If you’re buying a franchise for the first time, it can be difficult to know where to start. Because we like to help our clients as much as possible, here’s our Buying a Franchise FAQs to get you started.
- Preparing for the franchise purchase
- When buying a franchise, what questions should you ask?
- What general business advice is available on buying a franchise?
- What legal advice will you need when buying a franchise? Do you need a specialist franchising solicitor?
- Do you need a business plan to buy a franchise?
- What should you know, or consider, when buying a franchise?
- What’s the process of buying a franchise?
- Can I buy a franchise from an existing franchisee? What’s the process?
- Can I buy a franchise from overseas? What’s the process?
- Do you need a licence to buy a franchise?
- Can you buy a franchise online?
- Financing the purchase of a franchise
- Employment law and franchisees
- Types of franchise
- What is a business format franchise and why would you want to buy one?
- What is a master franchise? Why and how do you buy one?
- What is a franchise resale? Why would you buy one and what is the process?
- What is a buy to let franchise? Why would you buy one and what is the process?
- What is a franchise buy out?
- What is a pilot operation or a pilot franchisee?
- Rights, responsibilities and franchisee agreements
- What should be in a franchise agreement?
- What is a franchise purchase agreement?
- What is a franchise development agreement?
- What are the franchisee’s rights when buying a franchise?
- Why is a franchise agreement necessary?
- What are a franchisee’s rights and responsibilities concerning advertising?
- What are a franchisee’s rights and responsibilities concerning intellectual property rights, including trade marks, patents and licences?
- What are a franchisee’s rights and responsibilities concerning property leasing for any business premises?
- Is it better for a franchisee to have a licence or a lease for their business premises?
- Can a franchisee be required to complete works on the business property, such as rebranding or installing certain technologies and so on?
- What legal protection is a franchisee entitled to?
- How does the CRC Energy Efficiency Scheme (and its abolition from 2019) affect franchisees?
- Which laws and specific legislation apply to franchisees and their activities?
- Can a franchisee sue a franchisor?
- What happens to the franchisee’s business if and when the franchise comes to an end?
- How does the franchisee go about renewing their agreement with the franchisor?
- What if a franchisee wants to leave the franchise? How would an agreement be terminated?
- What are restrictive covenants and how do they affect the franchisee after they’ve left the franchise?
- Can a franchisee gain exclusive rights in a territory? How is this achieved?
- How is being a franchisee different to…
- What is the difference between franchising and distributorship (ie, with a distribution agreement)?
- What is the difference between being a franchisee and a licensee (ie, with a licensing agreement)?
- What is the difference between being a franchisee and a reseller (ie, with a reseller agreement)?
- What is the difference between being a franchisee and operating an outlet?
- What is the difference between being a franchisee and being part of a joint venture?
What does buying a franchise mean?
Buying a franchise means that you buy rights from one party (the ‘franchisor’) to develop and operate a copy of the franchisor’s business as the ‘franchisee’. You’ll be paying a regular fee to the franchisor for granting their rights to you, whilst making a profit from running the business you operate through exercising those rights.
Legally, the franchisor grants you, the franchisee, the right to use the brand of a franchisor as your own, and provides instructions so you can follow the franchisor’s proven business model/format. Whilst you remain an independent trader, the franchisor will impose restrictions on your business operation to preserve the reputation and identity of the franchise.
The key rights that will be granted to you as a franchisee include the right to:
- Use a name which is associated with the franchisor
- Receive assistance from the franchisor
- Use the intellectual property of the franchisor
The key responsibilities of the franchisee include:
- Making periodic payments to the franchisor for the right to use the name and IP, for example
- Promoting the brand of the franchise
- Protecting and preserving the reputation of the franchise
What are the advantages of buying a franchise?
Buying a franchise allows you to set up a business without starting from scratch. The advantages of buying a franchise are:
- As the franchise is based on a business idea that has already proven successful, there is less risk with buying that business.
