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Franchising involves the owner of a business (franchisor) granting the right to another party (franchisee) to set up and run an exact replica of that business in another defined area for a specific duration.
One of the most important document of any franchise is the franchise agreement. This sets the tone for the legal relationship between the franchisor and franchisee. It includes the obligations of both parties and is designed to be comprehensive.
It is worth remembering that term lengths for franchises are usually five years in the UK and 10 years for international franchisees, both usually with the option to renew on the same terms, so it is important that franchisors get it right up front.
The franchisee is going to use the business name and brand of the franchisor and so the agreement must specify what use is in scope and out of scope for the franchisee. Franchisors should consider if franchisees will operate an exact replica of every element of your business in a different location or just certain elements of it?
The franchise agreement will specify the area that the franchisee may operate. Key considerations are the geography, sizes of areas and demographics before setting the boundaries. Usually this is done using a map or postcodes. Franchisors should think about what areas of territory will be exclusive and what will be non-exclusive.
The territory will need to be big enough to make the franchise viable and there will need to be a level of equality between the franchisees. Territories which are too big will limit the expansion of the franchise. One way around this issue is to launch a pilot franchise to determine what size of territory will make a franchise viable.
Five years is typical for owner-operator style franchises whereas high investment, premises-based franchises may grant a franchise for 10 or 20 years. Considering the return on investment will inform the decision on the term of franchise.
Typically, at the end of the first term, franchise agreements include a right to renewal. The franchise agreement can set out the criteria that the franchisee must meet in order to receive an offer to renew and a limit on renewals should be set. It is worth remembering that the terms on which franchisees renew will likely be identical.
The franchise agreement should set out all of the fees that are payable by the franchisee. This will include the initial franchise fee, the on-going management service fee, marketing levies and any additional payments for products or services.
It is also important to consider who will receive the money from customers/ clients and how will the fees be deducted and retained by the Franchisor.
The franchise agreement sets out what each party expects from the other. The Franchisor will need to decide on the level of training and support provided to the franchisees, particularly at the start. These are usually split into initial obligations and continuing obligations.
The agreement will set out the obligations on franchisees (which are usually more extensive) and these include marketing, operations, administration, accounting, reporting, staffing, training, premises and vehicles.
What happens after the term is important. The franchise agreement will set out what the franchisee may and may not do once the term has finished. Most franchise agreements contain clauses to protect the commercial interests of the franchise and contain some restrictive covenants on the franchisee.
Franchisees will usually have the right to sell the business, but the franchisor will often have a right of first refusal to acquire it itself, or decide on the candidate and on terms.
Franchise agreements have a fixed term and so eventually will terminate. This may be due to natural expiry, or it may be forced because the franchisee has breached the terms. The agreement will set out the circumstances for termination.
Franchise agreements are typically unilateral in nature. They are written entirely with the interests of the franchisor in mind.
Franchisors are granting the rights to operate a business that they have made a success, so it’s logical that a franchise agreement is fully focused on protecting their interests.
For the same reason franchise agreements should also be non-negotiable – franchisors want every franchisee operating under precisely the same terms. It is very important that franchisors avoid varying the agreement to satisfy the requests of individual franchisees. That said it is vital, particularly for reasons of enforceability, for the terms of the franchise agreement to be reasonable.
The franchisor must have ownership of the intellectual property that underpins the franchise in order to charge a fee to grant the rights for another party (franchisee) to use that intellectual property.
The intellectual property could be the trading name and the logo or branding. It is highly recommended that registered trade marks are sought – for further information please see here.
Review if there are any other intellectual property rights that are important to your business and consider how they are protected.
The franchise manual is very important, but the franchise agreement which sits on top of the manual and its policies is the enforceable contract which contains the obligations.
