Franchise Agreement: How They Work, Key Parts

Do you have a successful B2C company that serves cross-markets well?

Then franchising may be the next logical step towards growth. However, the level of trust you place in a franchisee is high, which means you need a rock-solid legal contract to match.

Meet the franchise agreement.

A franchise agreement will protect your company’s legal rights. Poorly written contracts don’t serve their intended purposes. A well-written franchise agreement serves the purpose of protecting a franchisor 's brand. It also clarifies the rights and obligations of each of the parties - the franchisor and the franchisee - and ensures consistently and quality across each of the franchisor's various locations.

Instead of leaving your franchising agreement exposed to liability, read the article below that covers everything you should know.

What is a Franchise Agreement?

Franchise agreements are legal documents between a franchisor and a franchisee. They generally include franchise disclosure documents (FDDs) governed by the Federal Trade Commissions’ FTC Franchise Rule.

What is the FTC Franchise Rule?

As codified in 16 CFR Parts 436 and 437, the FTC Franchise Rule is a federal law compelling franchisors to disclose certain information about the franchise and its business to prospective franchisees, so that franchisees are informed prior to investing. More information can be found online at: https://www.ftc.gov/legal-library/browse/rules/franchise-rule.

A franchise agreement incorporates the rights and obligations of the franchisor and franchisee to license and sell a company’s intellectual property and licensing rights.

Examples of businesses that use franchise agreements include:

• Convenience stores
• Fast food and chain restaurants
• Financial advisors
• Health care providers
• Health clubs
• Real estate companies
• Retailers
• Travel agencies

If you plan to license your business for use as a franchise, you must have a franchise agreement to operate legally and successfully. Otherwise, your franchise agreements can result in pitfalls that come back to haunt you later. Ensure that you have a suitable franchise agreement for your situation and that you understand how they work.

How Franchise Agreements Work

A franchisee basically purchases the right to operate a company under the franchisor’s established system, playbook and brand. Franchises have a proven business model, and investors want to capitalize on their returns, especially those with previous experience. The franchisor and franchisee must collectively agree on expectations and guidelines.

Here’s how a typical negotiation of a franchise agreement works:

• Step 1. Meet with the potential franchisor
• Step 2. Establish the proposed territory rights for the franchisee’s location
• Step 3. Set the minimum standards for performance and associated penalties for missed goals
• Step 4. Determine how much you are willing to accept in exchange for your product’s or service’s use
• Step 5. Create the advertising standards and intellectual property rights by which the transaction is governed
• Step 6. Speak with franchising lawyers to help you translate your notes and conversations into a cohesive document
• Step 7. Revisit with the franchisor to review the terms and conditions
• Step 8. Schedule a franchise agreement signing for both parties
• Step 9. Make copies for the franchisor and franchisee and distribute them
• Step 10. Store your franchise agreement in a safe place and preferably with your other documents

Getting a franchise agreement together is a fairly straightforward process. However, there are legal and financial issues that you must consider carefully. The idea behind a franchise is to help you make a tremendous amount of money and gain brand recognition. Ensure that your documents reflect the level at which you operate.

Types of Franchise Agreements

At their core, a franchise agreement establishes how the franchisor and franchisee will operate together. It also outlines what duties and responsibilities must be upheld by both sides. However, specific franchise agreement types may work better for one situation over another.

There are seven types of franchise agreements, including:

1. Master franchise agreements. A contract granting the master franchisee the right to recruit, manage and support sub-franchisees within a particular geographic territory.
2. Product distribution franchise agreements. In this type of agreement, the franchisor confers the right to sell its products under its brand name without necessarily using its business processes or systems.
3. Job franchise agreements. An agreement granting the franchisee the rights to a specific service, rather than a full store or business location, offering specialized services under that franchisor's trade name.
4. Conversion franchise agreements. In this contract, the business owner converts their existing, standalone business, into a franchised location of a larger franchisor's brand. This allows the owner of the business to utilize the franchisor's brand while continuing to operate in a familiar market or location with existing customers.
5. Investment franchise agreements. In this contract, an individual obtains a financial interest in a franchising business, as opposed to obtaining rights to operate a location or distribute a product or service.
6. Business format franchise agreements. In this franchising model, the franchisor confers the right to its product, service, trademark, and system of operating the business, which could include site selection, development, operating manuals, training, marketing, and other business processes, to assist the franchisee.
7. Area development agreements. Under an area development agreement, the franchisee receives the right to open a number of franchisees within a specific location for a period of time.

