Franchise Agreements: Top Tips for Franchisees

July 9, 2024

By Stephen Thompson

Franchising offers many benefits to those looking to run their own business. However, before signing a franchise agreement, a prospective franchisee should ensure that the agreement does not contain anything unexpected, and that the franchise suits their plans.

Our franchise experts at Darwin Gray have summarised what steps prospective franchisees should take to protect themselves when entering into franchise agreements.

What are franchises?

Franchises occur when one party (franchisor) grants a licence to another party (franchisee) which enables the franchisee to use the franchisor’s business model and to trade under the franchisor’s brand. During the term of the franchise agreement, the franchisee is given the right to use the trademarks, brand name and intellectual property of the franchisor, which will remain licenced or owned by the franchisor at all times.

Under the franchise arrangement, the franchisee usually pays an initial fee to start their business and monthly royalties thereafter. In return, the franchisor provides initial training, usually an operations manual and ongoing support to the franchisee.

Why are franchise agreements so important?

Franchise agreements are legally binding contracts which govern the relationship between the franchisor and the franchisee. They deal with the scope of the franchisee’s right to use the business name and brand of the franchisor. The agreement will normally set out extensive obligations on the franchisee in relation to daily operations of the franchise business, including marketing, accounting and hiring of staff.

Franchise agreements are usually drafted heavily in favour of the franchisor. This is entirely normal given that the franchisor will wish to protect their brand from unauthorised use by the franchisee. Established franchisors usually adopt a “take it or leave it” approach in relation to their franchise agreements. However, it is still vitally important that a prospective franchisee ensures that they properly reads and understands the terms of the franchise agreement, and seeks specialist legal advice on the agreement, before signing.

What franchisees must look out for when signing franchise agreements:

  1. Personal Guarantee. If the franchisee is a newly formed limited company, the franchisor may require the main individual running the franchisee company to give a personal guarantee. If the agreement requires an individual to give such a guarantee, the individual will be personally liable for any breaches of the franchisee company’s obligations under the agreement.

 

  1. Terms and termination clauses. Franchise agreements are usually for a fixed term; normally 5 years. It will set out express grounds of termination that the franchisor may exercise, such as breaches of certain obligations under the agreement by the franchisee. For franchisees, it is normally more difficult for them to terminate the agreement early. Usually, franchisees have fewer express grounds to terminate the agreement before expiry of the fixed term. This is because most of the obligations under the agreement tend to be on the franchisee. Again, it is important that prospective franchisees understand the commitments that they are making before signing the agreement; given that they will unlikely have an easy exit route.

 

  1. Costs. As a franchisee, it is important to ensure that the initial fee and royalty payments reflect what you have agreed with the franchisor. It is common for royalty costs to be calculated as a percentage of turnover rather than a percentage of profit, which means you may still be required to make payments to the franchisor even where your business is making a loss.

 

  1. Franchise territory. The franchise agreement will outline the area that the franchisee may operate. The territory identified in the agreement can affect the future profitability of the business, therefore it is important that the area is analysed carefully by the franchisee.

 

  1. Sale of the business. Under a franchise agreement, the franchisee is usually entitled to sell the business. However, the franchisor will often have a right of first refusal to acquire the franchise business itself. If the franchisor does not exercise its right to purchase the franchise, then the franchisor will usually have rights to determine the prospective buyer. This is because it will wish to have some control over the suitability of the incoming franchisee.

 

For advice on any legal aspects of franchising, whether you are a franchisor or a franchisee, contact the franchising team at Darwin Gray on 02920 829 136 or email sthompson@darwingray.com.

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