Understanding Your Franchise Agreement

When entering into a franchise relationship with a parent company, the single most important document is the Franchise Agreement. This legal document outlines the terms and conditions of the franchisee’s relationship with the franchisor. It also spells out your obligations as a franchisee. This document is signed as a formal agreement when you decide to become part of the franchisor’s franchise system.

This agreement is a type of license that allows you certain privileges within the franchising relationship. The legal relationship can be a bit confusing. Every franchise is a type of license; but not every license is a franchise. What turns a license into a franchise in the United States is governed by the FTC Rule, established by the Federal Trade Commission, which governs all U.S. franchises.

According to the FTC Rule, there are three general requirements for a license to be considered a franchise:

1. The franchisee’s business shares a substantial association with the franchisor’s brand.
2. The franchisor exercises control or provides significant assistance to the franchisee in how they use the franchisor’s brand in conducting their business.
3. The franchisor receives from the franchisee a fee for the right to enter into the relationship and to operate their business using the franchisor’s trademarks.

The Franchise Agreement Establishes a Long-Term Business Relationship

Contrary to what some may believe, a franchise business relationship is not a partnership, a joint-venture or cooperative, and it’s not a joint-employer relationship. It’s a franchise license that establishes the rights and obligations of the licensor (franchisor or parent company) and the licensee (franchisee). Regardless of how the parties refer to the relationship, every franchise is governed by the terms of a written contract between the franchisor and the franchisee, and that document is called a Franchise Agreement.

The Franchise Agreement is designed to balance the needs of the franchisor to protect its intellectual property and ensure consistency in how each of its licensees operates under the brand. But is also needs to be flexible enough to allow the franchisor to modify the agreement, so when franchisees in different situations have specific needs, the agreement can reflect those changes. It must include provisions that allow franchisees to manage their independently-owned businesses on a day-to-day basis, and yet be governed by a requirement that they continually meet brand standards.

The Essential Components of a Franchise Agreement

Any Franchise Agreement will contain specific elements that vary from industry to industry and franchise to franchise. But each will contain some basic components, such as the following.

Basic Overview

This typically includes the identity of the parties to the contract, specifications regarding ownership of the intellectual property, and the overall obligations of the franchisee to operate their business to brand standards.

Duration of the Agreement

The term of the relationship (usually at least 10 years), the franchisee’s successor rights to enter into new agreements, the requirement to upgrade the franchisee’s location, and other time-specific items.

Fees

Franchisees generally pay an initial fee to the franchisor for entering into the system. In order to remain within the franchise system, a franchisee will pay ongoing fees, or royalties, that are usually based on gross sales. There are also a host of other fees that can be specified in agreements, like an advertising fee, training fee, technology fee, or equipment fee.

Assigned Territory

Some franchise agreements grant the rights for a franchisee to operate in an exclusive or even a protected territory. In any case, how a territory is established must be defined. This would also include any rights to Internet sales.

Site Development

In most cases, franchisees must find their own sites and develop them according to the franchisor’s guidelines. The franchisor only approves the location found by the franchisee and then verifies that the franchisee has built their location to meet design and other brand standards.

Training and Support

Franchisors generally provide a host of initial and ongoing support, including training, field support, headquarters support, supply chain connections and contracts, quality control, and more.

Use of Intellectual Property

This section would cover the use of trademarks, patents, and manuals. There are usually precise guidelines for what is licensed to the franchisee, how the franchisee can use the parent company’s intellectual property, and the rights of the franchisor to evolve the system through changes to the operating manual.

Much of the rest is standard boilerplate contained in most other business agreements, including default and termination rights, dispute resolution guidelines, governing law, personal guarantees, and general releases.

Developing a franchise agreement is a process that is best undertaken with the guidance of a qualified franchise advisor or attorney. The parent company’s business plan and other essential operating components must first be crafted to reflect the franchising efforts.

Franchise Guardian advisors provide comprehensive assistance to your business as you walk through the process of preparing to franchise, and even after you begin franchising. Contact us todaywith your questions or to schedule a consultation.