Franchises 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 franchise business. These contracts are often very long, making it easy to overlook terms that may become important in future. This article explains some of the most important terms to watch out for in the franchise agreement.
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 the reputation of the franchise and its location. However, the agreement will also state ongoing costs. These can include fees for:
- stock and supplies;
- communal marketing; and
- termination or renewal of the agreement.
It is essential to factor these fees into your business plan so that you know you can still make a profit.
2. Exclusive Territories
The franchise agreement will sometimes include a key term that grants an exclusive territory. This is a geographical area in which only one franchisee is allowed to 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 will be running a franchise that operates at least partially online, it is vital to do your research on how this will affect the exclusive territory.
3. The Property Lease
The franchise agreement will set out which party is responsible for the lease. In most cases, neither the franchisee nor 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.
On the other hand, not holding the lease means you have fewer obligations, especially when it comes time to sell the franchise. If you hold the lease, then the franchise agreement will often require you to get the consent of your landlord before selling your franchise business.
4. Marketing Fees
The franchise agreement will often have a key term that requires you to pay fees into a communal marketing fund. This fund will be used to pay for franchise-wide marketing activities across the entire network. For example, television, radio or internet ads.
The agreement may also specify how much you need to pay towards marketing your business locally. It is essential to understand how both franchise-wide and local marketing will align with your own marketing plans.
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. Furthermore, the franchisor has the opportunity to change the franchise agreement each time it is renewed.
A longer term gives you more opportunity 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 it is crucial that the business does become profitable before the first renewal.
6. Ending the Franchise Agreement: Termination and Transfer
Termination refers to ending the franchise agreement before the original term is up. In most cases, franchisees cannot terminate a franchise agreement 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 would allow the franchisor to start court action against the franchisee.
Transfer means selling the business and transferring the franchise agreement over to a new franchisee. The franchise agreement will specify the transfer process. This 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 will contain a restraint of trade clause. The terms will usually state that you cannot conduct the same or similar business within a certain area for a period of time. In some cases, this time extends up to 10 years. Whether the franchisor can enforce this clause depends on how it has been drafted.
The courts have upheld these clauses where they protect the legitimate business interests of the franchisor. The franchisor will need to show that the new business affects the profitability of the franchise in some way. For example, an independent bakery in the same area as a bakery franchise will directly compete and reduce the franchise’s profits. On the other hand, starting a bakery in a city where the franchise has yet to expand to 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. If you would like to open a similar business one day, then it is vital that you speak with a franchise lawyer about this before signing a franchise agreement.
8. Dispute Resolution
The franchise agreement will include a dispute resolution clause. These implement the dispute resolution procedure set out in the Franchising Code of Conduct. This allows you to resolve disputes before the franchisor removes you from the franchise. Therefore, ensure that you understand both how disputes will be resolved and the amount of time you have to rectify breaches of the franchise agreement.
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 chances of making a profit.
If you need assistance with reviewing a franchise agreement, call LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.
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