Thinking about buying a franchise? Understanding a franchise agreement

Owning a franchise can be a fantastic route into business ownership, as rather than having to develop an idea from scratch, franchisees can buy into an existing brand, business model and customer recognition.

However, to enter into a franchise, a franchise agreement must be signed. This is the document that will govern the entire relationship between the franchisor and franchisee.

What is a franchise agreement?

A franchise agreement is the legal agreement between a franchisor and franchisee governing the entire business relationship.

It will set out the rights, responsibilities and restrictions that both parties must follow throughout the duration of the agreement.

A franchise agreement typically runs for five to 10 years. During that period, its terms may be difficult to change unless both parties agree or the agreement provides a specific mechanism for variation.

A franchise agreement is a significant legal commitment and the terms can have a lasting impact on the success, profitability and future of your business.

Taking the time to review the agreement carefully and seeking professional legal advice can help you identify potential risks and ensure you understand what you are committing to.

Key terms of a franchise agreement that every franchisee should understand

Every franchise agreement will look different. However, there are several key terms that every franchisee should understand before signing an agreement.

These include:

Franchise fees and ongoing costs: Franchisees will typically be required to pay an initial franchise fee to join the network. In addition, the agreement may require ongoing royalty payments, marketing contributions and other charges.
Franchise territory: Some franchise agreements grant the franchisee exclusive rights to operate within a particular geographical area, while others allow the franchisor or other franchisees to operate in the same territory.
Operational requirements: Franchisees are generally expected to follow the franchisor’s established business model and brand standards. This may include requirements relating to products and services, pricing, suppliers, premises, marketing and staff training.
Performance obligations: Some agreements require franchisees to meet minimum sales targets, achieve specified performance standards or comply with other operational requirements. Failing to meet these obligations could result in remedial action or, in more serious cases, termination of the agreement.
Renewal rights: The agreement should explain whether renewal is available, the conditions that apply and whether additional fees or updated terms may be required.
Intellectual property: The agreement will usually govern how the franchisee may use the franchisor’s trade-marks, branding, systems and confidential information.
Insurance: Franchisees may be required to maintain specified types and levels of insurance throughout the term of the agreement.
Restrictive covenants: Restrictions may apply both during the term of the agreement and after the agreement has come to an end, including but not limited to limits on competing with the franchise network, soliciting customers or recruiting staff.
Personal guarantees: Where the franchisee operates through a company, its directors or owners may be asked to guarantee the company’s obligations personally, potentially exposing their personal assets if the business defaults.

Understanding these key terms of a franchise agreement can help prospective franchisees assess their rights, obligations and risks before committing to a franchise agreement.

Understanding exit strategies

While it is natural to focus on getting your franchise up and running, it is equally important to consider how you might exit the business in the future.

Your franchise agreement will outline the circumstances in which the relationship can end, including the expiry of the agreement, termination or the sale of your business.

If you decide to sell, you may need the franchisor’s consent and your buyer may need to meet certain requirements. There may also be transfer fees or other conditions to consider.

It is equally important to understand the consequences of termination. If the agreement ends, you may need to stop using the franchisor’s branding and comply with restrictions on operating a competing business. The agreement should clearly set out these obligations.

Understanding your exit options before signing can help you plan ahead, protect your investment and avoid unexpected complications further down the line. Seeking legal advice can help clarify your rights and obligations.