Franchise agreements – what you should know
Nicola Oldridge, Commercial Lawyer
Franchise agreements can be great for those people looking to walk into an established business structure. However, they also come with their downsides that can cause disputes between the parties in future, if not considered, and understood, completely. For this reason it is important that any person looking to enter into a Franchise Agreement is aware of the potential pitfalls and enters into the new business with their eyes wide open.
What is a Franchise? A franchise model differs from an independent business structure in that it offers tried and tested methods and systems for operating and managing a business, ongoing support and training, and an existing brand for a new business to leverage off.
One of the selling points of a franchise is that franchisees invest in setting up the business in their own areas and are the owners of their own businesses. The franchisees receive their income from effectively marketing their products or services with the benefit of the existing brand name of the franchisor.
A franchisor’s income is generally made from the initial and ongoing fees paid by the franchisee, in consideration for the franchisor providing various ongoing services and support to encourage the future growth and profitability of the franchisee’s business.
What is a Franchise Agreement? The franchise agreement (agreement) is the legal contract which records the arrangement between the person buying the franchise (the franchisee) and the person selling it (the franchisor). This agreement, among other things, sets out the:
- rights and obligations of both parties;
- length of time the arrangement will last;
- territory description (if any) granted to the franchisee; and
- costs involved (usually for the franchisee) and how those costs will be calculated.
It is this agreement that forms the the backbone of the business arrangement and therefore, it is critical that it is read and understood by the franchisee before signing. Often these agreements will consist of anywhere between 50-100 pages, which can be off-putting to many franchisees. However, this is all the more reason for us to review the agreement as we are able to summarise the key aspects and point out any fish hooks that a franchisee should be aware of.
How do you terminate an agreement? Entering into an agreement may appear straightforward; however ending the franchise arrangement can be far more involved.
A standard agreement is a long-term obligation to a third party. Failure by the franchisee to comply with their rights and obligations under the agreement for the full length of the term may (in a number of situations) give the franchisor the right to cancel the agreement.
This is one of the areas of an agreement where an imbalance of power between the parties can be seen, as many agreements provide very minimal rights, if any, for the franchisee to cancel the agreement.
Can a franchisee change an agreement? Given the importance of consistency of branding and customer experience to the franchise business, agreements often require all franchisees within a system to operate the franchise business in the same way.
A franchisee might want to request changes to an agreement, perhaps for financial reasons, or to change how the franchise operates from the existing systems already in place. However, often, it is not easy for a franchisor to agree to the requested changes, particularly if the franchise is part of a large or overseas franchise business.
Due diligence This highlights the importance of a franchisee completing a thorough due diligence investigation of the franchise business, including:
- Researching franchising as an operating vehicle for a business vs other operating vehicles that may be more suitable to you.
- What industry does the franchise operate within?
- What role will you be taking on as part of the franchise, and what role are you interested in?
- Talk to other franchisees within the same industry.
- Visit other franchise businesses and talk to those operators.
- Instruct a lawyer very early on, preferably one who is experienced with franchise agreements.
- Do not sign the sale and purchase agreement until you have seen a lawyer.
- Talk to your accountant. They will be able to help you determine if you will be able to get a return on your investment.
- Find out exactly how much money you need.
- Investigate the franchisor and its other franchise businesses.
- Talk to people who know you well, and know what your capabilities are.
- Talk to your partner, children or parents.
- Talk to self-employed friends and gauge what they’ve learned from their experience.
Given the level of commitment, financial and otherwise, it is important to consider the above issues and talk to your professional advisors before signing on the dotted line.
Having us explain your rights and obligations under the agreement at the outset, will assist your relationship with the franchisor, and allow you to focus on the operation and profitability of the business as intended with, hopefully, no hidden surprises down the track. For further information on issues raised in this article, contact Franklin Law solicitor Nicola Oldridge.
The information contained in this paper is necessarily of a generalised nature and specific advice should be sought in relation to any particular situation.