What is a franchising?
Franchising is used by corporations as a strategy for expansion or entry into a foreign market. A franchisor licenses out its know-how, procedures, intellectual property, business model, brand and the right to sell branded products or services to a franchisee. It is especially common among the big fast food chains like McDonald’s, Burger King or Subway, to name a few.
The advantage for a franchisor is that franchisees bear most of the risk for opening up a franchise. It also provides a continuous source of income due to the royalties a franchisee has to pay for the use of the trademark and products.
Franchisees have the advantage of being able to rely on already established brands and business concepts. Failure rates are much lower in comparison to opening up an individual business, for example.
What a franchise agreement should contain
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, who owns the intellectual property (IP), what are the obligations of the franchisee to operate its business to brand standards.
- Duration: length of the relationship, the franchisee’s successor rights to enter into new agreements, requirements to upgrade franchisee location.
- Fees: Initial and continuing fee paid by the franchisee to the franchisor for using the system and remaining a franchisee. Usually, these agreements include a number of side fees as well.
- Territory: Franchisee do not always have the exclusive or protected rights for a territory. Still, the territory has to be defined. In case a franchise system grants a franchisee exclusivity for a certain territory, the franchisor has to make sure to reserve those rights, including other distributors and internet sales.
- Site and development: Franchisees usually have to find the sites and develop them on their own in compliance with standards set by the franchisor. The franchisor has to approve the location and that the franchisee has built its location according to brand standards.
- Training and support: The franchisor provides support pre-opening and thereafter, including training, quality control, supply chain and field and headquarters support.
- Use of IP: Includes trademarks, patents, and manuals. The IP is the most valuable asset of a franchise system. The agreement clearly defines what the franchisee licenses and how they may use the IP. It also details the rights of the franchisor to evolve the system through changes to the operating manual.
- Advertising: Details on the franchisor’s advertising commitment and what fees the franchisee has to pay for advertisement.
- Insurance: A franchise agreement has to define what insurance is required from the franchisee prior to opening and during the term of the agreement.
- Record-keeping and auditing: The franchisor defines the records that the franchisee has to maintain as well as what software they are allowed to work with. Also defines a franchisor’s rights to access and audit the records.
- Other: Franchisee's successor rights, default, termination, indemnification, dispute resolution, resale rights, transfer rights, rights of first refusal, sources of supply, local advertising requirements, governing law, general releases, personal guarantees, and roll-up provisions.