Franchises are a popular and cost-effective way to get started in business. But before you jump in, you need to understand exactly what’s involved. Franchise agreements can be long, complicated, and contain hidden risks. What’s more, you can remain on the hook even after they come to an end.
We recommend that you use a lawyer to help you understand (and prepare for) what’s expected from you in the typical agreement. Nevertheless, here’s our essential guide to reviewing franchise agreements so you can purchase a franchise with confidence.
- Should I use a lawyer to review a franchise agreement?
- What are the main features of franchise agreements?
- What different types of franchise agreement are there?
- What are my rights when buying a franchise?
- Why do we need a franchise agreement at all?
- What are the potential downsides of franchise agreements?
- Will I be on the hook personally for any liabilities of the franchise?
- Aside from fees to the franchisor, what else will I have to pay for?
- Can I get exclusive rights in a territory? How do I look out for this?
- What are the main terms of franchise agreements?
- What legal protection am I entitled to?
- How do I go about renting premises?
- How do I renew my franchise?
- What if I want to leave early?
- What might I be liable for after the end of the franchise agreement?
- The impact of Covid-19 and Brexit on franchises
Should I use a lawyer to review a franchise agreement?
No-one would ever consider buying a house without consulting an expert professional. That’s why most banks insist upon it.
But consider this. While you may buy a house that declines in value, you’re unlikely to end up with a worthless asset. That’s not the case with franchises. While a franchise can be a great way to start in business, it’s far from a risk-free investment and if the business goes pear-shaped you could end up with nothing to show for your efforts.
That’s why we strongly recommend that you don’t take a DIY approach to reviewing a prospective franchise arrangement and consult a professional franchise lawyer.
While many sellers of franchises will tell you that the agreement is non-negotiable, you still need to understand exactly what’s involved so that you can evaluate the risks and prepare for them. We can help with that.
What are the main features of franchise agreements?
In legal terms, a franchise is the right to use the trademarks, know-how and processes needed to run the business in return for a fee. The franchisee makes promises to the franchisor when they sign a franchise agreement so they preserve the reputation of the franchisor’s brand. For example, they agree to meet certain quality standards, and follow set processes.
Once you buy a franchise, the franchisor typically provides training and support in the initial stages of running the business.
What different types of franchise agreement are there?
There are a number of different types of franchise, and the terms of the franchise agreement will reflect this:
- A business format franchise - This is where the franchisee operates under the franchisor’s brand name, and the franchisor influences or controls the way the franchisee operates the business
- A master franchise - This is where the franchisor grants the franchisee the right to issue sub-franchises in a certain area
- A franchise resale - This is where an existing franchisee sells their business to a new entity
What are my rights when buying a franchise?
In the franchise agreement, the franchisor will give you the right to:
- Carry on the business using their brand, and use all its intellectual property (IP) under an IP license, like trademarks and copyrighted material such as menus
- Use their accounting, management and marketing knowledge and expertise
- Benefit from their support, know-how and guidance
You’ll usually be given the exclusive rights to operate the business in a specific geographical location, so that you won’t face competition in that area from another franchise.
You may also be able to renew the franchise, and to sell it on with the consent of the franchisor. If this aspect is important to you, make sure it’s included.
Why do we need a franchise agreement at all?
You need a franchise agreement because it spells out your rights and any limitations on those rights. You need to understand these fully, because you have to abide by any requirements placed on your running of the business.
The agreement also details the fees payable, any payment terms and what’s included like, such we the right to use intellectual property. It will also contain details about suitable premises.
Although this can make the agreement long-winded, this is an advantage as the parties are clear what’s expected of them, and what might constitute a breach of the agreement. This makes resolving problems easier and increases the chance of a successful resolution of any differences between you without resorting to court action.
What are the potential downsides of franchise agreements?
One disadvantage of buying a franchise is that a franchise doesn’t usually come with premises, equipment and stock. You also need to pay your franchise fee or ‘royalty’ on top of the usual business expenses.
