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Here’s Everything You Need to Know About a Franchise Contract

By: Bill Bradley

 

a woman reviewing a franchise contract

In today’s world, there are plenty of ways you can make a living, and one that has been tried and tested is franchise ownership. It’s estimated that there are more than 750,000 franchise organizations in the US. Before you can take ownership of a franchise, however, you need to sign a franchise contract. It will detail the terms of business operation and any rules that you need to adhere to.

A franchise contract can be quite complicated, but in this guide, we’re going to cover everything you need to know about them. Keep reading for more.

What Is a Franchise Contract?

A franchise contract is a legally binding agreement that gives a franchisee the right to operate a business owned by the franchiser. In return, the franchisee makes a one-time payment or periodical payments based on terms set out in the franchise agreement.

A franchise will outline the rights and obligations of both parties. The contract helps to protect the franchisor’s IP (intellectual property) and ensures that the franchise operates in a way that aligns with the franchisor’s trademark.

Most franchise contracts include franchise disclosure documents (FDDs) that are set by the Federal Trade Commission (FTC) Franchise Rule. There are plenty of businesses that use franchise agreements, such as retailers, restaurants, convenience stores, health clubs, and more.

What’s in a Franchise Contract?

Franchise contracts can vary quite a bit based on the business involved. There are some elements, however, that are consistent, so you can expect to see these in any franchise contract you deal with.

Franchise Territory and Boundaries

A company should spread its franchises out strategically. Having two very close to each other may not be beneficial.

As such, each franchise location is chosen specifically to cover a certain area. The franchiser will decide this to ensure there isn’t too much competition between the two, as this will yield better results.

Training and Support From the Franchisor

To ensure all franchises operate as they should, a franchiser will provide training to any new franchisees. This will include uniform business practices to ensure all franchisees meet the standards a company wants to adhere to.

The franchisor will also offer ongoing support. This tends to come in the form of things like continuous training, advertising subsidies, and discounts on supplies and equipment.

Length of the Agreement

The length of franchise agreements can vary, but they’re typically 10 or 20 years. There will also be details in this section about conditions that need to be in place to sell the franchise to someone else.

These are often quite stringent to ensure the franchise can only be sold to someone who’s qualified. In some cases, the contract will have a right of first refusal clause. This can allow the franchisor to buy the franchise first instead of it being sold to a new owner.

Franchise Costs and Fees

Franchising ownership involves an initial purchase fee as well as various other costs. This often includes things like monthly royalties and advertising buy-ins.

Most franchise contracts also state that a franchise must have a set amount of money available before they can purchase a unit. This makes it clear to franchisors that the franchisee can cover other costs, such as equipment maintenance and payroll.

Trademarks, Patents, and Signs

Any corporate entity will have trademarks, patents, and signage in place. The contract will outline how these can and can’t be used by the franchisee.

Rules for Operating

Every franchise will have specific rules that they need to follow, which the franchisor will decide. Some of these will be the same throughout the company, but some may be put in place for specific franchises. These rules often refer to things such as items/services sold, pay scale for employees, and hours of operation.

Franchise Renewal Rights and Termination Policies

There will be specific details on how a franchise can be renewed, as well as the conditions under which it can be terminated. These situations can often cause conflict between a franchisor and a franchisee.

Negotiating the Terms of a Franchise Contract

Some franchise contracts are negotiable, and others aren’t. This all depends on the franchisor in question.

Due to how complex franchise contracts are, it’s best to have an experienced lawyer take a look at any contract before you sign it. They’ll be able to determine if any parts that are (or aren’t) advantageous to you.

Bear in mind the main purpose of the contract from the franchisor’s perspective is to protect the value and integrity of their franchise. If a franchise fails, all of the franchisees will be left with nothing. As such, most franchisors won’t negotiate their contracts at all, so you shouldn’t go in expecting them to.

You can always ask a franchisor questions about clauses that you might have any issues with. It’s worth asking if you can make changes, but it’s unlikely the franchisor will agree. You may determine that you might not get a good return on your investment from a franchise contract, in which case it may be best to move on and look for a different option.

Why Negotiable Contracts May Not Be a Good Thing

On the surface, it may seem like a negotiable contract is a good thing. This might not be the case, however, as most franchisors refuse negotiations for good reasons.

A business only becomes a franchise if it’s able to succeed and grow. When looking at franchise contracts, you’ll be dealing with companies that have years of experience and know what they’re doing.

Over time, the biggest franchises have been able to develop successful business models and determine the most effective ways to operate. Negotiations could alter what they’ve established, and it may not be for the better. They often already know what works best for their company, so they will want to keep things as they are.

