Franchise Agreement: What You Need To Know

This article sheds light on the standard franchise agreement obligations and rights the franchisor and franchisee owe each other. Consult for free today.

Understanding Franchise AgreementĀ 

The Next Step After FDD

A franchise is a type of business where the original business owner or franchisor licenses its operations to franchisees for a fee. Thus, it allows a franchisee access to a franchisor’s proprietary business knowledge, processes, and trademarks. The franchisee can then sell products or services using the franchisor’s business name and business model. Generally, the franchisee pays the franchisor an initial start-up fee, annual licensing, royalty, and other agreed-upon payments.

Franchising can be an enticing opportunity for entrepreneurs looking to benefit from the existing success of a franchise brand. It lets the original business owner (franchisor) retain ownership and control of their brand while allowing a franchisee to use the franchisor’s brand, supply chain, marketing initiatives, and business model for a fee. In the same vein, starting a franchise as a franchisor is a good way to boost a brand’s market share and geographical reach at a low cost. After all, when a franchisor sells a franchise to franchisees, new locations are opened, increasing brand awareness and market share, all at the franchisee’s expense.

AĀ Franchise AgreementĀ is a binding legal document between the franchisor and the franchisee and outlines the terms and conditions the franchisee must adhere to. It includes the obligations of both parties, the terms, and specifications of the contract, including the use of trademarks, training and support, advertising and marketing, fees, and termination rights.

Franchise agreements are usually long and complex, written in legal jargon that can be difficult for the average person to understand. As such, reading and understanding the agreement thoroughly before signing it is essential. You may also want to hire a franchise consultant to review the agreement and ensure that it is fair and reasonable. Knowing what each section of the franchise agreement entails will help in correct decision-making, making sure that franchisees know what they are signing up for.

A franchise agreement follows fourteen days after giving the franchisee a copy of theĀ Franchise Disclosure Document (FDD), which is a legal disclosure document given to individuals interested in buying a franchise. It is part of the pre-sale due diligence process. The FDD contains all the important information about the franchise; it helps franchisees understand what they are getting into, which is especially helpful since franchise investments can be very large. The FDD usually contains the following information: the franchisor’s business background, including parent companies and affiliates, litigation, initial fees, and other fees, estimated initial investment, restrictions, franchisee’s obligations, financing, franchisor’s offered assistance, territory, trademarks, patents and proprietary information, obligations, financial statements, other franchisees, contracts, receipts, and more. Thus, carefully reading the FDD is as important as scrutinizing the franchise agreement.

A franchise agreement being signed

Types Of Franchise Agreements

A franchise consultant pointing where to sign in a franchise agreement

4 Different Types

These are the 4 different types of franchise agreements that you need to know:

  • Single-unit: Single-unit franchise agreements grant the franchisee the right to own and operate one unit. First-time franchisees often opt for this option.

  • Multi-unit:Ā Multi-unit franchise agreements grant the franchisee the right to own and operate more than one franchise unit. It is usually not limited to a specific territory, and locations may spread across several city or town areas.

  • Area development franchise agreement: The area development franchise agreement, just like the multi-unit agreement, gives the franchisee the right to own and operate multiple units. In addition, it also gives the franchisee exclusive rights for development in a specified location. Thus, no other franchisees can open units within that exclusive territory throughout the duration or term of the agreement.

  • Master franchise agreement: The master franchise agreement grants the franchisee the right to sell franchises within their geographic area to other franchisees; thus, the franchisee essentially becomes a franchisor.

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Franchise Agreement Breakdown

18 Franchise Agreement Section

Franchise agreements typically comprise several sections, namely:

  1. IdentityĀ ā€“ This section identifies the franchisor and the franchisee in franchise agreements. It might seem obvious, but it is an integral aspect of any agreement and should not be omitted. Failure to correctly identify the parties involved in an agreement can lead to many legal issues down the line or result in the agreement being unenforceable.

  2. Grant of FranchiseĀ ā€“ This section typically states that the franchisor gives the franchisee a limited, non-transferable, and non-exclusive right to use the franchiseā€™s logos, trademarks, and service marks and systems for a given period as agreed (term). The franchisee receives no ownership rights to the franchise system or service marks or system. The franchisor may terminate the franchiseeā€™s grant-of-license if the franchise agreement is breached.

  3. Location and Territory RightsĀ ā€“ This section describes the franchiseeā€™s territory, whether it is exclusive or not, and sets up a schedule that the franchisee must abide by. I.e., a schedule by which the franchisee is supposed to find a physical location, ready all permits and plants for the unit to be approved, and when the premises must be built and opened. This section might also include any equipment needed to operate the location, such as computers.

  4. Term and RenewalĀ ā€“ A franchise agreement has a specified expiration. TheĀ term and renewalĀ section details the period of the agreement, from the signing to the expiration. It typically has an initial course or a specific contract duration before renewal. For example, if the initial course is five years and the agreement includes a renewal option, the franchisee may renew the contract upon expiration. Suppose a party has verbally communicated their desired term length to the other party. In that case, the agreed-upon duration must be included in the agreement to be enforceable.

  5. Franchise Fees and Other PaymentsĀ ā€“ The fees section typically includes details about the initial fee, franchise fees, royalty fees, marketing fund, and any other additional costs that may need to be paid by the franchisee to the franchisor before and during the business operations. Another fee that is often highlighted is the late fee for payments made by the franchisee to the franchisor that are past their due date.

