What is a Franchise Agreement?

An efficient business expansion method is franchising. Most companies choose to accept franchisees to establish their brand in other parts of the country and in the world. In this particular business relationship, a franchise agreement is needed to lay out the guidelines of the agreement. The relationship of each party, franchisor and franchisee, are specifically phrased in this document. The franchisor is the owner of the brand. They own and trademarked the brand and its operating system. On the other hand, the franchisee is an independent contractor that wants to expand and operate the brand in a specific area. The obligations of each party are also specifically spelled out in the agreement. The franchisor takes on the role of providing the brand name, operating system, management training, established marketing strategies, and full-on support from the head office. As the franchisee receives all these resources, their role is mainly the daily operations of the franchise and to uphold it according to the established quality standards. 

Having a legally binding franchise agreement protects both the franchisor and franchisee, who can also be labeled as licensor and licensee. As the brand name is the most valuable asset in this type of agreement, the contract protects it as the intellectual property of the licensor. It also protects the operating system of the company, which is essentially how they do their business. It includes their business plans and strategies. Apart from protecting the IP, the agreement also protects the reputation of the organization. There are stipulations in the contract that serve as guidelines on how the business should be to improve the reputation and boost the marketability of the business in the area. It is based on the assumption that the performance of one franchise affects the entire brand.

Elements of a Franchise Agreement

A franchise agreement needs to have several key elements for it to be enforceable. These elements align with the definition of the Federal Trades Act which. A brand must be shared by both parties which are passed on by granting and paying for the license. The franchisor must also provide sufficient support to the licensee and must stay within certain parameters. The regulation by the FTA is a guideline as other states may have certain laws that regulate the franchising system in their states.
Grant of the License: The brand and its operating system are part of the intellectual property of the franchisor, who is the owner of the business. The franchise agreement should explicitly state that allows the franchisee to use the brand and its system. The franchisee is not limited to utilizing the name and the system, they can also use the established marketing and advertising strategies from the head office. The grant also specifies the things that each party can do towards each other. The franchisor can provide support but not meddle with day-to-day operations and human resources development. On the other hand, the franchisee can make necessary adjustments with the provisions of the licensor but need to match the required quality standards.Provisions of the Franchisor: The franchisor is also bound to provide support and assistance to the franchisee. An integral part of any franchise agreement is a specific list of the franchisor’s provisions to contribute to the success of a new branch in the system. Aside from the trademarks, some companies provide or approve a particular area for the franchise; others opt to establish in areas where the brand has not established yet. On the other hand, there are also other companies that make sure the incoming employees of the new branch undergo extensive training. They send trainers and managers from the head office to facilitate a series of training and seminars. License Fee and Royalty: One defining factor of a franchise agreement according to the Federal Trades Commission is that initial and succeeding payments were made by the franchisee. The initial payment is the license fee. The payment of this amount provides the right to put up and manage a branch that is part of the franchise system of the company. Payment for the succeeding months is labeled as royalty fees. Royalty fees are for the use of the trademarks of the company, which are the system and the brand name. Moreover, royalties also bring in additional revenue to the original company. The amount of both should be clearly stated in the agreement and that both parties agree to it. More importantly, the schedule of the payment should also be clearly indicated to avoid conflict.Dispute Resolution: If in case the relationship between both parties reaches an impasse, they can refer to the agreement on how to go about the situation. But before drafting these resolutions, it is important to gather information about common disputes in franchising. A common cause of litigation between partners is untruthful reports of income. The franchisee may withhold information about the revenue for a particular month or time frame. In order to avoid this, the franchisee and franchisor must agree on a penalty that will be carried out upon its occurrence. These clauses may also cover as to what will happen when there are cancellations or termination in the agreement.Boilerplate Provisions: Boilerplates are thick pieces of steel that were used in the production of steam boilers. These materials are used again and again until damaged. In the same sense, boilerplate statements are present in legal documents and contracts. Because of its common occurrence, boilerplate clauses are also known as standard miscellaneous. These provisions are included in most legal documents for standardization. These clauses often protect the business owner, which is the franchisor in this context. More often than not, these clauses are also non-negotiable.

How to Make a Franchise Agreement

It comes to no surprise that most franchise agreements greatly favors the franchisor. It is only plausible because franchisee rides on the established reputation and operating system of the business. As a franchisee, even if your party will not significantly contribute to the drafting of the contract, it is ideal to know the process to know what to look out and demand for in an agreement. On the franchisor’s perpective, they want to sustain and uphold the reputation that they built over the course of years. So, it is also natural that the contract comes close to a rule book in presenting what the franchisee must and can do for the business to thrive.

Step 1: State the Introductory Statements

The introductory statements are the whereas statements that begin any agreement or contract. For a franchise agreement, it introduces and highlights the value of the brand. It describes the nature of the business and the role it plays in the industry. The build-up of the brand also doubles as a justification for its licensing rate. Utilizing a basic theory in Economics, a significant amount is justifiable for things with high demand and value. In the agreement, it also identifies the roles of the parties, points out which is the franchisor and which is the franchisee.

