The franchise agreement is one of the most important contracts you will sign as either a franchisor or a franchisee. It is the cornerstone of the relationship between both parties as it sets out each one’s rights, responsibilities and obligations. But there are multiple other aspects covered in a franchise agreement which you need to know about and understand as you embark on your journey into franchising. Take a look at what it entails and get a deeper understanding of this important document so that you are fully prepared for your journey ahead.
Table of contents:
What is a franchise agreement?
The franchise agreement is a contract that is entered into between a franchisor and a franchisee. As a legal document, it has legal implications. And much like other legally binding agreements, it is important for several reasons. Number one is that it can help to facilitate a smooth working relationship between the parties to the contract. Number two is that both parties are protected in the event of disputes or the need for conflict resolution such as mediation or arbitration.
When looking at the franchise agreement, it’s highly advisable that you do this together with a franchise lawyer, consultant or expert in the field so that you can identify red flags (if any).
Often, franchisors and franchisees find it helpful to refer to the Franchising Code of Ethical Conduct when composing an agreement. This ensures both parties behave ethically, following industry standards and requirements.
What should a franchise agreement contain?
Franchise agreements vary in length depending on the franchisor and the level of detail it contains. However, most franchise agreements contain the following standard clauses:
- Personal information of both parties
- Location of the franchisee (if applicable)
- Rights and obligations of both parties
- Provision of goods and services from the franchisor to the franchisee
- Payment terms and fees (including initial investment costs, royalties, operational costs, marketing costs, monthly fees, etc.)
- Duration of the agreement
- Terms, basis and details of renewal
- The re-sale of established franchise units/Pre-emption rights
- Expected practice with relation to the trademark, brand, signs, logos etc. and general marketing guidelines
- Franchisor’s training and ongoing support plan and structure
- Operational requirements
- Legal requirements
- Guidelines in the event of death or illness
- Any future adaptations to the franchise system
- Provisions for terminating the agreement
- Breach conditions
For the franchisor, the franchise agreement is there to protect their interests, help them evaluate cases in the event of an underperforming franchisee, guarantee the integrity of their intellectual property as well as limit the franchisee’s ability to act on certain rights.
For the franchisee, on the other hand, the franchise agreement also serves to protect their interests as well as gain clarification on what they can expect from a franchisor in return for their investment. Furthermore, franchisees will have much more clarity regarding each party’s responsibilities.
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Types of franchise agreements
It’s important to note that not all franchise agreements are the same and that there are generally four different types of these agreements that you can enter into, depending on your budget, interests, goals, aspirations and more. These are the single-unit, multi-unit, area development and master franchising agreements.
- Single-unit franchise agreement: with this agreement type, which is one of the most common and widely used ones, the franchisor grants the franchisee the right to open and operate only one franchise unit in a given location.
- Multi-unit franchise agreement: similar to the single-unit franchise agreement, the multi-unit agreement covers the rights and obligations of both parties in the event that the franchisee operates and runs more than one franchise unit. If you wish to know more about the single-unit and multi-unit agreements, check out our Single-Unit vs. Multi-Unit Franchising blog article.
- Area development franchise agreement: this type of agreement applies in cases where the franchisee is given the rights to open multiple units within a clearly defined geographical location over a specific period of time. They may also have the rights to their specific territory and thereby make earnings based on each franchise sold in their territory by sharing the franchise fee and receiving (partial) ongoing royalties.
- Master franchising agreement: perhaps the most complex type of franchise agreement is the master franchising agreement. Master franchising, which is often referred to as sub-franchising, is similar to an area development franchise but it also gives franchisees the rights to sell franchises to others within a specific territory. This can be developing and spreading the franchise brand in a new country. As a result of their wider rights and obligations, master franchisees typically take on the role of the franchisor, including providing training and support to new franchisees. They can also share in the turnover as well as receive a portion of the royalties earned in that new territory.
Does a franchise agreement renew automatically?
Because franchise agreements stipulate the length and duration of the business relationship between franchisor and franchisees, many happy and satisfied franchisees would like to renew their franchise agreement beyond the original term as stipulated in the agreement once a certain date has been reached. However, for franchise agreement renewal it must be remembered that every franchisor is different and will have different stipulations regarding the renewal process.
In some cases, renewal can be automatic whereas others may require the signing of a brand-new franchise agreement. Furthermore, whereas some franchisors will not charge a fee for a franchise renewal, others will do so. Therefore, it depends on a case-by-case basis. And the important thing is to always ensure that you check the terms and conditions of your franchise agreement with a specialist or expert so that you are fully aware of where you stand.
In conclusion
The franchise agreement governs the relationship between franchisor and franchisee. It is usually quite a lengthy document that, once signed, comes into effect and is binding on both parties. The franchise agreement contains numerous clauses that need to be studied carefully and in depth before signing on the dotted line. It’s always highly advisable to consult an expert such as a franchising lawyer to help ensure that you are fully aware of what you are taking on for the foreseeable future.
