Today in our Franchise Lawyer Special series: Franchise agreements offer a broad range of rights and obligations that are important to both franchisors and franchisees. One valuable right often granted to franchisees is the concept of an income guarantee. Most Australians have become accustomed to a regular set income, so to entice prospective franchisees the concept of providing an income guarantee has developed.
An income guarantee clause ensures a franchisee earns a minimum income over a determined period, often within the first year of trading. This is a valuable right as it gives security to franchisees to forecast their income, particularly in the early stages, and manage their expenses. It gives prospective franchisees an added incentive to purchase the franchise, knowing that they will earn at least a defined amount of income each month.
What are the benefits of an income guarantee clause?
For franchisors, the key benefit of this clause is that it will help attract franchisees who fear losing income or want some financial stability in the early stages of developing the franchise business. Income guarantees are usually offered on a short-term basis, most likely in the early stages of the franchise term.
For franchisees, in addition to having the financial security of the income guarantee, franchisees can also compare the different income guarantees offered under various franchise businesses and use this information as a good indicator of the types of returns they can expect to receive. This is based on the concept that a franchisor will carefully consider the potential returns from a franchise business and set the income guarantee accordingly, so the income guarantee amount invariably reveals valuable inside information from the franchisor.
What are the disadvantages?
Income guarantee clauses can also be quite misleading in that they might hide the true cash flow needs of a franchisee. A franchisee may be guaranteed an income that is not sufficient to cover the expenses of the franchise. Often this will not become apparent until after you have commenced operating the franchise business, at which time it may be too late to renegotiate the income guarantee in the agreement.
You may also become financially dependent on the franchisor which is not desirable for a successful franchise business. Franchisees are not employees and do not receive the same benefits that employees receive from their employers. Becoming dependent on a franchisor for payments may also be a disincentive for you to pursue the true potential of the franchise.
You should also consider when income guarantee payments are paid, as they are often deferred until the end of the income guarantee period, which could be as long as 6-12 months. This will impact your ability to manage costs and expenses during this period.
Income guarantee clauses are offered as an incentive in franchise agreements to reduce the apparent risks of purchasing a particular franchise. However, you should assess the purchase of a franchise against its real merits within the marketplace. To do this properly, you should always get legal advice from a franchise lawyer and also speak with an accountant.