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. In a franchise business, the company that owns the franchise (franchisor) guides the individual or business that operates the franchise (franchisee) on how to maintain the brand’s standards. This is especially important for automotive franchises, where consistency is key to ensuring customers are satisfied with their experience. 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?
- 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 the franchisee.
- Duration of the agreement: It is the tenure of the agreement as agreed between the franchisor and the franchisee. The agreement’s tenure can be extended further 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. The franchisor and the franchisee extensively discuss these matters before signing the agreement.
- Site selection & development: It clearly states the franchisee’s responsibility to find an appropriate location for the business establishment. The franchisor should approve the location before the franchisee signs the agreement, capturing all details about the location requirements and the business unit specifications 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 are 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. The franchise agreement strictly prohibits the franchisee from using these intangible assets after their expiry.
- 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. If either party fails to act according to the terms stated in the agreement, the agreement will be terminated. 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 certain qualified franchisees an optional lending assistance program. 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 is between $1.4 million and $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 SEC provides access to the full agreement format.
- 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 –