In addition, you have to understand fully the terms of your franchise deal before you sign. A franchise agreement will impose obligations on you to run the business as the franchisor wishes. There’s little freedom to do things your own way or make innovations.
Lastly, if you want to sell the franchise to someone else, a franchisor will typically want to approve the person you sell it to. It can sometimes be difficult and time-consuming to get this consent, causing problems for franchisors who wish to retire or move on to other things.
Will I be on the hook personally for any liabilities of the franchise?
Anyone can buy a franchise, whether you’re a sole trader, operating a partnership or are a limited company. If you own a limited company or operate a limited liability partnership, the franchisor may ask you, as a director, shareholder or partner, to sign a personal guarantee of the performance of the franchise agreement so you’ll be directly responsible.
As a sole trader, you will be personally responsible for any liabilities of the franchise.
If you’re financing the franchise by way of a loan, the bank may also ask for a personal guarantee, and your franchisor may ask you to have sufficient capital upfront as well as loans. In additional, you may be personally bound by any confidentiality agreement you enter into.
Aside from fees to the franchisor, what else will I have to pay for?
These are the kinds of fees that may be payable to the franchisor and that will be described in the agreement:
- Development fee, exclusivity fee or initial franchise fee - These are upfront fees charged for granting the franchise or offering exclusivity in a territory.
- Store opening fee - These are charged each time a new store is opened.
- Service fee or royalty - These are for use of the franchise name, and are usually calculated as a percentage of the franchise turnover or a fixed amount.
- Marketing contribution - Where a franchisor runs advertising campaigns, you pay a fee for the marketing efforts - This is usually a percentage of gross turnover.
- Training fees - This is where the franchisor offers training to run the business.
- Other fees - These may include lease rentals, software licences and support fees.
Can I get exclusive rights in a territory? How do I look out for this?
Franchise agreements often contain a term that gives you sole rights to operate the franchise in a certain geographical territory, so that you won’t face competition. You’ll find a clause in the agreement that describes this in detail, including what rights are granted and the boundaries of the territory.
What are the main terms of franchise agreements?
Here are the key terms you can expect to find in your franchise agreement and that work in the franchisor’s favour:
- The right of the franchisor to monitor your performance
- Your agreement not to compete with the franchisor’s business during the term of the franchise
- A provision protection the franchisor’s intellectual property rights
- Any limitations on your rights to operate the franchise
In addition, you’ll find certain key rights in your favour, like:
- The right to receive training for you and your staff
- Guarantees that any goods or services the franchisor provides will be good quality
- Agreement to provide marketing and advertising
- Your right to sell the franchisor, and whether the franchisor has the right of first refusal
- How long the franchise lasts, and if you can renew it or end it early
Here’s a complete list of the terms usually included in franchise agreements:
|Names and date, background||The names of the parties, the date the agreement is signed, and some background to the deal|
|Fees||How much you will pay, how and when it will be paid, and whether interest will be charged on late payment|
|Franchisor’s initial duties||Such as: |
|Franchisor’s continuing duties||Such as: |
|Your initial duties||Such as: |
|Staff||Your obligation to train staff adequately and make sure they are competent|
|Advertising||You may be required to promote the brand, or contribute towards the franchisor’s marketing efforts|
|Premises||The franchisor will want to make sure you keep the premises attractive and clean, not make any alterations and operate it in accordance with the manual. This clause may also specify opening hours|
|Intellectual property||Your right to use the trademark and other Intellectual property rights (IPR) of the franchisors. You’ll likely have to pay a registration fee and abide by the terms of the license There will also be provisions covering what happens if IPR is infringed, either by you or someone else|
|Sale and assignment||Any restrictions on your right to sell or assign the franchise, and that may need the franchisor’s approval|
|Termination||When the agreement will end, and in what circumstances, such as a breach of the agreement|
|Consequences of termination||What rights flow to the parties in the case of a termination. For example, that the franchisor can step into your shoes to run the business|
|Restrictions||For example, not to use confidential information of the franchisor, and not to start a competing business. This clause can carry on after the agreement ends, but only for a reasonable period|
|Guarantees||Any guarantees you’ll be giving|
|Disputes||How disputes will be dealt with|
What legal protection am I entitled to?