If they accept negotiations, it could also cause issues with their other franchises. They might then want to start negotiating their contracts too, which wouldn’t be ideal for the franchisor.

Many people consider it a sign of strength when a franchisor refuses to negotiate their contracts. It’s a clear sign that they’re confident that their current strategies will continue to work. Because of this, you could actually consider it a red flag if a franchisor is happy to negotiate any major parts of a contract.

Small Negotiations

It’s very rare that you’ll be able to negotiate any major changes, and if you can, it may not be a good franchisor to go with. Some will offer some smaller negotiations, however, that could be favorable to you.

Help With the Grand Opening

Some companies will offer extra support when a new franchise is opening. The franchisor’s personnel may attend in person to offer training and guidance. They might even provide additional funds for marketing to help the franchise get off to a good start.

Instalment Terms for Your Franchise Fee

The way you finance your franchise will be decided by the franchisor. Some want this to be in a single lump sum, while others will accept regular installments.

In-house financing may also be an option. It’s worth asking for the method you prefer, but they might not be willing to budge on this.

Extension of the Time to Cure Franchise Operations Defaults

Defaults are never ideal, and they could result in you losing your franchise. Your contract will have terms relating to correcting defaults, and you may be able to get extensions, giving you more time to deal with things. Note that even if they do offer extensions, you should still work to correct any defaults as soon as possible.

Waiving the Personal Guarantee

Many people decide to form corporations to own and operate franchises. Even if you do this, many franchisors will still require you to sign a personal guarantee.

In some cases, a franchisor might be willing to limit your liability or even waive this guarantee. This will typically only happen if you can show them that you can cover the loss if your franchise fails.

Rights of First Refusal

The right of refusal will allow a franchisor to buy the franchise back from you if you decide to sell it before your contract expires. You may be able to negotiate a modification to this so that you can sell it to someone else first.

Red Flags in Franchise Contracts

Franchise ownership can be very appealing, but it’s a big decision. You shouldn’t rush into it, and there are certain things that you can look out for which may indicate that a certain contract is a bad choice.

Being Rushed Into Signing

Signing a franchise contract isn’t something that should ever be done quickly. There should always be an initial research stage, and this typically takes between four and eight weeks. You should talk to the franchisor and the other franchises they have and take a look at the organization’s history.

When you’re happy with everything, you can sign the contract and start your fee payments. If the franchisor or sales rep tries to push you to sign before you’re ready, it may be because there’s a problem with the contract. Never sign before you’re sure that you’re ready, and if they push too much, you might want to find a new contractor.

Discounting Prices

Quality franchises may refuse to negotiate, and this applies to their prices too. If a franchisor offers some kind of discount, you can consider this a sign of a lack of quality.

It may feel like you’re getting a bargain, but the real reason is more likely a lack of interest. If they’re struggling to find new franchisees, it’s probably for a good reason.

Withholding Documents

You will have a Franchise Disclosure Document, which should contain specific details such as information relating to any financials and lawsuits that have been filed against the franchise. It should also have the contact details of the executive team.

If anything is missing, this might be because the franchisor is deliberately holding it back. A franchisor may do this so that you can’t review it properly before signing. Any franchise that does this is one that you probably don’t want to work with.

Lists of Franchises to Call

A franchise list isn’t necessarily a bad thing, but be cautious if there are any specific franchises they’re actively discouraging you from talking to. They’re only likely to do this if they have something to hide, which is a major red flag. You should be able to talk openly with anyone in the organization, so be wary if there’s anyone they don’t want you talking to.

Discouraging Attorney Involvement

A franchisor might advise you not to get an attorney to look at your contract, calling it a waste of time and money. This is another major red flag and is a sign that an attorney is even more essential. The franchisor likely knows there’s something in the contract that an attorney won’t like, so in this case, you may want to immediately start looking for a new franchisor.

Finding the Right Franchise Contract

There are plenty of franchises out there, so when you’re searching, it’s important to find one that’s right for you. Make sure you research the organizations you’re considering and take the time to ensure any franchise contracts you look at have no issues and will work well for you.

America’s Best Franchises specializes in helping people find franchises that suit them. You can look at different categories to find the types of franchises you’re after. Take a look at some of the best franchises you can work with in 2023.

Published: September 19, 2023
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Source: America's Best Franchises

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Bill Bradley

Bill Bradley

Bill Bradley is founding member and CEO of America’s Best Franchises, LLC.  Bill founded three financial services firms, Ocean Shores Ventures, Denali International and William Bradley Enterprises. In addition, to launching America’s Best Franchises in 2005, Bill orchestrated approximately 20 private equity transactions in excess of $31 million, and launched five specific purpose private equity partnerships.

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