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Understanding the Franchise Agreement

A franchise partnership is incomplete without a franchise agreement. Learn about the different types of agreements available and what they require, so you can begin your new journey with confidence.

the franchise agreement

Defining the Franchise Agreement

Having decided that franchising is the best step in pursuing business ownership as a franchisee, you must know what the agreement will look like.

For a franchising deal to hold between you and the franchisor, both parties must come to an agreement that would state clearly what both parties stand to gain, for how long, and other vital conditions. This agreement is called the franchise agreement.

It is a legally binding agreement that gives details of the mutual relationship between the franchisor and the franchisee. In drafting a franchise agreement, there is no standard method. However, you can draw up one of the four main types of contracts between the two parties.

Single-unit franchise:

The single-unit franchise is the oldest and most common type of understanding between two franchise parties. With this type of arrangement, the franchisee has the permission of the franchisor to operate a single franchise unit.

In this type of franchise agreement, there is a direct link between franchisor and franchisee as no middlemen are involved in their dealings.

Multi-unit franchise:

With a multi-unit franchise, the franchisor grants the franchisee the rights to operate more than one franchise unit. Most times, multi-unit franchises start up as single-unit franchises and then expand after a while.

The process works this way: initially, franchisors grant the franchisees permission to open an outlet that sells their products. After considerable growth in this outlet, the franchisor then permits the Franchisee to open more franchise units within a stated location.

Area development franchise:

The area development franchise is like the multi-unit franchise but works on a larger scale and over a more extensive territory. In this type of franchise, the franchisee (an area developer) agrees with the franchisor to open multiple franchise units and have a certain number of franchises sold in a given period.

People that are interested in an area development franchise want to buy many units so that they don't have any competition in their backyard and have complete control over a defined zone.

This allows them to profit from all of their businesses in one location, as well as gain access to a variety of benefits such as volume purchasing discounts, labor economies of scale, higher overall earnings, in-house training and marketing, and more.

While having a single franchise might provide a good livelihood, the great money is in owning numerous franchises.

Master franchise:

The master franchise agreement is also known as sub-franchising. With this type of agreement, the franchisor grants the master franchisee the rights to use intellectual property, trademarks, and an operating manual. The master franchisee can grant permission to other parties to open new franchises within the stated territory.

There are other vital contractual requirements you should keep in mind about the franchise agreement. Some of these are highlighted below:

Key Elements of the Agreement You Need to be Aware of

what to expect

1. Usage of trademarks:

One of the benefits of buying a franchise is the right to use the trademark of a reputable company as your own. This trademark right is usually stated in a franchise agreement as companies’ trademarks are typically registered (with USPTO in the US); hence they have legal protection. Using them without the company’s permission is illegal.

For example, Domino’s is the trademark of Domino’s IP Holder LLC along with the blue and red logo colors that everyone is familiar with. The franchise agreement will state that you, as a franchisee, now have the right to use the trademark and logo.

2. Advertising standards:

Another critical section of a franchise agreement is the advertisement. The agreement would contain how advertisements of the franchise would be carried out, which should primarily be the responsibility of the franchisor. It details how much the franchisor would be spending (and the fees the franchisee would be paying) in promoting the new franchise so they need to gain as much publicity as needed for the growth of the new unit.

3. Location/ territory:

In the franchise agreement, the franchisor would assign a designated territory or location to the Franchisee to operate in. Territories must be marked out by the franchisor, as this helps with dealing with the risk of oversaturating a particular region.

Something you as a franchisee should research is how effective the franchisor’s location strategy is.

4. Training and support:

In most franchise cases, franchisors offer new franchisees training services and round-the-clock support. This training and access are usually done in the company’s offices or on the field, depending on what business type.

For example, the UPS store trains new franchisees to help them “get started and succeed as a UPS store franchisee.” The training also helps new franchisees understand the business model. The terms of training and support are therefore provided in the franchise agreement.

5. Insurance requirements:

Insurance is also a key element in a franchise agreement. The details of what type of insurance the franchisee has to purchase are stated in this section. This will ensure that the franchisee (and consequently the franchisor) is protected from financial risk.

6. Terms of the franchise:

Another important section in a franchise agreement is the terms of the franchise, which includes details about the duration of the contract and rights of renewal of the deal once it expires.

The terms of the franchise safeguards both parties. It safeguards both you as a franchisee and the franchisor's brand. You will be making a significant financial investment when you purchase a franchise. A written agreement gives you rights to help protect your business investment.

7. Payments:

Another section of a franchise agreement describes all forms of standard fees to be paid or received. One payment fee that is almost always compulsory is the initial fees you pay for permissions and rights that the franchisor grants you to use their brand name and other properties. This is stated in the payment section of the franchise agreements.

Other payment details included here are royalty—a certain percentage of total earnings that franchisors receive from franchisees. The percentage the franchisees get to keep from total revenues is also stated here.

8. Restrictions on goods and services:

This is another crucial element of a franchise agreement as it contains the details of various forms of restrictions placed on the goods or services you might want to offer as a franchisee. For example, the franchisor can place restrictions on the suppliers that you might want to use such that only selected suppliers are allowed to supply you with certain products.

Franchisors can place restrictions on prices of goods or services, mode of advertisement, and the times of operation. Using McDonald’s as an example, the prices of goods are similar in every McDonald’s outlet, so it is unlikely that a franchisee will have the freedom to adapt these prices.

9. Minimum performance standards:

For every franchisee, when in an agreement with the franchisor, there is an expected minimum performance standard. In the instance where this is not met per the allocated time, a Court can sign off on the termination of the franchise agreement.

Therefore, the minimum performance that is expected for your franchisee unit is stated in the franchise agreement under this section. For example, you might be expected to have a minimum of a thousand sales of your products per week, based on your location. Failure to meet this requirement can result in termination of the contract.

10. Renewal, termination, and transfer of the agreement:

Franchise agreements also state terms of renewal of the contract and conditions for terminating the contract of agreement early. Usually, the franchisor had the most rights in case of termination, and all that the franchisees have are obligations if early termination happens.

For example, you are obligated to stop using the brand’s name, trademark, and intellectual property upon termination. You would also be expected to pay all amounts due for payment in this case.

It’s Time to Sign the Dotted Line and Be Your Own Boss

A franchise agreement summarily explains what to expect from both the franchisor and the franchisee; it sums up the relationship between both parties.

As a franchisee, understanding the content of your franchise agreement is as important as operating your franchise establishment, therefore this guide shows you the common key elements you are expected to find in your franchise agreement.

Before you sign the agreement, you should have your lawyer go over the details with you. We wish you the best of luck as you embark on your new franchise venture.

If you have further questions or clarifications about the franchise agreement, get in touch with us here.