The devil is in the detail.
Franchising is a business model in which one business (the franchisor) allows a separately owned business (the franchisee) to use their systems, brand name and other intellectual property rights in return for royalties and other considerations. The advantage for a franchisee is that they get the benefit of a proven and tested business model. According to Franchise Information New Zealand, around 80% of franchised businesses still operate after 5 years compared with only 20% of independently started businesses. The franchisor, on the other hand, is able to expand their business without providing the capital and taking on the risk.
The association between the parties is interactive. The franchisee relies on the franchisor and the other franchises to maintain the reputation of the brand. The document that gives rise to the relationship is the franchise agreement which sets out the conditions upon which the franchise is to operate. The franchise agreement includes:
- fees to be paid by the franchisee, both upfront and ongoing;
- duration of the agreement and renewal rights (if any);
- intended territory or market;
- dispute resolution procedure; and
- rules relating to the on-sale of the franchise.
In order to assist the franchisee and to ensure consistent quality of service amongst franchises there is usually a franchise manual that provides operational details. This manual contains the business model, with most agreements requiring strict adherence to it to ensure that all franchisees maintain a common standard.
Fundamentally, franchise agreements should be approached like any other contract and need to clearly reflect the arrangement between the parties. Clauses that are unnecessary to the functioning of the relationship need to be carefully examined. Many franchise agreements, particularly with large firms, are non-negotiable. Prospective franchisees should be prepared to decline to sign contracts that contain onerous and one-sided terms.
There are a number of common pitfalls within franchise agreements. For example:
- the franchisee needs an exclusive territory within which the franchisor may not grant any other franchise licenses - clauses that allow reduction of this territory by the franchisor are common and should be considered very carefully;
- the franchisor should specify the steps they will take to protect the intellectual property rights being paid for; the exact method of calculating the royalties needs to be specified as well as penalties for late payments;
- clauses that allow for early termination are very common and need to be clearly understood;
- Agreements that limit the liability of the franchisor to the franchisee are cause for concern, particularly when related to obligations for marketing, training, and disclosure statements in the negotiation phase.
There is no specific franchise legislation to protect franchisees, however around half of franchisors abide by a self regulating code of conduct that aims to “promote high standards of franchise conduct” and does offer some protection against unreasonable and unfair conduct on the part of the franchisor.
If you are considering purchasing a Franchise, our best advice is to see us at as earlier stage as possible – certainly before you make any commitment. Franchise agreements can be lengthy with many potential traps. It is false economy to decline to take advice owing to the length and complexity of the agreement. While such documents may take time to analyse it is essential that this analysis is done. Our role is to identify the issues, explain them to you and then let you decide whether it is an investment worth making.