When you appoint a franchisee you are taking a leap of faith with your brand and your brand’s reputation. It only takes one rogue franchisee to mess up years of hard work building up hard-earned trust in the marketplace for your product or service. So you want to be careful.
Here are some key tips for a franchisor:
You must carry out some due diligence on your potential franchisee before you start. This includes carrying out a credit check on the franchisee.
Check out its latest accounts. Find out about its financial reputation. Do some digging on the on the key individuals who will be running the franchise for you.
After you have done this due diligence there are a number of legal issues to address in the franchise agreement:
What’s the length of your agreement? It is typical for a franchise agreement to last for five years and give franchisees one or two “automatic” renewal options to carry on for a period after that.
From your point of view, you may want to try to limit the term and/or the number of renewals.
Are you giving exclusivity in relation to a geographical area or will there be other franchisees competing in the same territorial space?
Having competition may keep the franchisee on its toes – but you want the franchisee to be successful and motivated, so crowding the market with extra franchisees in the same territory may not ultimately be beneficial.
Typically, there is an initial fee payable for taking on the franchise. The purpose of this fee is really to compensate you for your costs involved in recruiting and training franchisees.
There is also a continuing fee (sometimes called a management service fee) often calculated as a percentage of a franchisee’s gross turnover (8-9% is typical) and a marketing/advertising fee to give you funds to promote the brand nationally (2.5% would be normal).
It may also be that you can insist on the franchisee purchasing products or services from you or your preferred supplier, on which you may earn a profit or retain discounts or receive a commission.
Most franchise agreements contain a manual or style guide which the franchisee has to comply with in the way that it runs the business – make sure that this contains all the brand attributes that you want the franchisor to maintain and live up to.
Also insert approvals in the agreement over areas of key concern, (eg over marketing materials, suppliers and even stationery). Ideally these approvals should be absolute, though don’t be surprised if these approvals are limited in some way.
Eg ‘Not to be unreasonably withheld or delayed’ or ‘with bona fide reasons given in writing for any failure to approve’.
If you are dealing with a new franchisee it may be that you want to require the franchisee to guarantee your payments or obligations personally.
This gives you an extra remedy in the event that the franchisee defaults under the terms of the franchise agreement.
Do you want to insert restrictions on the franchisee’s other business activities either during or after the term? During the term this may prevent the franchisee from being distracted by other activities they want to carry out which you feel would take them away from the running of the franchise or be incompatible with their franchise responsibilities.
After the term you may want the franchisee prevented from acting in a particular area or a particular business that would compete with your franchise. Don’t make these restrictions too long or they will be unenforceable – one year is usually plenty.
If you are going to grant a renewal right see if you can insert a (defensible) renewal fee for granting such right, or maybe increase the level of your percentage charges during any renewal period.
If the franchisee wants to sell the business you may want an approval right since you don’t want the franchise being sold to an inappropriate franchisee.
One way of doing this would be to give yourself a first option to purchase the franchisee’s business.
Also you might want to ask for a percentage of any sale price (since a portion of the value of the sale will consist of the brand equity you built up before the franchise was granted).
Consider including minimum performance clauses which either require the franchisee to pay a minimum amount of continuing fees, or to perform to minimum levels, failing which you may have remedies against the franchisee, including termination.
*Clive Rich is CEO and Chairman of LawBite, an online legal service providing Simple Law for Small companies. He is also a legal expert on Workingmums.co.uk’s site. LawBite is headline sponsor of Workingmums.co.uk’s first Top Franchise Awards in May. The Awards are open for nominations until 4th March.