Finally, owning your own business is an exciting time. But before you get ahead of yourself, you need to sign a franchise agreement.
This document is a legally binding contract between you and the franchisor that establishes the rules and guidelines you must follow as a franchisee.
Understanding everything included in a franchise agreement is crucial before signing on the dotted line. In this article, we will discuss what you can expect to find in a typical franchise agreement.
What Exactly Is A Franchise Agreement?
Before we dive into the nitty-gritty details, let’s first define what a franchise agreement is.
A franchise agreement is a contract between two parties: the franchisor and the franchisee.
The franchisor is the company that owns the rights to the business model, while the franchisee is the individual who pays to open and operate a franchise location.
The franchisor and franchisee each have certain rights and responsibilities under the terms of a franchise agreement regarding the sale and licensing of a company’s intellectual property and licensing rights.
Some examples of businesses that use franchise agreements include:
- Convenience stores
- The fast food industry and restaurant chains
- Financial advisors
- Healthcare service providers
- Health clubs and gyms
You are required to sign a franchise agreement if you intend to sell products or services under a franchisor’s brand name and business model.
If you fail to adhere to the terms of your contract, you could be subject to termination, legal action, or other penalties.
The Information Included In A Franchise Agreement
Since the franchise agreement underlines the obligations of both the franchisor and the franchisee, it is extremely important to have a clear knowledge of all the provisions contained within it.
This ensures that both parties are on the same page with regard to what is expected of them.
Here are some of the key components that you can expect to find in a franchise agreement:
1. Elements Of Running A Franchise
A company that provides franchises to independent business entities or, in some situations, sole owners is different from other companies that enter into commercial agreements, which can be summed up using the following important elements:
- This is a relationship based on a contract.
- Regular know-how transfer and further training opportunities are provided by the franchisor, who either volunteers to do so or is legally obliged to do so.
- The franchisee must adhere to a standard operating procedure, format, or trademark.
- The term “licensed to operate the franchise” is still held by the franchisor, who owns or is the rightful licensee of the brand, product, or service.
- The franchise has already made plans to make a significant capital commitment out of its own resources.
2. Important Definitions in the Franchise Agreement
Before you get too far into reading your franchise agreement, it is important to understand some key terms used throughout the document.
These definitions will help you better understand the franchisor’s expectations and your rights and responsibilities under the agreement.
Here are a few important terms that you should be familiar with:
- Franchise: The right to use a company’s name, business model, and intellectual property to sell products or services in a specific territory
- The franchisor: The company that owns the rights to the franchise and grants franchises to independent business entities
- Franchisee: The individual or entity who purchases a franchise
- Territory: The geographic area where the franchisee is granted the exclusive right to operate their franchise
- Term: The length of time during which the franchise agreement is valid
- Renewal: The franchisor’s right to extend the term of the franchise agreement at their discretion
- Royalty: A periodic fee that the franchisee pays to the franchisor for continued use of their intellectual property and business model
- Advertising Fee: A periodic fee that the franchisee pays to the franchisor to support advertising and marketing initiatives
- Initial Investment: The upfront costs associated with opening and operating a franchise location
- Ongoing Fees: The periodic fees associated with maintaining a franchise location, such as rent, utilities, and insurance
3. Intellectual Property
One of the primary aspects of a franchise agreement is the licensing of intellectual property to the franchisee.
Most franchise systems strongly emphasize three types of intellectual property: trademarks, copyright, and know-how.
- Trademarks: A phrase, word, design, or logo that identifies the source of a product or service
- Copyright: The legal right to exclusive use of creative work, such as a book, movie, or song
- Know-how: Proprietary information about a company’s products, services, or business methods
In some ways, a franchise agreement is a more complex version of a licensing agreement in which the franchisor/licensor is the owner or the holder of specific intellectual property rights or technology, and he/she permits the licensee/franchisee to use in exchange for certain fees and/or compliance with certain conditions.
4. The Franchise Period’s Duration and Requirements for Renewal
A franchise agreement also specifies the day when the franchise will officially open for business (the “start date”) as well as the period of time during which the franchisee has the right to operate their franchise (the “franchise period”).
The franchise period is typically 5-10 years, but it can be shorter or longer depending on the franchisor’s preference. In some cases, the franchisor may include an option for the franchisee to renew the agreement for an additional term at their discretion.
5. Terms and Circumstances Under Which the Franchise Agreement May Be Terminated
A franchise agreement can be terminated under certain circumstances like any other contractual agreement. The franchisor may have the right to terminate the agreement if the franchisee fails to meet certain performance standards, such as sales targets or profitability goals.
The franchisor may also terminate the agreement if the franchisee violates any of the terms or conditions outlined in the agreement, such as engaging in unauthorized changes to the business model or failing to comply with the franchisor’s quality standards.
6. Post-Term Demands
The franchisor will have actions to do once the term expires, whether naturally or by default. These actions are important to the franchisor in order to protect its business model and intellectual property.
The franchisor may require the franchisee to:
- Give up the use of intellectual property
- Pay back any unpaid royalties or advertising fees
- Remove any signage or other branding materials from the franchise location
- Cease all operations related to the franchise business
Franchisees may get a written non-compete clause if they are in an industry where the franchisor fears they could open up a competing business.
This clause protects the franchisor by limiting the franchisee’s ability to compete with the franchisor’s business.
7. Dispute Resolution Process
A dispute resolution process is typically included in a franchise agreement as a way to handle any disagreements that may arise between the franchisor and franchisee.
This process can take many forms, but it typically includes mediation or arbitration to resolve disputes without going to court.
The mediation process involves both parties meeting with a neutral third party (the mediator) who will help them reach an agreement. If the parties cannot reach an agreement, they can proceed to arbitration.
Arbitration is similar to mediation but involves a hearing in which both parties present their case to an arbitrator, who will then make a decision.
This decision is binding, meaning that the parties must comply with it even if they don’t agree with it.
A franchise agreement is a contractual agreement between a franchisor and a franchisee that outlines the terms and conditions of the relationship.
This agreement typically includes information about the franchisor’s business model, intellectual property, and quality standards.
Make sure you understand all the terms and conditions of a franchise agreement before signing it. If you’re ever in doubt, it’s always best to consult with a lawyer who specializes in franchises.
Amit Gupta is an experienced expert in digital marketing and co-founder of DrFranchises. With more than 11 years of knowledge in franchise digital marketing, SEO, email marketing, and social media marketing, Amit has helped many brands achieve incredible success online. As a passionate entrepreneur and owner of 7 franchises, he continues to study franchise models, looking at costs, revenue, and profitability to guide brands toward profitable growth. When he’s not working on digital marketing, Amit enjoys spending time playing with his beloved dog.