You may find the following provisions in the agreement that give you some protection:
- Warranties and representations by the franchisor that confirm financial information they’ve given you about the business. You may be able to sue for compensation if these are proved to be false
- A limitation on the amount of your liability in the event of a claim against you by the franchisor
- Promises to keep your information confidential by the franchisor to protect your interests
- A promise by the franchisor to let you know if they are selling the business, or thinking of doing so, so that you can prepare
How do I go about renting premises?
You’ll need to think about:
- Conducting a health and safety risk assessment. This includes responsibility for fire safety, safety of electrical equipment, gas safety, managing asbestos
- Providing a reasonable temperature for employees and customers of the business
- Providing adequate space, ventilation and lighting
- Providing toilet and washing facilities
- Providing drinking water
- Providing safe equipment and
- Maintenance and repair of the property as agreed in the lease including both internal and external repair
How do I renew my franchise?
If you think you may be in business for the long haul, you should make sure there’s a term that allows you to renew the agreement. Usually, you have to give the franchisor written notice before the end of the term.
You’ll probably need to pay a renewal fee and certify that you haven’t breached any terms of the franchise agreement.
What if I want to leave early?
If the agreement says so, you can end your franchise early.
Otherwise, franchise agreements normally end like this:
- You are in breach of it
- The franchisor breaches it
- It comes to the end of the term and isn’t renewed
- Where you both agree to end it
- Where you sell it
What might I be liable for after the end of the franchise agreement?
If your franchise agreement contains a ‘restrictive covenant’ that, for example, forbids you entering into competition with your franchisor, then this may extend for a period after the franchise agreement terminates.
Here are the types of restrictive covenants that you may find:
- A non-compete clause during the franchise
- A non-solicit clause that stops you approaching employees, customers or suppliers after the franchise ends
- A confidentiality clause that stops you using the franchisor’s confidential information
- A non-compete clause that continues after the end of the franchise, for example for a year, and in a specific territory
If you’re buying a franchise to learn about the business and market, then you need to be sure that a restrictive covenant won’t restrain your ambitions after the franchise ends. Also, make sure if you’ll continue in business after, that you don’t poach the franchisors contacts and customers.
There may be a little scope for negotiation with restrictive covenants. For example, you can try to get these limited to solicitation of key suppliers or customers. Using a lawyer is the best way to help you negotiate a deal that’s right for you.
To be valid, a restrictive covenant must be reasonable and necessary to protect the legitimate interests of the franchisor. If you feel this isn’t the case, then ask for it to be modified. It’s in the interests of the franchisor to make sure their covenant is valid and legally effective, so you may be in with a chance.
The impact of Covid-19 and Brexit on franchises
Both Covid-19 and Brexit have had an influence on the franchising scene. Here’s how.
While the economy is now picking up, the combined impact of Covid and Brexit has had a major effect on supply chains. Some franchisors have even used force majeure clauses to bring contracts to an end early. Sectors like tourism, food & beverage and hospitality have lost a lot of customers, and in some cases like Flybe, this has proved fatal.
A shortage of HGV drivers and interruption to overseas trade has also caused difficulties for some franchises.
The best way to prepare yourself as a franchisee is to look carefully at the force majeure clause in your franchise contract and any contracts with suppliers. These clauses are a ‘get out’ for events outside a party’s control, but their terms can vary quite a lot. Make sure you understand them. Some may specifically exclude epidemics as a force majeure. Other events like government action in response to problems may, or may not, be a force majeure and there’s scope for argument. Remember that force majeure can work for, as well as against you.
EU competition rules will continue to apply in the UK post-Brexit, and these can have an impact on franchising. However, the EU commission will have fewer powers, and the UK has also introduced its own competition rules.
The most significant effect on franchisors will be likely to be a shortage of labour, particularly in the food & beverage and hospitality industry, given that many workers came from EU countries. To the extent you intend to employ foreign-born workers, you’ll need to check their employment status first.