by Chris Way

Entrepreneurship takes many forms. At our core, all entrepreneurs endeavor to build something that solves a problem, supplies a need, or satisfies a want. There are many ways to pursue this vision, and no singular correct path. Among the many options, purchasing a franchise is a popular move. But before you make the commitment to a franchise, it is important to understand the relationship and the many business and legal elements that relationship is founded upon. If you already know your franchise basics, skip ahead a bit. If you don’t, I’ve laid out a few of the basics for you.

What Is a Franchise?

Franchises are subject to some regulation at both the federal and state level.

Federally, the Federal Trade Commission’s Franchise Rule provides:

 “A commercial business arrangement is a “franchise” if it satisfies three definitional elements. Specifically, the franchisor must: (1) promise to provide a trademark or other commercial symbol; (2) promise to exercise significant control or provide significant assistance in the operation of the business; and (3) require a minimum payment of at least $500 during the first six months of operations.”

Virginia defines a franchise as:

“A written contract or agreement between two or more persons, by which:

1. A franchisee is granted the right to engage in the business of offering, selling or distributing goods or services at retail under a marketing plan or system prescribed in substantial part by a franchisor;
2. The operation of the franchisee’s business pursuant to such plan or system is substantially associated with the franchisor’s trademark, service mark, trade name, logotype, advertising or other commercial symbol designating the franchisor or its affiliate; and
3. The franchisee is required to pay, directly or indirectly, a franchise fee of $500 or more.”

Regardless of whether the definition comes from federal or state law, if an arrangement involves where Company A granting you the right to use Company A’s branding and business operation model (or require adherence to a model) in exchange for at least $500, you likely have a franchise.

Negotiating a Franchise Agreement

A franchise can be amazing opportunity for a small business owner to pursue your passion, without needing to develop the entire business model and brand. Rather than building these from scratch, a franchise relationship allows you to learn from and use a proven model and benefit from the branding efforts and marketing scale that a larger enterprise enjoys.

But a franchisor isn’t a generous, kind benefactor. It is a shrewd and savvy business enterprise. Franchise agreements are complex relationships often lasting for initial terms of at least five to ten years. Therefore, it is critical that when you negotiate a franchise arrangement, you understand the key pieces of that relationship. Today we focus on franchise territories and how they work.

What is a Franchise Territory?

After all that preamble, we get to our main topic! A franchise territory is a defined geographical area where a franchisee has the right to operate their business under the franchisor’s brand and system. Territories are designed to provide franchisees with a viable market for their products or services while minimizing competition between franchisees of the same brand. This sort of cannibalization, where locations of the same brand pull business from each other, can be very harmful to all the affected locations. Assigning each franchise location a specific territory helps them focus on competing with outside competition rather than with other franchisees.

Constructing Franchise Territories

Franchisors typically construct territories based on various factors, such as population density, demographic characteristics, and market potential. One common approach is to define territories based on a specific number of households within the area. For example, a franchisor may grant a franchisee a territory that encompasses about 100,000 households. Other popular approaches include local municipal boundaries like city limits and county lines, radius measurements, zip codes, and geographic boundaries.

While geographically bounded territories may seem odd to include and different from the others, these natural barriers are important. Think of the role rivers play in influencing travel behavior. No matter how delicious the donut, if it’s across a river, proximity to a bridge or traffic on the bridge can influence whether you’re having those donuts that day, or whether you go somewhere easier to reach.

In fact, geographic boundaries are an important consideration for a franchisee. As resident in or near your potential territory, you likely know more about the area than the national franchisor. Use that knowledge to make sure the territory reflects the behavior of the people supposedly within it.

Generally, a franchisor will have established factors they consider when constructing a potential territory. These might include:

• Population growth projections
• Average household income
• Traffic patterns and accessibility
• Presence of complementary businesses
• Proximity to other franchisees or company-owned units

The franchisor’s goal is to create territories that provide franchisees with a reasonable opportunity for success while ensuring the brand’s overall growth and profitability. Your goal is to secure yourself the best economic footprint for your location’s success. Don’t be afraid to negotiate territorial boundaries to keep these interests in balance.

Protected Territories vs. Exclusive Territories

Franchise territories generally come in two primary flavors: protected territories and exclusive territories. As a franchisee, it is critical that you understand the distinctions between the two.

Protected Territories

Protected territories are the more common of the two. A protected territory is an area in which the franchisor agrees not to establish another franchised or company-owned unit of the same brand. This means that franchisees within protected territories are shielded from direct competition from other units operating under the same brand.

However, protected territories do not necessarily prevent the franchisor or other franchisees from engaging in certain competitive activities within your territory. For example, the franchisor may reserve the right to sell products or services through alternative channels, such as online sales or wholesale distribution, within the borders of a franchisee’s protected territory.

When you are presented with a protected territory for your potential franchise relationship, it is important to review it carefully. Not all protected territories are created equal. There’s no single uniform type of protected territory. Various franchisors may include some protections over others. It’s possible that if you’re looking at three different franchise opportunities, you may see three different protection structures.

For this reason, protected territories are the more common as they are very helpful to the franchisor. A protected franchise territory allows the franchisor to retain some revenue within the territory through whatever channels are best for that franchisor and protect from the risks of an underperforming franchisee.

Exclusive Territories

An exclusive territory, on the other hand, provides franchisees with a higher level of protection from competition. In an exclusive territory, the franchisor agrees not to establish another franchised or company-owned unit and refrains from engaging in certain, not necessarily all, competitive activities (see below) within the defined area.

Exclusive territories are less common than protected territories, as they may limit the franchisor’s ability to expand the brand’s presence and adapt to changing market conditions. While not as common, exclusivity isn’t out of reach. Franchisors may be more likely to grant exclusive territories in negotiations in situations where franchisees make significant investments in their businesses or where the market potential is limited. You might have an easier time securing an exclusive territory where you are entering an agreement to develop multiple franchise locations within a given region. Barring these circumstances, you also may be able to negotiate options or rights of first refusal to expand to adjacent territories.

Franchisor’s Competitive Activities Within Territories

Even within protected or exclusive territories, franchisors may reserve the right to engage in certain competitive activities. These activities can include:

1. Online sales: Franchisors may sell products or services through e-commerce platforms, potentially competing with franchisees within their territories.
2. Wholesale distribution: Franchisors may distribute products to third-party retailers, such as supermarkets or convenience stores, within a franchisee’s territory.
3. Alternative brands and private labels: Some franchisors operate multiple brands within the same industry. In such cases, they may reserve the right to establish units of different brands within a franchisee’s territory.
4. Non-traditional outlets: Franchisors may establish units in non-traditional locations, such as airports, grocery stores, bookstores, universities, or hospitals, even if these locations fall within a franchisee’s territory.
5. National accounts. Franchisors may designate certain customers (even if they’re within your territory) as big enough to merit the franchisor’s attention and reserve the right for the franchisor to manage the relationship and potentially assign you, and other franchisees, work from it.

To minimize future conflict, make sure the franchisor has clearly disclosed their rights to engage in competitive activities within the franchise agreement. Review these terms carefully and ask questions!

Putting It All Together

Understanding franchise territories is crucial for anyone considering becoming a franchisee. By familiarizing yourself with how territories and the concepts underlying them, you can make an informed decision about whether a particular franchise opportunity aligns with your goals and expectations. Be sure to thoroughly review the franchise disclosure document (FDD) & franchise agreement and discuss any concerns or questions you may have with the franchisor.

And of course, when you need help evaluating how the franchise model aligns with your business goals and how the franchise agreements should be tweaked to best meet your needs, the team at Way Law is always here to help!