Franchise Information—Understanding Franchise Agreements

What is the Franchise Agreement?

The franchise agreement outlines the way your business will work within your franchise system. It gives both you, the franchisee, and your franchisor a clear understanding of the terms of your business relationship.

The franchise agreement also serves to ensure uniformity, which is beneficial not only to the franchisor but to the franchisee as well. If, for example, a customer has an unsatisfactory experience at another unit within your franchise, he will be unlikely to want to do business with your unit. Therefore, the franchisee is under obligation to maintain uniformity, and the franchise agreement will establish parameters for that uniformity.

These parameters include what products you’ll use or sell at your franchise and the quality of services that must be provided by your employees.

The franchise agreement also details what actions will be taken should you breach these parameters. It explains, for example, what notices the company must give you and how much time you have to respond once notice is given.

What Should be Included in a Franchise Agreement?

First and foremost the franchise agreement should state that you are part of the franchise and that you have a fixed fee (your franchise fee) to pay in compensation for this privilege.

The franchisor has the right to approve or disapprove of sites for your location, but at the same time they will be obligated to assist you in the selection of a site for your business.

There will be a section in the agreement that goes over the use of the franchise name. Specifically, you may not challenge the franchisor’s right to use the name and will be required to inform the franchisor if you discover someone else using the name without permission.

The franchise agreement also indicates how you will be expected to maintain the aforementioned uniformity.

Other Provisions You May See

The agreement will state the manner in which you must display signage at your locations. There may be certain requirements and/or restrictions on the use of a sign with the franchise name.

Often a section is included detailing what training and assistance will be provided by the franchisor. This section would go over the franchisor’s responsibility to help a new franchisee get his unit going.

A franchise agreement may contain a section on advertising. Some companies use a national advertising fund to which you will have to contribute but will also benefit from during a national ad campaign. Additionally, many franchisors want to retain the right to review any and all advertising/promotional materials you may use to ensure—you guessed it—uniformity.

A section about the operating manual will require that you abide by it and adopt any revisions made to it by the franchisor. You will be under a confidentiality agreement concerning the operating manual—which remains the property of the franchisor—because the manual will divulge everything about the franchise’s business plan.

It’s in the best interest of the franchisor that his franchisees operate out of clean, well-maintained buildings, so there may be a section of the franchise agreement pertaining to maintenance and repairs.

The franchise agreement will have requirements concerning records and accounting. You will be required to keep certain records and to provide your franchisor with annual statements which have been audited by a certified public accountant (CPA).

Standards and quality sections—which can be very lengthy in some cases—will, again, provide for uniformity across the franchise system.

If the business opportunity you’re availing yourself of requires a lot of labor or products that are produced at your location (this includes food), a franchisor will insist on quality assurance provisions. This, too, will be a lengthy section of the franchise agreement.

A section on modifications will basically state that the franchisor has the right to make system changes at anytime and require you to adopt them, but you, the franchisee, may not make any changes without approval.

The franchise agreement will specify what royalties the franchisee must pay for continuing to use the franchise’s name and business plan.

The franchisor will have some amount of insurance it requires franchisees to carry, and this will be outlined in the franchise agreement.

Of course, there will be a section of the franchise agreement that states how long your franchise will last. In many cases, this term coincides with a lease, so if, for example, you have a ten-year lease on your building, you will have a ten-year franchise agreement. The agreements may or may not be renewed at the end of the agreement period at either party’s discretion.

Something called a “covenant” section will state that you cannot use the knowledge and training provided to you by the franchisor to open an identical business that simply has a different name.

A section of your franchise agreement will detail what will happen at the end of the agreement including what rights each party has at that time. This section will also deal with actions that will cause you to be in default of your franchise agreement and, therefore, subject to termination by the franchisor.

The franchise agreement will state that you are required to obtain all permits, licenses, etc. necessary to conduct business in your area and that you must be in compliance with all local, state and federal laws. This section will also state that debts you incur in the course of doing business are your responsibility and not the responsibility of the franchisor.

A “nonwaiver provision” will explain that all provisions of the franchise agreement are enforceable at any time. Although a franchisor might not enforce a certain provision at a given time, they still reserve the right to enforce that provision at a later time. The same rule will apply to fees owed by the franchisee. If the franchisor does not accept payment from you for any reason, they will still have the right to collect on that debt at a later time.

Sometimes an arbitration clause will be included, although these clauses are disallowed in some states. If your franchise agreement does have an arbitration clause, it may require you to submit to binding arbitration in the event of a dispute.

Finally, the franchise agreement will designate you and your successors as the franchisee for that agreement and state that you are aware of the assumption of risk. The success of your business will not be guaranteed by the franchisor.