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Franchise Agreement: what you need to know

Written by : Allbusiness.com
2007-01-15

Understanding Franchise Agreements

A franchise agreement is the legally binding cornerstone of a franchisor-franchisee business relationship. It spells out, in carefully worded terms, how the new franchise will be run, as well as what the franchisor's role will be. It ensures that the franchise will be operated in a manner that is
identical to the way in which all other franchises are being run, and it also addresses future potential speed bumps down the road, such as how a default will be remedied.
Franchise agreements are almost always tilted in favor of the franchisor, who is traditionally the one calling the shots on how the licensed franchisees will market and sell the company's brand and product.
The key elements of the standard franchise agreement are:

  1. Adherence to the franchise operations manual. The operations manual is essentially the "bible" that all franchisees must consult when unsure about a decision that needs to be made in regards to the business. It is the intellectual property of the franchisor, and legal action can be taken if a franchisee makes its contents public. Franchisees should be aware that they will also be expected to follow any possible additions and amendments made to the operations manual.

  2. Explanation of how the contract will work. This section covers the franchise contract and explains the nature of the relationship the franchisor and franchisee are entering into. This section of the agreement — and your signing off on it — is the equivalent to entering into a marriage. Be absolutely sure you understand in layman's terms what is being set forth in the contract. It's highly recommended that you have your lawyer review the contract, in case any questions or issues arise.

  3. The remarks of the proprietor. Here details will be set forth on the use (and misuse) of the franchise name; what types of training, advising, and support systems will be in place for the franchisee; and which marketing strategies and advertising tools the franchisee will be expected to use.

  4. The approval and costs of all advertising. The franchisor should clearly spell out which materials and mediums will be used in conveying information about the franchise and its products. There should also be a section that covers how much money from gross sales a franchisee can be expected to sink into regional advertising and promotion.

  5. Repair, upkeep, and maintenance. Specifies the types of repairs and cosmetic upgrades the franchisor will expect the franchisee to make after a certain period of time (or when needed). This will cover such topics as interior and exterior paint jobs and the updating of decor, including artwork and furniture. Stipulations are usually in line with the term of the contract; for example, if a franchisee enters into a 10-year contract, he/she will probably be expected to supply a fresh coat of interior paint after five years have passed.
Additional matters that are traditionally covered in a franchise agreement include accounting, royalty fees, insurance, the terms of the agreement (i.e., specified lengths of time in short-term and long-term agreements), termination repercussions, and alterations to the systems of operation in place. Again, be sure you understand everything in your agreement before sealing the deal.

Ten Key Provisions of Franchise Agreements

The Franchise Agreement is the legal document that governs the franchisee/franchisor relationship. There is no standard format for a Franchise Agreement because the terms and conditions and operations vary from franchise to franchise and industry to industry. In general, Franchise Agreements cover
The following main provisions:

  1. Training and/or ongoing support provided by the franchisor. Each franchisor has its own training program for franchisees and their staff, which can include training done at the franchisee's location or at the corporate headquarters or a combination. Most franchisors offer ongoing support including administrative and technical support.

  2. Assigned territory. Your franchise Agreement will designate the territory in which you will operate and whether or not you have exclusivity rights.

  3. Duration of the franchise agreement. This provision states the length of the agreement.

  4. Franchise fee and total anticipated investment. Franchisees are required to pay an initial franchise fee that grants them the right to use the franchisor's trademark and operating system.

  5. Trademark, patent, and signage use. This provision covers how a franchisee can use the franchisor's trademark, patent and signage.

  6. Royalties and other fees you are expected to pay. Most franchisors require franchisees to pay an ongoing royalty, usually 4-8 percent of total sales, typically on a monthly basis.

  7. Advertising. The franchisor will reveal its advertising commitment and what fees franchisees are required to pay towards those costs.

  8. Operating protocol. This section details how franchisees run their outlets.

  9. Renewal rights and franchisee termination/cancellation policies. These provisions deal with how the franchise can be renewed or terminated. Some franchisors have an Arbitration Clause in the Franchise Agreement, which means that if legal action on either side is warranted, an arbitrator will review the case instead of going to court.

  10. Resale rights. Some franchisors allow franchisees to sell their franchises for whatever reason. Many, however, write in buy back or right of first refusal clauses, which allow the franchisor to buy back the franchise at a rate determined by them or to match any potential buyer's offer who has expressed interest in buying your franchise.
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