When you want to open a business with a proven strategy already in place, a franchise is the way to go. But first: you need a franchise agreement—a standard legal document that governs the business relationship between the business that owns all the franchise locations and the franchisee who wants to run one of them.
Franchise agreements explained
The franchise agreement is the legal contract between the main operating business (franchisor) and the franchisee. It gives franchisees the right to operate a location of the business in their area. Franchisees are then responsible for initial fees and ongoing royalty payments to the franchisor. The agreement outlines brand and operating standards for them to adhere to.
It also ensures that franchisees will adhere to the marketing and brand standards of the main business. Like any contract, the franchise agreement outlines a business relationship between two parties. Before signing, you can master the basics.
What information is included in a franchise agreement?
The common standards across franchise agreements are about how the overall business wants their locations to run.
Franchise agreement format and structure
A franchise agreement sets up the formal processes of your business. It includes an outline of the following information:
- Opening date and territory: when you are expected to open the business and the geographical area you’ll be serving (that won’t compete with other locations of the franchise)
- Fees and royalties expected: the initial cost you’ll have to pay to license the business, as well as ongoing royalties to factor into your budget
- Accounting and reporting requirements: the financial records you’ll have to send to the franchise business owners and how often you’ll have to send them
- Advertising and marketing: signage, design, advertising placement, and more information about marketing your business
- Operations and staff training guidelines: how to conduct new hire training and recommendations about staffing your business
- Duration: how long the agreement is in place for and how long your license to operate the franchise lasts
- Grounds for termination and post-termination requirements: the reasons the business relationship could be ended by the franchisor (like missing royalty payments)
- Overall compliance with the law and standards of the business: legal requirements to adhere to and overall quality standards of the business
Fees and royalties
A franchise agreement is more than a money in, money out operation. First and foremost, franchise agreements state that the franchisee has to pay the franchisor an initial franchise fee. That initial fee can be anywhere from around ten thousand dollars to hundreds of thousands or more. The fee allows you as the franchisee to do business, but you’ll also have to have available cash to set up the business location. If you’re franchising a restaurant, this means renting a building, securing equipment, and anything else needed to operate the business.
The franchise agreement also includes royalties that the franchisor charges based on your weekly or monthly revenue. They can range from around 4% to 12% of the revenue, or they may operate on a fixed fee. The franchisor is invested in your success, and the name recognition carries a lot of weight for a newly opened business. In some cases, franchises that invest heavily in marketing also charge an advertising fee.
How does a franchise agreement work?
Moving forward with a franchise agreement, shared responsibility for the business is a huge consideration. The franchise agreement ensures that your new location representing their business does so in alignment with their corporate standards. A franchisee’s responsibility to the franchisor is not only royalty payments, but also smooth business operations and high corporate standards.
What items are delineated in a franchise agreement?
The most important items delineated in a franchise agreement are usually the length of the agreement and the various standards of the business (fees, upkeep, brand).
The length of the agreement can be anywhere from a few years to twenty. It’s like leasing a car. If you operate the business well, you can probably get a longer-term contract when it comes time for renewal.
Termination of a franchise agreement
Sometimes, the franchise doesn’t work out. Any franchise agreement will have an outline for what would constitute a breach of the agreement. These are a few reasons the franchisor might terminate the agreement with the franchisee:
- Failure to pay royalties
- Failure to operate to franchisor business standards
- Loss of a lease or business license
- Criminal convictions
- Bankruptcy of owner
As a franchisee, you can seek to end the relationship with the franchisor. Standard reasons that would allow a franchisee to end the agreement include:
- Franchisor does not offer adequate training
- Franchise business misrepresents profits and earnings
- Franchise business allows a new location to open up that overlaps with your territory
- Bankruptcy of business
The standard in franchise agreements is to provide written notice to the franchise of your intention to end the agreement. Ending the agreement early is possible, but complicated. A franchise lawyer could help you with the process of finding a buyer for your franchise location and agreement.
Model franchise agreement: what to know before using one
There are a ton of model franchise agreements available online. The models usually include everything we’ve listed above, but also include more detail about running the business and maintenance expectations for the franchisee.
More specific information you’ll find in a model franchise agreement:
- Recommended suppliers and stocking requirements
- Trademark usage requirements
- Supplementary staff training for any staff looking to go into the corporate side of the franchise
Before signing a franchise agreement, make sure you’re familiar with all expectations on you as the franchisee. Also, if the franchise agreement is missing anything crucial like the royalty payment expectation or termination clauses, return it to the franchisor with questions.
Franchise agreement vs. franchise disclosure document
A franchise agreement is the contract between the franchisor and franchisee. It’s a legal document that outlines the operating procedures between you as the one responsible for operating a franchise location and the overall business, with the terms and standards outlined above.
A franchise disclosure document is a document with information about the franchise to help you make your decision. It is a legal document franchisors must provide to franchisees seeking a franchise agreement, with important information about the franchise.
What you’ll find in a franchise disclosure document:
- The background of the franchisor
- Background of other businesses in the franchise
- A history of litigation
- Bankruptcy claims from the past
- Initial and ongoing costs
- Supplier, territory, and customer restrictions
According to the Franchise Rule enforced by the FTC in the United States, a franchisee must receive a franchise disclosure document (FDD) from the franchisor at least 14 days before signing. This gives the franchisee the opportunity to review this carefully and understand what kind of business they’ll be able to do.
Do you need a franchise agreement lawyer?
When in doubt, consult the experts. A franchise agreement attorney can help you understand the context in terms of what you’re responsible for as the franchisee and what the franchisor expects of you.
The franchise agreement lawyer can also help you get all your documentation in place. They’ll assist you in evaluating the startup costs and understand what profits you’ll want to target for your budget (including paying royalties, employees, and keeping the business running).
Another early relationship you can consider is an accountant familiar with franchise agreements. The attorney and accountant will help you keep on top of the financial risk and benefits of your franchise operation.
Starting your franchise
Once you’ve reviewed everything and have all your documentation in place for your business and with the franchisor, you’re ready to get started.
If you have an entrepreneurial spirit and want to get a business off the ground quickly, the investment in a franchise could be the right move.
This content is provided for informational purposes only and does not constitute legal, tax, financial, or professional advice. Laws and regulations vary by state and individual circumstances and may change over time. Readers should consult a qualified attorney, tax professional, or other licensed professional regarding their specific situation. Nothing herein creates an attorney-client relationship.
