intellectual property, brand, and systems in exchange for periodic or one-time payments.
- Both parties involved in the franchise agreement benefit – the franchisor gets to expand their business into new territories, while the franchisee gets access to an established brand which increases their likelihood of success.
- There are two main parties involved in a Franchise Agreement – The Franchisor (the business owner) and The Franchisee (who acquires a license from the business owner).
- A typical Franchise Agreement will include: a franchise disclosure document; territory limits; fees & purchases; timeline & renewal; advertising & marketing; sourcing & design; confidential data.
What is a franchise agreement?
A franchise agreement refers to a master legal document that defines the rights and obligations of parties involved in a franchise – franchisor and franchisee. Legally, a franchise agreement is a contractual agreement from the franchisor to the franchisee. The license the franchisor offers legally permits the other party to act or do something of value.
The franchising contract from the franchisor licenses the franchisee to use their intellectual property, brand, and systems. The franchise agreement is legal and binding, meaning the franchisee gains the rights to operate business activities using the franchisor’s property, brand, and systems as long as they meet the set conditions.
The general requirements to ensure that the franchise contract is official include:
- The franchisee’s business should be associated with the franchisor’s brand. In other words, the franchisor and the franchisee should share a common brand.
- The franchisor is responsible for exercising control or providing the much-required assistance to the franchisee on how the franchisee should conduct business or use the brand.
- In exchange for the franchising agreement, the franchisee makes periodical or one-time payments to the franchisor based on the terms and conditions mentioned in the franchisee agreement.
How does a franchise agreement work?
Generally, the central premise behind a typical franchise agreement is that it allows the franchisee to enter a given market easily by leveraging the franchisor’s established business model. It is a legal agreement to purchase a franchise business and access the franchisor’s intellectual property. Both parties involved in the franchise agreement benefit since the franchisor charges a fee in the form of continuing royalties on sales, advertising assistance, rent, supplies, equipment, and more.
While it’s relatively easy for the franchisee to enter a new market through a franchise agreement, the franchisor also gains because they get to expand their business to new territories.
The franchisor in the contractual agreement is usually an established business in a given market. On the other hand, the franchisee is a new business or a business interested in entering the market.
The franchisee pays a certain amount, called the initial franchise fee, to the franchisor to permit them to run their business activities using their trademark. The advantage to the franchisor is that they can rapidly expand into a new market because of their established brand. Moreover, it’s easier to manage the business activities since the franchisee takes charge of such management. The franchisor also benefits from the increased profits they will get from operating in a new market. Other benefits include improved brand presence and reduced risk of venturing into a new market.
Conversely, the franchise agreement benefits the franchisee in many ways. The franchisor will support the franchisee to ensure they have everything they need to operate successfully. For instance, a franchisor offers training, supplies, management support, and/or technical support for things to run smoothly. Working with an established brand also increases the likelihood of succeeding in the new market.
What parties are involved in a franchise agreement?
Two main parties are involved in a franchise agreement – the franchisor, the business owner, and the franchisee, who acquires a license from the business owner.
More about the roles of these parties is discussed in the following paragraphs.
Franchisor
A franchisor can be an individual or a company. The franchisor licenses a third party (franchisee) through a contractual agreement to operate their business activities in a given market. Essentially, the leading role of the franchisor in this stake is to provide the required license to the franchisee to operate using their trademark.
Other roles of the franchisor within the business model include:
Providing a high-quality business model
The franchisor should work to ensure that franchisees have access to what they need to function optimally under the franchisor’s trademark. Based on the franchising policy, it’s wise to set up a lucrative business model and provide the necessary support to streamline processes for the franchisees. The franchisors require franchisees to follow certain operating systems in order to run the franchised business to their specifications.
Recruiting suitable franchisees
The success of the franchises hinges on the franchisor’s ability to bring in dependable partners. As a result, franchisors should invest their time and effort in recruiting suitable franchisees.
Provide ongoing support
Irrespective of how good or stable the franchisee is, the franchisor should offer ongoing support. The franchisor should guide the franchisees to guarantee they progress in the right direction. Ongoing support can entail providing regular training, professional development opportunities, and networking.
Nurture the franchising relationship
The franchisor should also nurture their relationship with franchisees. Working together toward a common goal is crucial, and this starts from the recruitment phase. Franchisors should make intelligent choices when choosing who to partner with.
Franchisee
The franchisee is the party (individual or entity) that purchases the franchise from the business owner (franchisor).
