The Franchise Agreement is a legally binding agreement which outlines the franchisor’s terms and conditions for the franchisee. It also outlines the obligations of the franchisor and the obligations of the franchisee. The franchise agreement is signed at the time an individual makes the decision to enter the franchise system.
While Every Franchise Is a License, Not Every License Is a Franchise
What turns a license into a franchise in the United States is governed by the definition established by the Federal Trade Commission (“The FTC Rule”) and by the various states that have adopted alternative definitions. Under the FTC Rule, there are three general requirements for a license to be considered a franchise:
- The franchisee’s business is substantially associated with the franchisor’s brand. In franchising, the franchisor and each of its franchisees are sharing a common brand.
- The franchisor exercises control or provides significant assistance to the franchisee in how they use the franchisor’s brand in conducting their business. Since the franchisee is an independent contractor and not a joint employer, generally those controls are over brand standards and do not extend to the human resources of the franchisee, nor do they extend to how the franchisee manages their business – subject to meeting the requirements of the brand standards – on a day-to-day basis.
- The franchisor receives from the franchisee a fee for the right to enter into the relationship and to operate their business using the franchisor’s trademarks. The fee can be an initial fee, or it may be a continuing fee in excess of $500 (adjusted annually) with certain exemptions provided under the law.
It’s a Formal and Complicated Long-Term Business Relationship
It’s not a partnership, it’s not a joint-venture or cooperative (although it could be), and it’s not a joint-employer relationship (although it could be that also). It’s a license that establishes the rights and obligations of the licensor and the licensee. Regardless of how the parties refer to the relationship, every franchise is governed by the terms of a contract (generally a written agreement) between the licensor (the franchisor) and a licensee (the franchisee), and that document is called a Franchise Agreement.
As in any well-crafted contract, the Franchise Agreement is designed to balance the needs of the franchisor to protect its intellectual property and ensure consistency in how each of its licensees operates under the brand. It needs to also ensure that even though the relationship is codified in a written agreement, meant to last sometimes more than 20 years (generally the agreement is ten years), that the franchisor has the ability to evolve the brand and its consumer offering over time.
Basic Elements of Franchise Agreement
As with any well-written contract, the Franchise Agreement needs to deal with some basic elements including, but not limited to:
An Overview of the Relationship. The parties to the contract, the ownership of the intellectual property, the overall obligations of the franchisee to operate their business to brand standards, etc.
Duration of the Franchise Agreement. The term of the relationship, the franchisee’s successor rights to enter into new agreements, the requirement to upgrade the franchisee’s location, etc.
Initial and Continuing Fees. Franchisees generally pay an initial and continuing fee to the franchisor for entering into the system and remaining a franchisee. There are also a host of other a la carte fees that are included in most agreements. Most franchise systems also provide for a payment to an Advertising or Brand Fund that is used by the franchisor to market the brand to the public and for other contractually defined purposes.
Assigned Territory. Not every franchise agreement grants a franchisee an exclusive or even a protected territory, and how a territory is established must be defined. Franchisors also need to deal with reservation of their rights within a franchisee’s territory, including alternative distribution sites, sales over the Internet, etc.
Site Selection and Development. Franchisees generally find their own sites and develop them according to the franchisor’s standards. The role of the franchisor is generally to approve the location found by the franchisee and then approve, prior to opening, that the franchisee has built their location to meet design and other brand standards.
Initial and Ongoing Training and Support. Franchisors generally provide a host of pre-opening and continuing support including training, field, and headquarters support, supply chain, quality control, etc.
Use of the Intellectual Property including Trademarks, Patents, Manuals. As the IP of every franchise system is its most valuable asset, some of which will change as the system evolves, the agreement defines what is licensed to the franchisee, how the franchisee can use the IP, and the rights of the franchisor to evolve the system through changes to the franchisor’s operating manual.
Advertising. The franchisor will reveal its advertising commitment and what fees franchisees are required to pay towards those costs.
Insurance Requirements. Franchise agreements will define the minimum insurance a franchisee is required to have prior to opening and during the term of the agreement.
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