Franchise Agreements: What Are The Key Features?

Franchise agreements are contracts between two parties, the franchisor and the franchisee, under which a right is granted to the franchisee to utilise the intellectual property of the franchisor’s business in return for a commercial benefit. These agreements determine how the relationship between the two parties will operate. This type of relationship can be very attractive for the parties involved as franchisees benefit from a proven business model, operational support and brand recognition. Conversely, franchisors benefit from growth and increased profitability.

Some reasons an owner of a business may wish to operate through a franchise model include:

For a franchisee:

1. The benefit from the existing goodwill a franchise has built.
2. The opportunity, as an inexperienced business owner, to operate through a proven business model.
3. Access to operational support, know-how and expertise from the franchisor.

For a franchisor:

1. The opportunity to increase brand recognition.
2. The potential for rapid growth of its business.
3. The opportunity to expand its business without raising capital.

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Types of franchise agreements

There are three main types of franchise agreements. These are: franchise agreements, master franchise agreements and franchise development agreements.

Franchise agreements involve licensing from one party, the franchisor, to another, the franchisee, in a one tier structure.

In a master franchise agreement the owner of the intellectual property subsisting in the franchise, which will typically be the franchisor, will grant the right and impose a duty on a licensee to operate the franchise itself within a specific territory and to grant sub-franchises in that territory to third parties. In doing so, master franchise agreements establish a two tier structure.

Under a franchise development agreement, a two-tier licensing structure is created whereby the licensor will license a developer to operate franchise outlets through wholly-owned subsidiaries. However, it does not grant the right to sub-franchise to third parties.

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The key features

In any event, all franchise agreements should be underpinned by the same key features. From the perspective of a franchisee, terms relating to the licensing of intellectual property and assistance from the franchisor are essential.

• Licensing of intellectual property

A major draw of franchise agreements is the licensing of the franchisor’s intellectual property to the franchisee. Under a franchise agreement, the franchisee benefits from the ability to operate their own business but under the franchisor’s established brand. A well drafted franchise agreement will ensure that clauses allowing the franchisee to use the franchisor’s name, trade marks and other intellectual property in the operation of its business are included. Doing so allows the franchisee to follow a proven business model and benefit from the existing brand recognition – arguably the most valuable aspect of this type of agreement.

• Continued support from the franchisor to the franchisee

Another major attraction to franchise agreements is the support that the system provides to franchisees, who may be first-time or inexperienced business owners. Franchise agreements should include clauses relating to the franchisor’s continued involvement to offer support and assistance to the franchisee in the running of the business. On the other hand, the key clauses for the benefit of the franchisor will include those relating to maintaining ultimate control over the franchise and the entitlement to receive royalties.

• Maintaining control of the franchise

The involvement of the franchisor does not end once the franchisee begins running its business under the franchise agreement. Rather, the franchisor will want to retain ultimate control despite the fact that the franchisee operates as an independent trader. The agreement will need to contain clauses that reflect the franchisor’s high degree of control and it will also need to ensure that the franchisee complies, amongst other things, with the franchisor’s operational manual.

• Entitlement to royalties

A franchise agreement should also make provision for the payment of royalties to the franchisor in exchange for it granting licences and providing its expertise to the franchisee. Inclusion of such a provision allows for both parties to commercially benefit from the agreement. The franchise agreement will, therefore, typically set out terms for periodic payments by the franchisee to the franchisor.

Properly incorporating these key terms comes down to a well drafted contract. Obtaining advice early can prevent missing out on crucial clauses and avoid disappointment.

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If you have any enquiries in relation to franchise agreements, please contact David.Gordon@healys.com.

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