Step 2:Declare the License Grant

There should be stipulations in the contract that directly express consent to use the trademarks of the franchisor in exchange for paying the licensing fee. In this sense, the licensing and royalty fees are also introduced in this part of the contract. Most companies compute for their royalty fee based on the monthly gross income of the franchise. They take a particular percentage from the amount. Most franchise agreements are also nonexclusive in nature. This arrangement means that the franchisor can engage in several franchise agreements at the same time. Naturally, businesses opt for this arrangement because franchising aims to widen its market.

This part of the contract also states limitations. You can choose to include specific stipulations on how the other party can use the trademarks, such as the logo, brand statements, and business colors. Some companies are very strict in their uniformity across all the stores in the franchise system. Other companies also impose the territory of a new branch, mainly to avoid competition within the company. Important dates are also presented in this part of the agreement. The start date of the agreement and when it should open and start operations.

Step 3: Indicate Duration of the Agreement

A standard franchise agreement runs for ten to twenty years on average. In this span, there are several key dates to take note of. Aside from remembering the dates for tax filing, payment due dates are essential to remember. In these agreements, the franchisee has monthly payment dues to the franchisor for its continued use of its business trademarks. On the flip side, the end date of the agreement is also already noted. For agreements as long-lasting as this, notices for renewals are sent several months before the end date of the business contract. This document notifies the franchisee to start thinking about continuing the contract for the next years. Renewing has a corresponding renewal fee and the branch must pass the standards set for eligibility.

In some cases, the franchisor demands the franchisee to start operations on a particular date, but this can also depend on the location of the branch. The starting date of operations may also be considered as the start of the agreement. Some companies adhere to this agreement, seeing that this arrangement is more beneficial for them.

Step 4: List Down Reasons for Termination

An agreement may end because of several legal reasons. First and foremost, the franchisee may choose not to renew the partnership. The franchise relationship may also be terminated because of the bankruptcy of either of the party. The franchisor can no longer sustain the business and need to cut some expenses or the franchisee is no longer capable of paying the monthly fees because of little or no revenue. The agreement can also be cut short when either of the parties committed a crime or fraudulent activity. Clauses regarding termination because of criminal activity can also be included as part of dispute resolution. Furthermore, it is also impossible to continue with the partnership if the franchisor loses its trademark on its branding due to dispute, which went under proper litigation processes.

Step 5: Review of Federal and State Regulations

It is important to review related documents, federal, and state regulations in coming up with the agreement to make sure that the terms are legal, binding, and executable. One thing is to review the definition of a franchise according to the Federal Trade Act. Upon its signing, its main purpose is to ban unfair practices that affect activities in commerce. The act provided several factors that define a franchise. However, the factors provided in the Federal Trade Act serve as guides, there are states which have more stringent defining factors of what a franchise is. Moreover, some states also require additional requirements and processes such as franchise registrations. So, before finalizing your franchise agreements, make sure that all the clauses and stipulations are enforceable in your state. It is also a best practice to consult with an experienced business lawyer who focuses on franchise agreements. This additional step will only help you make sure that the agreement protects the interests of both parties, and at the same time, demand more or less equal efforts from both.

Dos and Don’ts in Making a Franchise Agreement

With the long and fruitful history of franchise agreements, it has picked up several ideal practices for both the franchisee and the franchisor. This list provides some of them which are applicable to franchise agreements, regardless of the nature of the business.

Dos

1. Do read and understand the demands of the franchisor. 

The contract can be a long list of demands from the franchisor. As the franchisee, make sure to provide time and effort to understand the demands of the other party. These demands are present for a reason, it aims to protect the business and its name. Some mishaps in one branch may affect the image of the brand entirely, so it’s better to be careful than be sorry.

2. Do learn more about business operations.

Even if you agree to pay for the use of the business’ existing operating system, it is not enough to keep your business running. A franchise is a single unit of the franchise system of the company. Even if it has proved its effectivity for the other branches, it is also ideal to learn more about business management to effectively make adjustments to make it work best for your unit.

3. Do ask advice from experienced franchisees. 

Especially when it is your first time handling a franchise or first time operating a business, it is best to ask advice from people who are in the business for a significant amount of time. You can learn and, maybe even, benchmark some best practices that you think will produce the same positive effects in your franchise. Never be afraid to learn more about how the business is run, they may also provide some hacks that can make the transition more manageable for you.

Don’ts

1. Do not underestimate the upfront payment fees. 

There are some interested franchisees who often overlook the amount of the initial payment fees. They often directly calculate the monthly dues and other taxes which they think are manageable but forget about a major hurdle in the beginning. The initial fee is similar to a capital fee or downpayment to start a new business. Also, when the franchisor asks about your financial activity, avoid exaggerating your current status as it may place both of you at risk of financial instability.

2. Do not mainly rely on materials provided by the franchisor.

The franchisor is required to provide materials and resources to help the franchisee stabilize the business as early as possible. On the part of the franchisee, do not rely only on what is provided. Seek out additional training for you and your employees. You can also choose to take classes to know more about business management and its different functions.

Franchising is a reliable method of business expansion. But, it also comes with several risks as it needs to partner with people who are not from within the main company. The nature of the relationship demands strict and demanding stipulations in the agreement to protect the interests of both parties.