Franchise Agreement Definition
A franchise agreement is a legal document that regulates the relationship between a franchisee and franchisor. A well-written franchise agreement can help to ensure the success of a franchise. While each franchise agreement is unique, there are some specifics that should be included in each one.
If you’re considering franchising your business to expand your brand’s reach and profit potential, then you’ll need a franchise agreement to legally enter into this business model with your franchisees.
What is a franchise agreement? This document will be created by you (the franchisor) and shared with any potential franchisees to make sure the legal requirements of both parties are clearly spelled out. Sounds simple in theory, but there are several elements that should be included. In this guide, we’ll walk you through the franchise agreement definition, as well as what you should include in this important document. Let’s get started.
What Is a Franchise Agreement?
A franchise agreement is a legally binding document between a franchisor and a franchisee. The franchise agreement lays out the conditions that must be met by both the franchisee and franchisor. A franchise agreement is just one of many steps in how to start a franchise.
In general, most franchise agreements are written by the franchisor and will focus heavily on what terms must be met by the franchisee. A franchise agreement is also generally non-negotiable. Since a franchise is a highly replicable business model, the terms for each franchisee should more or less be the same. Uniformity throughout each of your franchise locations is key.
If both parties are satisfied with the terms laid out in the franchise agreement, they will sign and you’ll officially be in business together. The franchise agreement will be part of the franchise disclosure document.
What to Include in a Franchise Agreement
While there’s no franchise agreement template or laws stating what must be included in a franchise agreement—every franchise is different, after all—there are strict regulations as to what makes a franchise a franchise. It’s important to ensure your franchise adheres to the Federal Trade Commission’s Franchise Rule. The FTC Franchise Rule lays out the criteria that must be met for a business model to be considered a franchise. Overall, these include:
- The franchisor licenses its brand trademarks and other intellectual property to the franchisee.
- The franchisor has significant operating control over and offers assistance to the franchisee’s business.
- The franchisee pays the franchisor $500 or more within the first six months.
In addition to the FTC Franchise Rule, some states have written their own rules which must be followed if you’re opening a franchise in that state. You’ll want to familiarize yourself with state laws both for your state of operation, as well as any other state in which you plan to expand your franchise.
When writing a franchise agreement, make sure to meet the standards set down by the FTC, your state, and consider including the following provisions. We also recommend seeking the help of a legal professional who has experience with franchise agreements to help ensure you’re not forgetting any crucial aspects.
1. The Franchise Grant
Your franchise agreement must include a franchise grant. This part of the agreement is where the franchisor states that they’re giving the franchisee limited and non-transferable rights to use the franchisor’s trademarks, logos, proprietary information, and any other parts of the brand.
Keep in mind, granting this permission does not mean you’re giving the franchisee ownership over your brand elements. The franchisor can terminate the franchisee’s grant if the franchise agreement is breached.
2. Relationship Overview
The franchise agreement determines the relationship between the franchisee and franchisor. You should spell out certain aspects of this relationship so both parties know what to expect. This includes:
- Ownership of intellectual property
- Obligations of the franchisee
- Obligations of the franchisor
- Brand standards and use
- That the franchisee is an independent contractor of the franchisor
- Statement that the franchisor won’t control how the franchisee manages the human resources of their franchise
Any other factors that are important to the relationship between the franchisee and franchisor should be mentioned in the relationship overview section.
As part of the franchisee using the franchisor’s brand, the franchisee will pay both initial and ongoing franchise fees to the franchisor. Spelling out these fees upfront is important to both parties, as it will help the franchisee determine if they can afford to buy into this franchise—or if they need to seek out franchise financing to help cover the costs—as well as if the franchisor has created a sustainable business model.
The franchisee will pay an initial fee, often simply called the franchise fee. In addition to this one-time cost, the franchisee will pay ongoing licensing and advertising fees, as well as royalties, renewal fees, and more. The amount of the franchise fees is determined on a case-by-case basis.
While fees may be mentioned throughout the agreement, this is where the fees are specifically listed in their entirety.
4. Duration of the Agreement
The franchise agreement should include a section about the length of the franchise agreement. The date the franchise agreement is signed is the start of the term. This section can also include franchisee renewal rights and successor rights.
5. Intellectual Property and Brand Use
One of the most valuable assets of a business is it’s brand and intellectual property. Intellectual property includes any logos, trademarks, and other branding material. The franchise agreement should help you protect your intellectual property.
As a franchisor, you’re loaning your brand to your franchisee. This is a big risk if you don’t properly protect yourself and your brand. That’s why it’s important to lay down rules about how your brand should look and sound, when to use the trademarked intellectual property, what advertising can be done, and anything else the franchisee should know about using your brand.
You likely decided to franchise your business as a way to expand your market. And as franchisees open new outposts of your company, they will need to find new places to do so. A key to business success is making sure there is a demand for the products or services your business provides, and if too many of your franchise start popping up within the same area, each of their sales will suffer.
To prevent this from happening, the franchise agreement must state the territory requirements for that location. These requirements for the business location can determine the success or failure of the business.
There are some options when it comes to laying out these territory rules. Some franchises grant the franchisee protected territory, meaning they have exclusive rights to a certain range around their franchise and no one else can open a franchise within that area.
