What is a Franchise Agreement?
The term “franchise agreement” refers to the legally binding document establishing the terms and conditions between a franchisor and a franchisee. The franchise agreement governs everything right, from the floor design of the franchisee’s establishment to how the franchisee should run the business. In other words, the franchise agreement is a license that outlines the rights and obligations of the franchisee and the franchisor. One of the primary objectives of the franchise agreement is to safeguard the intellectual property of the franchisor and ensure a consistent approach among all the franchisees operating under the brand.
How Does it Work?
The franchise agreement offers the franchisor the right to exercise control and obligation to assist the franchisee in setting up the business by leveraging its established brand. Typically, the franchisor guides the franchisee in maintaining the brand standards. On the other hand, the franchisee pays the franchisor fees for the franchise rights, basically operating the business using the franchisor’s trademarks. The fees primarily include royalty fees along with other related charges.
What is Included in Franchise Agreement?
Some of the essential elements that are included in a franchise agreement are mentioned below:
- Details about the franchisor and franchisee: The first information captured in a franchise agreement is the details of the franchisor and franchisee. It also outlines details about the relationship between the franchisor and franchisee.
- Duration of the agreement: It is the tenure of the agreement as agreed between the franchisor and the franchisee. The tenure of the agreement can be further extended if both parties are willing to continue the relationship.
- Franchisee fee: This section captures payment-related matters, such as initial deposit, franchise fee, royalty, etc. It also captures the modes of payment and the corresponding due dates. These matters are discussed at length between the franchisor and the franchisee well before the agreement’s signing.
- Site selection & development: It clearly states the franchisee’s responsibility to find an appropriate location for the business establishment. The franchisee should get the location approved by the franchisor before signing the agreement. All details about the location requirements and the business unit specifications are captured in this section.
- Business operations: This section captures all details about the support the franchisor should extend to the franchisee and the franchisee’s responsibilities towards the business operations. Some of the major points covered in this section are:
- The franchisee should run the business operations as per the operating standards decided by the franchisor
- The franchisee is allowed to offer particular goods/services only
- The franchisee must purchase the goods/services exclusively from the franchisor
- Branding &Promotion: This section captures the franchise’s responsibility to spend on branding and advertising to promote the franchisee unit. It also clearly documents the franchisee’s responsibility toward the brand-building activities.
- Intellectual property & trademark: This section describes how the franchisee can use the franchisor’s intellectual property, such as trademarks, patents, etc. It also states that the franchisee is strictly prohibited from using these intangible assets after the expiry of the franchise agreement.
- Training & Support: This section details the franchisor’s responsibility to extend required training and support and supervise the franchisee’s business operation.
- Termination clause: This section captures all details about the termination clause of the franchise agreement. It states that the agreement will be terminated if either party fails to act by the terms mentioned in the agreement. It also mentions the penalties applicable to the termination of the agreement.
Example Franchise Agreement
Let us take the example of the franchise agreement of KFC US LLC [Source: Franchise Direct]and look at some of the major highlights of the document.
- Franchise Details: The franchisor is KFC US LLC, a YUM subsidiary! Brands Inc. The franchisee is offered the right to operate a dine-in and carry-out KFC outlet.
- Training: The franchisee must attend all initial training programs the franchisor sets. The completion of the training programs will depend on the franchisor’s satisfaction.
- Territory: The franchisee is not offered any exclusive territory. However, the franchisee has a protected territory that is smaller:
- A radius of 1.50 miles around the franchisee unit
- An area around the franchisee unit with 30,000 residents or working people
- Obligations & Restrictions: It mandates that either the franchisee or an appropriately qualified manager must dedicate their round-the-clock involvement in the management and operation of the franchisee unit.
- Term of Agreement & renewal: The initial tenure of the franchise is 20 years, which can get renewed if both parties meet the requirements of the franchise agreement.
- Lending assistance: The parent company (YUM! Brands) offers an optional lending assistance program to certain qualified franchisees. The company guarantees 25% of the principal of the franchised business loan up to a limit of $3 million per franchise.
- Initial investment: As per the available estimates, the initial investment in setting up a franchised outlet lies between $1.4 million to $2.8 million.
- Royalty fees: Every month, the franchisee needs to pay the franchisor a greater of
- 4% to 5% of the gross revenue
- A sum of $1,260
Franchise Agreement Sample Format
The following is the snapshot of the franchise agreement format used by Baskin-Robbins Franchising LLC. The full agreement format can be accessed at the SEC.
- It is a legally binding document that outlines the terms and conditions between a franchisor and a franchisee.
- A franchise agreement safeguards the franchisor’s intellectual property and ensures consistency of approach among the franchisees.
- Both parties should review the franchise agreement with proper legal support before signing it.
This is a guide to Franchise agreements. Here we also discuss the introduction and how a franchise agreement works with an example. You may also have a look at the following articles to learn more –