In Short
- Franchise agreements outline the rights and obligations of both franchisors and franchisees, covering aspects such as financial commitments, territorial rights, intellectual property usage, and termination conditions.
- Key terms to review include initial and ongoing fees, exclusive territories, property lease responsibilities, marketing contributions, agreement duration, termination and transfer conditions, restraint of trade clauses, and dispute resolution procedures.
- Understanding these terms is crucial for franchisees to ensure alignment with their business goals and to avoid potential conflicts or unexpected obligations.
Tips for Businesses
Before entering a franchise agreement, conduct thorough due diligence. Carefully assess all financial obligations, territorial rights, and operational responsibilities. Pay close attention to termination clauses and any restraints on future business activities. Consulting with a franchise lawyer can provide valuable insights and help safeguard your interests.
Franchising can be a great way to operate a business with a proven record of success. However, hidden key terms in the franchise agreement can derail your business. These contracts are often very long, making it easy to overlook terms that may become important in future. This article explains some key terms to watch out for in the franchise agreement.
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1. Financial Terms
The franchise agreement will first state the franchise purchase price. This is often a large amount of money in the range of $20,000 to $1,000,000. Whether this price is worth paying will depend on many factors, including the reputation of the franchise and its location. However, the agreement will also state ongoing costs. These can include fees for:
- royalties;
- stock and supplies; and
- communal marketing.
Factoring these fees into your business plan is essential to ensuring you can still profit.
2. Exclusive Territories
The franchise agreement sometimes includes a key term granting an exclusive territory. This is a geographical area where only one franchisee can operate or market. If the franchise agreement grants you an exclusive territory, ensure that you know:
- how many potential customers are in that territory; and
- whether the number of customers in the territory will be enough to make a profit.
Exclusive territories can be more complicated with franchises that operate online. This may require the franchisor to have systems that direct online orders to the right franchisee. Therefore, if you are running a franchise that serves at least partially online, it is vital to research how this will affect exclusive territory.
Continue reading this article below the form3. The Property Lease
The franchise agreement will set out which party is responsible for the lease. In most cases, neither the franchisee nor the franchisor will own the premises from which the franchise operates. Therefore, one party will need to hold a lease. If the franchisor holds the lease, this gives them additional control over your premises. However, this also means you have fewer obligations, especially when selling the franchise.
If you hold the lease, then the franchise agreement will often require you to get your landlord’s consent before selling your franchise business. In addition, you will be directly liable to the landlord for any breach of the lease.
4. Marketing Fees
The franchise agreement often has a key term requiring you to pay fees into a communal marketing fund. This fund will pay for franchise-wide marketing activities across the entire network, such as television, radio, or internet ads.
The agreement may also specify the cost of marketing your business locally. Understanding how franchise-wide and local marketing align with your marketing plans is essential.
5. Length of the Original Term
The length of the original term is how long the franchise agreement requires you to operate the franchise. A shorter term reduces the risk of being locked into an unprofitable business. On the other hand, it also means that you will need to pay renewal costs more often, which may limit your ability to profit from the operation of the franchised business. Furthermore, the franchisor can change the franchise agreement each time it is renewed and is not obligated to renew it.
A longer term allows you to build a successful business, break even and turn a profit before the agreement is renewed. The franchise agreement may include performance targets to meet, so the business must become profitable before the first renewal.
6. Ending the Franchise Agreement: Termination and Transfer
Termination refers to ending the franchise agreement before its original term expires. In most cases, franchisees cannot terminate it at will and are locked in for the entire duration. In this case, the termination clause will specify that the franchisee is in breach of the agreement if they try to terminate. This breach may allow the franchisor to commence legal action against the franchisee, including litigation.
Transfer means selling the business and transferring the franchise agreement to a new franchisee. The franchise agreement will specify the transfer process. Generally, the transfer process will allow the franchisor to choose or at least approve an appropriate franchisee and to deny others on stated grounds. Understanding this process gives you greater clarity on how to pick candidates to whom you will be able to sell your franchise business.
7. Restraint of Trade
Almost all franchise agreements contain a restraint of trade clause. The terms usually state that you cannot conduct the same or similar business within a specific area for a certain period, which sometimes extends up to 10 years. Whether the franchisor can enforce this clause depends on many factors, including how it was drafted.
The courts have upheld these clauses when they protect the franchisor’s legitimate business interests. The franchisor must show that the new business somehow affects the franchise’s profitability. For example, an independent bakery in the same area as a bakery franchise will directly compete with the franchise and reduce its profits. On the other hand, starting a bakery in a city where the franchise has yet to expand will not.
Therefore, it is possible that you will not be able to operate the same or similar business under a different name in a similar location after you terminate, sell or complete your franchise agreement, even if this means not working in your profession or area of expertise.
8. Breaches and Dispute Resolution
A breach of the franchise agreement will likely entitle the franchisor to take specific actions against you. You should understand what actions may be considered breaches and how long you must rectify them.
The franchise agreement will also include a dispute resolution clause, which may be used to resolve disputes related to breaches of the franchise agreement. This clause implements the dispute resolution procedure in the Franchising Code of Conduct, which provides a mechanism for resolving disputes through alternative dispute resolution processes such as arbitration or mediation. You should familiarise yourself with how disputes will be resolved under the franchise agreement.
Key Takeaways
When entering a franchise agreement, it is tempting to focus on the initial investment and length of the franchise term. However, you should also take time to understand other key terms such as the ongoing costs, the property leasing arrangements and dispute resolution. This will ensure that you can prepare a business plan for your franchise agreement that maximises your profit chances.
If you need help reviewing a franchise agreement, our experienced franchise lawyers can assist you as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers who can answer your questions and draft and review your documents. Call us today at 1300 544 755 or visit our membership page.
Frequently Asked Questions
A franchise agreement includes upfront franchise fees, ongoing royalties, marketing fees, and operational costs (e.g., stock and supplies). Ensure these costs are factored into your business plan to determine profitability.
An exclusive territory gives a franchisee the right to operate in a specific area without competition from other franchisees. Check how many potential customers are in the area and whether online sales are included in the territory agreement.
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