For many situations, a master franchise agreement is sufficient. However, your needs may be different according to your industry, market, and geographic location.

Key Elements of a Franchise Agreement

Franchise agreements primarily contain the same elements regardless of the type you use. There may be critical differences, however, if you need a highly specialized agreement. As such, you should always seek a customized option when drafting your contracts.

The key elements of a franchise agreement generally include:

1. Territory rights. The geographic area where a franchisee is permitted to operate and develop the franchised business.
2. Minimum performance standards. The franchisor's requirements of the franchisee for benchmark sales, revenue, or other metrics.
3. Franchisors services requirements. The franchisor's obligation to provide certain marketing, business development, or other services to support the franchisee.
4. Franchisee payments. The royalty payments a franchisee must make to the franchisor, typically a percentage of net revenue.
5. Trademark use. The license obtain by the franchisee to use the brand and other marks of the franchisor to promote its business.
6. Advertising standards. The baseline advertising requirements for the franchisee when promoting the franchisor's products.
7. Exclusivity clause. The right of the franchisee to sell or distribute the franchisor's products within a given territory.
8. Insurance requirements. The obligation of the franchisee to insure against business losses and other liabilities.

Carefully consider the elements as referenced above. They will set the tone and foundation for the relationship you share with your franchisors. Ensure that your franchise agreements contain the necessary provisions and elements for accuracy and completeness.

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Parties Involved in Franchise Agreement

The parties involved in a franchise agreement are the franchisor and franchisee. While there may be third parties involved, such as franchising lawyers and insurance companies, the center of a franchise agreement applies the primary principles described below.

Franchisor

Franchisors are the entities or individuals who license and sell their franchise rights to a franchisee. They sell the licensing, branding, and intellectual property rights to them. The business that is selling their rights is called the franchise and can exist as a brick-and-mortar business or an online company, or both.

Here is an article that goes further into a Franchisor.

Franchisee

Franchisees are the entities or individuals who purchase franchise rights from a franchisor. They are typically entrepreneurial small business owners that have experience in the industry. If you are a franchisor, you should select franchisees capable of upholding the standards and procedures you created.

Here is an article on what franchisors look for in a franchisee.

Sample Clauses from Franchise Agreement

Grant of Franchise

1.1. Grant. We have the exclusive right to operate and to license others to operate a tax return preparation business using our Operating System. Subject to the terms and conditions of this Agreement, we grant to you, subject to Sections 3.2 and 3.7-3.9 below, a license to use the Marks and our proprietary business methods and software to operate an income tax return preparation business identified by the Jackson Hewitt Marks solely at approved locations in the Territory described on Schedule A. Neither we nor an affiliate will operate or license others to operate in the Territory an income tax return preparation business using the Marks and the Jackson Hewitt Tax Service® proprietary software and business methods, subject to Sections 3.2 and 3.7-3.9 below.

1.2. Number of Locations. You must open at least one office, either a Kiosk or a Standard Office, and such Processing Center(s) as specified in the Manual, in the Territory by the start of the first Tax Season after the Effective Date of this Agreement. By the start of the second Tax Season thereafter, one of your offices must be a Standard Office. For each subsequent Tax Season you must maintain a Standard Office. Once you open a Kiosk, you may not discontinue operating the Kiosk for any Tax Season without our consent, which will not be unreasonably withheld or delayed if the closure criteria in the Manual are met, unless you are unable to rent space in the National Account or Affinity Location where the Kiosk previously operated.

Performance Standards

Initial Performance. You must prepare 500 or more federal income tax returns in the Territory in your second Tax Season. If you do not prepare at least 500 federal income tax returns in your second Tax Season, you must (i) submit to us a business improvement plan by June 1 following your second Tax Season that we approve, which approval will not be unreasonably withheld or delayed, (ii) implement the business improvement plan, and (iii) prepare 600 or more federal income tax returns in the Territory in your third Tax Season. We may require you to open a second Standard Office or Kiosk as part of the business improvement plan. If you do not satisfy all of these conditions, we may, in our discretion, terminate this Agreement for cause by written notice to you given after May 1 following your third Tax Season.

