When entering into a franchise agreement, a franchisee essentially obtains the rights to operate a business under the franchisor’s brand and system. This complex contractual relationship involves various provisions that can significantly impact the franchisee’s operations, financial obligations and legal rights.
It’s crucial for potential franchisees to carefully review and understand several key points in a franchise contract before committing to it.
Franchise fee and ongoing royalties
The franchise agreement will specify the initial franchise fee, which is a one-time payment for the rights to use the franchisor’s trademarks, service marks and business system. Additionally, the contract should outline ongoing royalties or fees that the franchisee must pay, typically based on a percentage of the franchisee’s sales.
Territory rights
Territory rights refer to the geographic area within which the franchisee is allowed to operate and whether the franchisor guarantees exclusivity in that area. Exclusivity means the franchisor won’t open or authorize another franchise within the specified territory.
Term of the franchise and renewal conditions
The franchise agreement will state the duration of the franchise relationship, after which the franchisee may have the option to renew. It’s important to understand the term’s length, any conditions that must be met for renewal and whether any fees are associated with the renewal process.
Obligations and restrictions
Franchise agreements typically include detailed sections on the franchisee’s operational obligations and restrictions. These may cover a wide range of topics, including required operating hours, approved products or services, mandatory training programs and adherence to the franchisor’s operational guidelines. Restrictions might also address the franchisee’s ability to sell or transfer the franchise.
Exit strategies
Exit strategies or termination provisions outline the conditions under which the franchise agreement can be terminated before the end of its term. This includes both voluntary exit by the franchisee and termination by the franchisor for breach of contract.
Having a legal representative review a franchise contract can help potential franchisees to ensure they fully understand their responsibilities and rights. This should be done before a franchise agreement is signed because it becomes legally binding once it has been fully executed.