According to the franchise agreement terms, the franchisee is expected to run the business and make a profit. They should work in a prescribed manner to ensure the franchise system works.
The roles of a franchisee in the franchise include:
Building the business
While franchising helps a franchisee penetrate a new market easily, it doesn’t mean it’s a walk in the park. As with growing any enterprise, long working hours, financial struggles, and setbacks are part of the game. The franchisee’s role is to build the business using the franchisor’s well-charted path.
Safeguarding the franchise brand
The franchisee should run the business in a manner that upholds the franchisor’s brand. This should be mentioned in the conditions of the franchise agreement. The actions of the franchisee can affect the franchisor and other franchisees.
Advertising and marketing
The franchisor might provide local advertising and marketing resources depending on the contractual agreement. The franchisee should follow the required regulations to perform their marketing according to prescribed conditions.
Hiring and training employees
Franchisors should provide franchisees with the proper guidelines for hiring and training employees. The franchising firm understands the value of hiring qualified individuals and should guide franchisees in bringing on board the right employees to help the business thrive.
What is included in a franchise agreement?
A franchise agreement is legally binding. This means there must be an offer from one party (prospective franchisee) and an acceptance from the franchisor. The contract is only binding if the offer is accepted and both parties agree to the franchise agreement terms.
The elements of a franchise contract can differ depending on the type of franchise. However, here’s a look at standard features in most agreements.
Disclosure Document
Legally, a franchise should feature a franchise disclosure document. This document details all the required information about the franchise that the franchisee should be aware of. The disclosure document explains the legal terms and conditions of the franchise, contact details of current and former franchisees, franchise fees, and other conditions that apply to the franchise agreement.
Territory Limits
The franchise contract will also provide territory limits and the timeline for when the franchisee should operate in a given area. Additional information about local restrictions of a given market can also be included here.
Fees and Purchases
The franchise fees and any other additional payments that the franchisee should make are detailed in the agreement. In some cases, the contract provides information regarding late payment fees franchisees must pay.
Timeline and Renewal
Contractual terms and renewal timelines are also indicated in the franchise agreement. Details of the time duration of the contract and how long the relationship will last are clearly indicated. If franchisees seek to renew their terms, the contract details what needs to be done and any payments required.
Advertising and Marketing
The franchise agreement outlines the rules and regulations governing advertising and marketing. Any form of advertising and marketing campaigns are conducted according to the franchisor’s terms. Other local arrangements to market the products should still follow set standards.
Sourcing and Design
The agreement details the required structural features the franchisee should have and the timeline to ensure the structural requirements are available. In terms of sourcing, the franchisee is required to source supplies that meet the franchisor’s standards. The supplies must be bought from the franchisor’s approved supplier.
Confidential Data
The franchise agreement details information concerning the use and sharing of confidential information. It states that confidential information can only be used and shared with the franchisor’s consent. Such data cannot be reproduced, duplicated, copied, or shared with unauthorized individuals.
Are franchise agreements negotiable?
Franchise contracts are negotiable. However, most franchisors strive to limit what franchisees can negotiate. The agreement terms that can be negotiable include the opening dates, the amount of support from the franchisor, and the amount of standard fee to impose if the franchisee opts to sell.
What to consider before signing a franchise agreement
Before signing the franchise contract, you must ensure you’re a good fit for the industry. Choose an industry you’re interested in since this will keep you motivated to do your best for the business to thrive.
You also need to read reviews about the potential franchisor. Knowing what you should expect from the franchisor helps to build a better relationship with them. If the franchisor has bad reviews, this is an indication that you may have to work harder to improve your business relationship. In such cases, it’s advisable to look for other entities or persons to work with.
Investigating all the money obligations you’re required to fulfill also helps to make intelligent decisions. Determine how much the franchise will cost you and weigh it against your total investment budget.
Moreover, it pays to consider the support you’ll get from the franchisor. A reputable franchisor in the industry should provide you with everything you need to run a successful business.
Ending Summary
If you’re thinking of investing in a franchise, you now have all the required information to help you make better decisions. Franchising is a lucrative business idea as long as you work with the right individuals or entities. The most important thing during the franchise is to do your due diligence before signing any franchise agreement. Invest your time in knowing more about the legal aspects of the contractual agreement to avoid any surprises that might harm your business. The information detailed herein is valuable for the franchisee and the franchisor.