  6. Advertising and MarketingĀ ā€“ Every franchise agreement contains a section specifying the franchiseā€™s advertising and marketing initiatives and any of the franchiseeā€™s obligations. Generally, the franchisor is in charge of the marketing and advertising initiatives and collects marketing funds from the franchisees to fund the franchiseā€™s marketing actions. Doing this ensures that each franchise uses the same materials to promote, thus remaining consistent no matter where the franchise unit is located and regardless of who operates it. Any marketing material, arrangement, or initiative thought of by the franchisee usually requires prior approval from the franchisor before it can be used. This section also typically includes specific guidelines and standards for any local advertising done at the franchiseeā€™s expense.

  7. Training and SupportĀ ā€“ This section usually outlines the franchisorā€™s training and support services to the franchisee; for instance, the initial training period, ongoing support, and access to the franchisorā€™s technology (i.e., software). Additional training beyond the initial training period usually comes with an additional fee.

  8. Proprietary Marks and Intellectual Property RightsĀ ā€“ This section is essential to the franchise agreement. The three areas of intellectual property in most franchises are trademarks, copyright, and know-how:

    1. A trademark includes any sign or graphic representation legally registered to represent a company, including a logo, name, signature, slogan, a series of letters or numbers, fonts, the shape of a product or part thereof, the graphics or pattern appearing on a product or advertising material, a color or combination of colors, packaging, and any combination of those mentioned above.

    2. A copyright is a right given to the creator, author, or other people who may own the copyright of certain types of works. It is done to prevent copying or reproduction without authorization. Even if a franchisor outsources the creative process of its logo design, the legal copyright should be transferred to the franchisor.

    3. The know-how refers to the franchisorā€™s technical knowledge, experience, and commercial information developed by the company. It is usually shared with the franchisee as anĀ operating manual. It includes trade secrets and confidential information that cannot become public knowledge.

  9. Restrictions on Goods and Services OfferedĀ ā€“ This section often describes anyĀ restrictionsĀ placed on the products or services, such as approved suppliers, hours of operations, pricing, and minimum standards.

  10. Accounting and ReportsĀ ā€“ Accurate books, records, and accounts should be in accordance with standard accounting principles as enforced by law. These must be at the franchiseeā€™s expense. The franchise agreement typically obligates the franchisee to send their account reports to the franchisor periodically and must submit any statement asked for by the franchisor. At any time, the franchisor can audit the franchiseeā€™s financial statements.

  11. Quality ControlĀ ā€“ This part of the franchise agreement addresses the franchiseeā€™s specific quality-control requirements. Quality control measures are necessary to ensure that the franchisee does not neglect the level of quality and minimum requirements in delivering the franchisorā€™s goods and services, thus ensuring a consistent level of quality for the products and services regardless of the location or business owner.

  12. Indemnification and InsuranceĀ ā€“ All franchise agreements include an indemnification section, which pertains to the franchiseeā€™s obligation to reimburse the franchisor for any losses it might suffer due to the negligence or wrongdoing of the franchisee. This is almost always in favor of the franchisor since the franchisee is the one who is responsible for the day-to-day operations and maintenance of the business.6 This section also includes insurance information. Typically, the franchisee is solely responsible for obtaining and maintaining insurance policies necessary for the business.

  13. TerminationĀ ā€“Ā TerminationsĀ can be initiated by either the franchisor or the franchisee, depending on the circumstance. A franchisor may elect to terminate the franchise agreement if the terms have been breached. On the other hand, a franchisee may elect to terminate the franchise agreement if the business model turns out to be not as profitable or strong as they had thought or if there is a lack of profits. This section usually also contains a recitation of violations to the agreement that will be considered a breach.

  14. Non-competeĀ ā€“ Franchise agreements typically contain restrictions that limit what the franchisee can do. In aĀ non-compete section, the franchisee (or its affiliate company) is not permitted to operate a competing business during the agreement term. It may also contain a non-compete after the agreement has been terminated, i.e., no competing business within five miles of the former location for three years after the agreementā€™s termination.

  15. Transfer and Re-saleĀ ā€“ Franchise agreements often outline any rights to transfer the franchiseeā€™s ownership interest in the franchise relationship to a buyer. Sometimes, the franchisor will have the right to refuse first. In other words, the franchisor gets the first chance to buy the franchiseeā€™s business if they decide to sell.

  16. Dispute ResolutionĀ ā€“ For any dispute regarding the franchise agreement, there is a specified process for resolving them in the agreement, including the agreed-upon mediation and arbitration.

  17. Obligations upon TerminationĀ ā€“ This section states what happens when the franchise agreement expires or terminates early, such as obligations to stop using the brand name, take down signs, return the operations manual, and pay all amounts due. The franchise agreement usually lists steps the franchisee must take to de-identify the business and the franchiseeā€™s association with the franchiseā€™s system.

  18. Governing LawĀ ā€“ This section identifies the state or county whose laws will govern the franchise agreement since laws can vary depending on the state.

A franchisor and franchisee shaking hand with 2 team members

How a Franchise Consultant Can Help You Negotiate Your Franchise Agreement

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If you are considering buying a franchise, it is essential to understand the legal agreement that governs your relationship with the franchisor. This document is crucial for protecting your investment and ensuring the success of your franchise.

A franchise consultant is a professional who specializes in helping entrepreneurs and investors evaluate and purchase franchises. They are experts in the franchise industry, with a deep understanding of the legal, financial, and operational aspects of running a franchise.

A franchise consultant can offer one of the most valuable services by reviewing the franchise agreement. They can help you identify potential red flags and negotiate better terms that protect your interests. They can also help you understand the various fees and costs associated with owning a franchise, such as royalties, advertising fees, and training costs.

Before hiring a franchise consultant, be sure to research their credentials and experience. Look for someone who has a track record of success and positive reviews from previous clients. It is also essential to understand their fees and how they are compensated. Some consultants charge a flat fee, while others charge a percentage of the total investment. Have the best franchise options for your investment and get a free consultation today with our expert team.

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