Franchise Agreements: The key negotiating points to consider

Exclusive Rights
These grant the franchisee exclusive rights to run franchise outlets within a certain territory. The definition of ‘territory’ must be carefully defined as this will determine the size of the area of operation for the franchisee. Exclusive rights help to reduce competition for the franchisee who will want to maximise revenue through their outlets. The franchisor may not wish to grant any exclusivity rights or limit these rights or the size of the territories to open their franchise up to as many business owners as possible.

Management Fee and Advertising Levy
These fees are paid by the franchisee to cover a proportion of the cost of advertising the franchise and the franchisor’s cost of providing support to the franchisee. These costs are normally calculated as a percentage of the revenue of the franchise outlets. If the franchisee is in a particularly strong bargaining position, it may attempt to drive down the percentage cost in negotiation. Franchisees should also consider whether it is more cost-effective to elect to pay for advertising within its given territory of business or as a proportion of the franchise’s national expenditure.

Franchisee and Franchisor Obligations
Both parties need to be clear on their requirements, as these will apply throughout the term of the Franchise Agreement. Naturally, a franchisee will want to reduce their obligations to the franchisor, for example, by removing any restrictions on pricing for products/services or negotiating performance targets that better reflect the economic landscape, but this may not be possible unless the franchisee has significant bargaining strength. An alternative approach can be to focus on increasing the franchisor’s obligations to provide the franchisee with as much support as possible when running their business. For example, the franchisee may attempt to insert a requirement to ensure the franchisor continues to provide a resource for research and development of its products, services or training. As is often the case, if you don’t ask, you don’t get!

Premises
Certain franchisees, particularly those in the retail and restaurant sectors, will want to lease and use premises owned by the franchisor as this will help reduce initial set-up costs and these premises may be ideally located to generate revenue for the business. Even where premises are not offered within the Franchise Agreement, the franchisee should consider such provisions carefully, as the franchisor may want to stipulate selection criteria for the location of the business, stipulate fit-out criteria regarding how the premises should look or require consent for any alterations to business premises to ensure that these aspects are in line with the style and branding of the franchise. The franchisee should try to ensure that these requirements do not inhibit its ability to put its own ‘creative stamp’ on the business, as this may be a key factor in generating revenue and growth through their particular outlets.

Sale or Transfer of the Business
Consideration should also be given to how the franchisee’s business can be sold or transferred. The franchisor will not want the franchisee to transfer its business freely to ensure the business does not fall into the hands of those who may threaten the goodwill within its trademarks. However, the franchisee will want to exploit any sale value generated if the business does well. The franchisor may ask for rights of first refusal and/or conditions on sales to third parties, for example, the franchisor’s consent may be required, or the potential third-party purchaser may have to meet certain requirements set by the franchisor. The franchisee should ensure there is as much flexibility as possible to continue to run and develop the business and to ensure future generations benefit.

Restrictive Covenants
The franchisor will want considerable restrictions on the franchisee preventing it from trading under similar businesses. The purpose of these restrictions is to protect intellectual property rights and confidential information within the franchisor’s brand and to reduce competition within its franchise. The detail of these provisions should also be a key consideration for the franchisee because restrictions can last for some years following the end of the Franchise Agreement. The franchisee should attempt to narrow the scope and duration of these provisions so that they are not bound to overly onerous restrictions for a long period of time and can therefore utilise the experience they have gained to generate future revenue streams.

Renewal Conditions
Both franchisors and franchisees should consider setting out criteria for renewing/extending their Franchise Agreement in the Agreement itself to ensure both parties are clear on how the Franchise Agreement is renewed/extended and so remove any risk around what the franchisor will require to do this. Franchisees should bear in mind that the franchisor will want renewal terms and processes to be consistent across its franchise operations, and this is likely to inform any negotiation on this. Franchisees should make sure they have a clear understanding of these terms to inform their long-term planning.

Carefully considering these key points should help both franchisors and franchisees establish a strong foundation for their franchise business and ensure a successful partnership.

Our highly experienced Corporate & Commercial team specialises in both drafting and negotiating Franchise Agreements.

Contact the team if you are a franchisor looking to build your franchise or an aspiring franchisee looking to capitalise on a growing brand.