How Does a Franchise Work: Five Things You Need to Know

by Lisa Brennan

Have you considered starting your own business but feel daunted by the prospect of building a brand from the ground up? Enter the franchise business model.  It is your business, but their name. A franchise offers the opportunity to own and operate your own business with the backing of a known brand and tried business model. So how does a franchise work? What should a franchise agreement cover? While there is a seemingly endless list of due diligence to undertake before you enter into a franchise agreement, here are five highlights to focus on as you proceed:

  1. Royalties and Franchise Fees: While there are start-up costs associated with opening any business, franchises have additional costs to consider. An initial franchise fee, which is the cost of purchasing the right to use the franchise name will typically be the first cost incurred. Additionally, most franchises require the payment of ongoing royalties, which are typically either a minimum flat fee or a percentage of the franchisee’s revenue, or a combination thereof. Some franchises will further require that you purchase certain equipment, supplies, or systems directly from them or their preferred providers. Carefully review these associated costs when making your initial investment.
  1. Territory Rights: Important in establishing a successful franchise is your ability to compete in a given local market. Your McBurger brand would lose sales and its competitive advantage if it was set up next to another McBurger store. Territory rights define the geographical area in which the franchisee is granted an exclusive right to own and operate the franchise. As a franchisee, you will want to maintain as much exclusivity and control of the market share as possible.
  1. Franchise Term and Renewal: The term of the franchise agreement refers to the initial length of the contract. Because of the necessary time and investment in building a business, the term is usually measured in years or even decades. The franchise agreement will outline the length of the term and will likely include provisions for additional renewal options.
  1. Operating Standards: Franchise agreements will include detailed specifications for operating the franchise business. Most franchisors will have stringent expectations regarding service, product, and marketing. Franchisees are required to adhere to these standards to maintain consistency and uphold the reputation of the franchise brand. Failing to follow these operational standards could lead to termination of your franchise, or other consequences as may be outlined in the agreement.
  1. Exit Clauses and Termination: Most do not want to plan an ending in the beginning however, it is important to consider what the end of the franchisor/franchisee relationship will look like. Can you sell the business to another operator? Will any fees or financial penalties be due upon termination? What about breaches of contract, non-performance, bankruptcy? Will you be barred from competing in a similar industry? Carefully reviewing this portion of the franchise agreement ensures that you are prepared for the expected and the unexpected that can arise when operating a business.

While these are some of the typical subjects covered in a franchise agreement, it is important to note that franchise agreements can have significantly different terms and conditions depending on the company and the industry. It is therefore essential for prospective franchisees to ensure they fully understand their rights and obligations before signing. The attorneys at Way Law are here to help! Let’s get started today!