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Reading a franchise agreement can be like having dinner at Aunt Martha's. There's a lot of stuff, you're not sure what you'll have to swallow, and you don't quite trust what went into it. Unlike eating Aunt Martha's Sunday Surprise, though, signing a franchise agreement without understanding it could cost you thousands of dollars. Here's a brief introduction to the most common terms.
You normally have to pay an initial franchise fee (usually between $15,000 and $25,000), plus an ongoing
royalty for the term of the agreement. This royalty may range between three per cent and six per cent of the
gross sales, depending on the industry. It is very important that you understand how the agreement defines
"gross sales." What is included and excluded?
Term and Territory
A franchise agreement lasts for a set period of time, usually several years. The term of the agreement should last only as long as the lease or sublease of the location. There may be an option to renew the term.
An important part of the franchise agreement is the territory clause. You're usually given an exclusive trading area in which to operate the business. For example, this might be within a 10-kilometre radius around your location. Sometimes, this territory protection is not absolute but merely gives you the right of first refusal. That is, if a new franchise comes up in your territory, you get the first chance to buy it. If you turn it down, you'll have another competing location in your territory.
You should make sure the franchise agreement does not allow the franchisor
to sell product through "alternative channels." For example, while there
might not be any MegaDonuts outlet near your franchise, the supermarket
next door might sell pre-packaged megadonuts.
Franchisors will usually agree to provide a certain amount of initial training. You may have to pay some fee to the franchisor for this training, in addition
to travel and accommodation costs. The franchise agreement may impose mandatory annual or ongoing training seminars which you or designated managers must pay
for and attend.
Authorized Services and Supplies
The franchise agreement may require you to purchase services and supplies from an authorized supplier, because
Sometimes the authorized supplier is the franchisor or a subsidiary, which generates a mark up on the supplies or services. Ensure that the authorized
supplier offers reasonable prices.
The franchise agreement will require you to provide regular sales reports. The franchisor may also do quality-control surveys to
assess your performance and to ensure that it is receiving its rightful royalty payments. Some franchisors also require costly
audited financial statements. You should see if the franchisor is willing to drop or modify this requirement.
In addition to the payment of royalties, you may have to pay towards an advertising fund. For example, all the franchisees may have to contribute two per cent of their gross sales to pay for an expensive national ad campaign. Make sure there are controls over how the franchisor uses the advertising fund. Ask questions like,
In addition to the joint advertising, you may be required to spend a certain amount of money on local advertising (e.g. local flyers, community newspapers etc.).
You're usually not allowed to compete with the franchisor while you are a franchisee, and for a certain period of time after that. This "restrictive covenant" must be reasonable as to the area and length of time, and should go no further than reasonably necessary to protect the business adequately (e.g. three years after the business relationship ends for a radius of ten kilo metres from the franchise location).
There will be a confidentiality clause which prevents you from disclosing or using any of the franchisor's confidential information about the business (i.e.
trade secrets, business systems, inventories, methods of production, etc.). There may be provisions which restrict you from "moonlighting" during the term
of the franchise agreement. This makes sure that you give your full time and attention to the franchise business.
Sometimes you will want to operate the business through a limited a company. The franchisor usually insists that
the shareholders personally guarantee all of the company's obligations under the franchise agreement and related agreements.
The franchise agreement usually gives the franchisor a lot of power if you default on any of your obligations under the franchise agreement or related agreements. Also, a default under one agreement will mean a default under all of the agreements, so if you fail to pay the rent, you may lose your right to lease the location, your right to operate the business, and your license to use the franchisor's brand name, trademarks and systems of operation.
The franchise agreement may separate serious defaults from less-serious defaults. The less-serious defaults may be "curable." This means that you may
be able to bring yourself back into good standing by fixing whatever you did wrong. For example, by paying the royalties due, by ordering the correct
supplies, or by changing management policies. Some defaults may be so serious as to be "non-curable" (e.g. bankruptcy, getting evicted by the landlord,
assignment without the franchisor's consent etc.).
More questions? Phone us at (604) HELP-LAW.
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This page last updated: October 5, 1999
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