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What Components Should Always Be In A Franchise Agreement?
The Franchise Agreement is a segment of the Franchise Disclosure Document. The Franchise Agreement is a 30-40 page document showing that you have formally entered a franchise arrangement with another party known as the franchisor. There are many important features to review in the Franchise Agreement. One of these important areas is a well defined territory for your franchise, meaning they’ve outlined a particular area in which you will work and no other franchisee, or the franchisor, can compete with you in.
Another important area in the franchise agreement is the rules of the franchise. For example, the seller will provide you with what rules you must follow on marketing and where you can track your customers. The franchise systems’ rules on marketing are especially pertinent when you have a territory of another franchisee abutting yours. There can be marketing rules regarding how much money you are to contribute to a marketing fund, whether nationally, regionally, or locally.
Another critical aspect of a franchise agreement is that it should outline any royalties you have to pay. This section will dictate how royalties will function, how much royalties you’d have to pay, and the royalty’s basis. For example, royalties can be based on gross revenues, profits, or a percentage. But, at times, the royalty can be a fixed amount, and sometimes it’s a hybrid amount of fixed plus a percentage.
Attorney Senen Garcia often sees a time limit in some franchise agreements when he represents franchisees. A traditional franchise agreement has no time limit, but with specific yearly metrics to maintain yourself as a franchisee.
The next important section of a franchise agreement is what would happen if you should fail with your franchise. There are ramifications for failing, and they are supposed to be in the franchise agreement. These consequences could be a probation period to provide the franchisee with an opportunity to still reach those goals. If you don’t achieve those goals, you are likely automatically out as a franchisee.
Another section of the franchise agreement describes the specific terms and expectations. This section will include information such as:
- Who are the parties that are involved?
- What’s being offered?
- What are the franchise’s expectations of the franchisee regarding training?
- How much training must the franchisee go through in a year?
- If the franchisee hires people, what training will they need? Those with and without experience?
Senen explains that one of the most critical parts of the franchise agreement is a non-compete clause. These non-compete agreements should be concrete. The non-compete clause can be somewhat onerous depending on how it is written. The non-compete must be crafted very carefully to protect the franchisor but simultaneously, not wholly and ultimately restrict the franchisee.
Senen also sees unenforceable non-compete agreements within franchise agreements. Unenforceable non-compete agreements are something to be aware of because it happens. Having a brilliant Business Law Attorney on your side can help you determine proper or inaccurate franchise agreements, saving you from making the wrong decision.
What Should You Look For When Reviewing A Franchise Agreement Or Contract?
As an attorney, Senen Garcia reviews the entire franchise agreement or contract for his clients. He looks for elements in these agreements. The following represents some of the actions he performs when reviewing franchise agreements.
Senen normally reviews territory and its definition in the franchise agreement. Senen wants to know if any franchises or franchisees are abutting your territory. He also wants to see whether you can go into the area outside your territory to promote your franchise or if you’re entirely limited to your own territory. Knowing your territory is important because you don’t want to be in breach of contract without knowing.
He also wants to see if there are any limits, such as the franchise agreement will automatically cease after ten years. This is an issue for franchisee consider they will have built the business within that territory and may take years before the franchise is successful in that particular territory. Because of this, Senen would have serious issues with the franchise agreement expiring after ten years.
Next, Senen reviews the non-compete section to ensure it’s not too onerous. The non-compete could be a potential deal breaker if they prevent the franchisee from conducting any business for an extended period of time or an unreasonable large geographic area.
Then, Senen looks at the franchise fee. He wants to know if the cost is commensurate with the franchise system. Younger franchises are or should have cheaper franchise fees than a more established franchise system. For a franchise system that is only a year old, Senen doesn’t expect his clients to spend more than $10,000.
Some franchise systems have been around for 30-40 years and, in some cases, more than that. For example, at McDonald’s, you’re going to spend six, sometimes even seven figures, on a franchise fee. That’s just the way McDonald’s works, simply because it can. McDonald’s is an established franchise system, and you know that you will make money if you invest.
Next, Senen looks at the royalty arrangements. He also looks for any remedies if those royalties aren’t met. He then reviews the marketing budget and how it functions. For example, suppose you know you’re going to give 2% of your net revenues yearly, along with your royalties, to the franchise system to market your business in the local area. Senen questions whether all the money you’re to pay is genuinely for local marketing or does it contribute to a national fund that will market across the country. Suppose you’re in a highly populated area. You’d want to have a more unbalanced approach to marketing because you have to reach more people than the average franchisee.
Marketing requirements Senen pays attention to in a franchise agreement can answer the following:
- Is there a possibility of having to give to a national marketing system?
- Can the franchise create a fund for a local marketing system?
- Are there situations where marketing contributions are going to be determined?
Some franchise models have marketing rules that allow the franchise system to create sub-franchise systems for marketing purposes. For example, the franchise system could allow a group of franchisees in a particular area to pool their resources to develop their marketing.
But some franchise systems don’t allow separate marketing at all. They’ll say, “You cannot market on your own. You cannot do marketing unless it’s through the company; only the company can market independently.” So, you need to know the flexibility in marketing and what they allow within and outside your territory.
Next, Senen looks at the requirements and determines the following:
- What are the franchise requirements relating to how you function?
- Is the functioning of the territory going to be financially burdensome on top of the franchise fee?
Even if you’re paying a small franchise setup fee, that will be onerous. Some franchise systems are very particular and very expensive. The good thing is that if it’s a well-established franchise, you know it’s a system that works. Chances are, the franchise fee is a reasonable price considering your return on investment.
Senen also goes back to the Franchise Disclosure Document. He wants to know the following:
- How much revenue is this company generating?
- Are they doing well?
- If they’re not performing well, why?
Senen tells his clients that if the company is a young franchise system, they should have some level of success. If they have no success, he advises either not to get involved or for the buyer to use some leverage considering the franchise is new to extract concessions to make it more worthwhile for them as investors.
With the guidance of a skilled attorney for Franchising, there is a lot involved. Knowing that we’ll make your merger or acquisition look easy and benefit you can have peace of mind. For more information on the Essential Components Of A Franchise Agreement, an initial consultation is your next step. Get the information and legal answers you seek by calling (305) 606-6139 | (305) 285-3042 today.