LAYING DOWN THE LAW
The rules of the game have changed. With the legal implications of franchising becoming ever more complicated, HN gets down to the nitty gritty of franchising agreements and talks tax
The Franchise Agreement is the most important document in the whole franchise process, as it lists the terms on which the franchise is granted, the obligations of both the franchisor and the franchisee and, most importantly, what happens if something goes wrong. In simple terms, the franchisor grants a franchisee the right to operate a business using the franchised company’s intellectual properties; such as the name, branding, products and or services, systems and processes that the franchisors have successfully operated themselves. These are intangible assets and are included in what is called the Franchise Operations Manual. The Franchise Operations Manual provides all the detailed instructions regarding how a franchisee must operate his/her business and forms, with the Franchise Agreement, the legal framework under which the franchisee will operate.
Franchise Agreements are usually about 50 pages long, follow a similar structure and have their own terminology.
Before going any further let us clarify who is who in a Franchise Agreement. The franchisor is the company that is franchising its business. The franchisee is the person who buys the franchise from the franchisor. The franchise may be a single franchise or a master franchise, whereby the master franchisee serves as a subfranchisor for a determined territory. In this case, the master franchisee will have to open a number of franchised outlets or point of sales in the territory during a certain term.
In addition to granting to the franchisee the right to operate the business using the franchisor's system, the franchisor has obligations to continually develop the franchise, to protect the franchisee within the territory, and to provide ongoing support and assistance to the franchisee; such as guidance, training and advice.
In return, the franchisee usually pays an initial upfront fee, called an entry fee at the signature of the Franchise Agreement, and an ongoing monthly fee, called a royalty fee, which is a certain percentage of the revenues during the term of the franchise. The franchisee may also be required to make a marketing and advertising contribution, calculated as a percentage of the revenues. Before starting operations, the franchisee must lease premises that are approved by the franchisor. The premises must also be designed, decorated, furnished and equipped by a contractor approved by the franchisor. This incurs initial investment to be disbursed by the franchisee. The initial investment, the investment rate of return (IRR or the numbers of years necessary to return the investment) and the fees are included in what is called the franchise package.
The franchise is granted for a limited period of time. It is usually between 5 and 10 years, with the option to renew it for additional terms. This is referred to as initial and renewable terms. The term of the Franchise Agreement must be sufficient for the franchisee to recoup his/her investment. In case of material breach of the Franchise Agreement by the franchisee, the franchisor may terminate the agreement before its term.
A Franchise Agreement offered by a well-established franchisor is usually non-negotiable, so is it important to understand the complete meaning and implications of each word.