As well, this section of the franchise agreement can lay out what type of location the franchisee can choose for the franchise. You can set terms on what type of market surrounds the physical location, how much foot traffic or auto traffic it sees, and other stipulations. This section might also set a timeframe on how long the franchisee has to establish a brick and mortar location.
7. Site Development
While a franchisee generally finds their own site and develops it, the franchisor can stipulate approval and refusal rights on the location of the site. The franchisor should also include in the franchise agreement that they get to approve the site to make sure it adheres to brand standards prior to the grand opening.
8. Marketing and Advertising Costs
Often, a franchisor will control and set up all marketing and advertising for their brand. However, as the franchisee will also reap the rewards of these efforts, they are expected to contribute to the costs. These fees will also be detailed in the fees section, but it’s worth reiterating and providing additional context on what the fees are, how often they will be paid (i.e. monthly quarterly, yearly), and what exactly the money will be going toward.
Every business needs some type of small business insurance. The franchise agreement should include a section that discusses how much business insurance the franchisee must provide for their franchise. Additionally, the franchisor should be listed as an “additional insured” on the franchisee’s policy.
This section of the franchise agreement should also determine who pays for the insurance coverage.
10. Training and Support
Many franchisees are first-time business owners. One of the benefits of opening a franchise is the training, support, and wisdom provided by the franchisor. The franchise agreement should stipulate what support and training the franchisor will provide. The franchisor might also require that the franchisee attend outside trainings and seminars.
11. Record Keeping
Different franchisor’s offer different levels of instruction to their franchisees. While you don’t want to micromanage your franchisees, many will be first-time business owners and unsure of how to start and operate a business. The franchise agreement can contain instructions on what record-keeping software the franchisee must use and what records they must maintain. The franchisor may also grant themselves rights to access those records in the franchise agreement.
12. Quality Control
While each franchise is independently owned and operated, it will still bear your brand’s name and is the same entity in the eyes of the customer. As such, your brand will play a large role in the customer experience and you’ll want to make sure that experience is consistent throughout. Laying out rules for quality control in the franchise agreement will help ensure a consistent brand experience across all franchises.
A non-compete or non-competition covenant is a statement in the franchise agreement that prohibits the franchisee from opening a business that would compete with the franchised business.
The non-compete should be broken down into two sections in the franchise agreement: in-term and post-term.
The in-term section will regulate the non-compete while the franchisee is operating within your franchise agreement. The post-term regulates what happens after a franchisee no longer owns the franchise. The non-compete clause should include a geographic limitation.
14. Right of First Refusal
If a franchisee wants to sell their franchise, the right of first refusal clause in the franchise agreement gives the franchisor first dibs on buying the franchise from the franchisee. If the franchisor isn’t interested, then the franchisee can sell to someone else.
The indemnification clause in the franchise agreement should state that the franchisee will reimburse the franchisor for any losses incurred due to negligence or wrongdoing.
16. Exit and Transfer Options
At some point, the franchise agreement will end. This might be a termination or expiration, but the different exit strategies should be laid out in the franchise agreement. This section of the franchise agreement should also list the steps taken at the end of the franchise agreement to de-identify or separate the franchisee from the business.
17. Breach of Contract
The franchise agreement should also include a section that outlines what constitutes a breach of contract and the consequences of the breach of contract. It should also outline the steps taken to fix a breach of contract or what happens if the contract is terminated.
18. Dispute Resolution
The dispute resolution section of the franchise agreement should include what happens when there’s a disagreement between the franchisee and franchisor. In general, this includes nonbinding mediation followed by binding arbitration, but can be set up in any way the franchisor wants.
19. Other Legal Provisions
This is the section of the franchise agreement that acts as a catch-all. Any legal requirements that aren’t covered under their own section will be covered here.
Each franchise agreement will be unique to the franchise. While these sections can be a guideline for creating your franchise agreement, there’s a lot of legal language that must be included in a franchise agreement and you’re likely going to need the help of a franchise lawyer to complete it. A franchise lawyer can ensure that your franchise agreement is a legally binding document.
Franchise Disclosure Document
A franchise agreement is part of the whole franchise disclosure document, or FDD. While a franchise agreement is a document that’s unique to the franchise, the FDD is a federally regulated document.
The FTC’s franchise compliance rule requires that the FDD be presented to the franchisor at least 14 days prior to the signing of the agreement. This ensures that the potential franchisee has enough time to review the document and seek the review of a lawyer prior to signing. The FDD must include information about the risks and rewards of purchasing the franchise.
The Bottom Line
A franchise agreement is the regulating document for how a franchisee will operate their franchise. This franchise agreement is important to the success of both the franchisor and the franchise and creating the agreement should be done carefully. Ensuring that the franchise agreement is written clearly and legally to enforce all of the requirements necessary to operate the franchise should be very important to the franchisor.
While a franchise agreement is unique to each franchise, it still must include all of the necessary elements. While there’s no franchise agreement template you can plug your business name into and run with, the above elements will help you complete a thorough agreement to help you start your franchise business. Working with a franchise consultant or a franchise lawyer can also ensure that your franchise agreement is legal and will protect your brand every step of the way.