Continuing Performance. You must prepare 1,000 or more federal income tax returns in the Territory in your fifth Tax Season and each Tax Season after that. If you prepare more than 600 federal income tax returns and fewer than 1,000 federal income tax returns in the fifth or any subsequent Tax Season, you must (i) submit to us a business improvement plan by June 1 following such Tax Season that we approve, which approval will not be unreasonably withheld or delayed, (ii) implement the business improvement plan, and (iii) prepare 1,000 or more federal income tax returns in the Territory in your next Tax Season. If you do not satisfy all of these conditions, we may, in our discretion, terminate this Agreement for cause by written notice to you given between May 1 and September 1 following that Tax Season.

Minimum Performance. If you prepare fewer than 600 federal income tax returns in the Territory in any Tax Season beginning with your fifth Tax Season, we may, in our discretion, terminate this Agreement for cause by written notice to you given between May 1 and September 1 following that Tax Season.

For Small Market Territories, all tax return preparation numerical requirements set forth in paragraph 2.3 are reduced by 35%.

Territory

Your Territory. The area within which you may operate the Franchised Business is described on Schedule A to this Agreement. You may not operate the Franchised Business at any location outside the Territory. You expressly acknowledge and agree that we can operate or grant a license to others to operate a franchised business at any location outside the Territory.

Competition. We will not operate the Franchised Business in your Territory except as provided in this paragraph and in paragraphs 3.7-3.9 herein. We may commercialize and distribute or license or sublicense others to commercialize and distribute our proprietary software in the Territory through other channels of distribution using the name “Jackson Hewitt” and the Marks or using other trade names and Marks to identify the software.

Business Outside the Territory. You may not locate your Franchised Business office or Processing Center at any location outside the Territory. You may perform the authorized services in your Territory for customers who reside outside the Territory, but you may not travel outside your Territory to perform tax preparation or other services authorized by this Agreement.

Royalty Fees

Royalties. During the term of this Agreement, you must pay us royalty fees equal to fifteen percent (15%) of your Gross Volume of Business.

Royalty Payment Schedule. The royalty fees are due and payable according to the following schedule or on such other schedule specified in the Manual:

(a) Semi-Monthly Payments. From January 1 through April 15, you must pay royalties on the 5th and the 20th of the month for the Gross Volume of Business generated during the preceding half month. For the period from April 16 through April 30, you must pay royalties on the following May 5th.

(b) Monthly Payments. From May 1 through December 31, your royalty payment is due on the 5th of each month for the Gross Volume of Business generated during the prior month.

Reference:

Security Exchange Commission - Edgar Database, EX-10.8 5 dex108.htm FORM OF FRANCHISE AGREEMENT, Viewed May 14, 2021, < https://www.sec.gov/Archives/edgar/data/1283552/000119312504065633/dex108.htm >.

Image via Pexels by Norma Mortenson

Getting Help With a Franchise Agreement

You do not have to feel overwhelmed by the prospect of drafting your franchise agreements. Getting help with a franchise agreement and understanding small business law is as straightforward as speak with an intellectual property lawyer. It is usually much more affordable hire a legal professional to hire a legal professional than you think.

Here are a few persuasive reasons as to why you will want to get legal help with a franchise agreement:

Reason 1. Affordability

Franchising lawyers generally work on a flat fee or quoted hourly rate. This strategy ensures that franchisors can predict their legal fees rather than pay a hefty retainer. Hiring an attorney is always well worth the investment due to the level of protection that they provide.

Here is ContractsCounsel’s attorney fees data page.

Reason 2. A Worthy Investment

If you are serious about franchising your company, you need to have a legal agreement that reflects these values. Experienced businesspeople can spot an incomplete or inadequate contract a mile away. Maximize your opportunities to attract aligned individuals by making the investment in a professional and polished franchise agreement.

Reason 3. Form Key Relationships

Have you ever noticed that people only call an attorney after a problem arises? At this point, it is already too late to do anything about the issue or dispute. By hiring an attorney to draft your franchise agreements, you establish a relationship with a legal professional that understands your business and upon whom you can call at any time a question arises.

Reason 4. Protecting Your Rights

Your franchise lawyer can also review new and existing contracts as you draft and receive them. Document management and legal reviews can become time-consuming activities for busy company managers. You can delegate these responsibilities to your legal team.

Reason 5. Negotiation Assistance

Negotiation is not an activity that franchisees and franchisors approach regularly. While there is some familiarity with the process required, having an experienced professional on your side can elevate your results. Consider bringing in an intellectual property or franchising lawyer into your negotiation discussions.