- A good franchisor will continue to research and update the business idea meaning you are purchasing a more valuable and (potentially) more profitable business.
- Buying a franchise may mean you’re using a recognised brand name and trademarks. This strong reputation will make it easier for you to sell so will help boost your profit-making abilities.
- Buying a franchise will grant you the benefit of any national advertising or promotion undertaken by the franchisor.
- A good franchise operation will give you significant support by helping train you and advising you on how to run the business, whilst also helping you set up the business.
- As you will be given exclusive rights to the franchise, usually within a specified region or an exclusive client base, there is reduced competition for your business.
- It is also easier to obtain finance to invest in a franchise which has a good reputation.
- Buying a franchise with a good relationship with banks will make it easier for you to obtain finances for your business.
What are the disadvantages of buying a franchise?
There are some disadvantages of buying a franchise. These include:
- Buying a franchise can be expensive because, in addition to paying the fee to buy into a franchise, you must also pay the usual business cost for premises, equipment and stock. You will also be required to pay a royalty on sales or a management fee, which is a fixed amount or a percentage of the values of sales. This payment will need to be made regardless of whether you’re in profit. There may even be additional costs for any training received from the franchisor, or any advertising benefits for example.
- When buying a franchise, you will have to agree to operate within limits. As a result, you won’t be able to change the nature of the business to pursue your own business initiative and ideas.
- When you eventually sell the franchise, the franchisor must approve the buyer.
Should you buy a franchise or start your own business?
Based on the advantages and disadvantages we’ve discussed above, whether you should buy a franchise or start your own independent business depends mainly on your commercial objectives. Let’s explore what’s most important for you as a franchisee:
- Ease: If looking for a quick entry into a business with limited risk, buying a franchise is ideal. This is particularly true if you wish to run a business but believe that you’d also like ongoing support with your operations. If you’re also keen to buy into an established customer base, buying a franchise would better meet your needs. The same is true if you’d like to run a business without having to build new relationships with suppliers and media contacts, because a franchise will usually have an established relationship with suppliers and media contacts – who can also support your franchise business.
- Freedom: Another important question to ask when deciding if you should buy a franchise is whether you believe you’d be happy to operate the business within the restrictions imposed by the franchisor. If you’d feel inhibited from pursuing your commercial objectives due to the restrictions, starting your own business may be a better option to explore your own business ideas and seek freedom. It’s worth noting that whilst there is unlimited prospect for start-ups to grow, a franchise can only grow up to a certain point. However, it’s also true that start-ups have a higher failure rate. Buying a franchise reduces this risk because you will be structuring your business on the same model of a successful franchise.
- Costs: Another key consideration that will impact on your decision to buy a franchise or start up your own business is whether you have the finances to pay the high costs of buying a franchise. Whilst there are numerous types of costs involved in buying and running a franchise, there are also costs involved with starting up your own business. For example, in addition to paying a fee to Companies House to incorporate your business, you may also incur significant expenses from employing solicitors to draft documents such as the articles of association, memorandum of understanding, and the shareholder’s agreement. Find out more about this our advice, The Honest Guide to What You Do And Don’t Need A Solicitor For – Part 1: Setting Up A Business. You may also have significant costs arising from acquiring a lease for the premise of your business, and from buying stock and equipment. In addition, you will face costs for marketing and advertising, as well as costs incurred from obtaining business insurance. And yet despite all these fees and costs of a start-up, this may still be cheaper than buying a franchise.
Should you buy a franchise or an existing business?
Whether you should buy a franchise, or an existing business depends on your objectives.
Buying an existing business is preferable to buying a franchise if you wish to have independent control over the business, and seek the freedom to pursue your own ideas. Similarly, if you wish to buy a business operating poorly at an undervalue to turn the business around for profit, buying an existing business may be a better option that matches your commercial goals.
If, however, your objective is to run a business under guidance, buying a franchise will offer you the support to run and manage the business in the market.
Can anyone buy a franchise?
All legal persons can buy a franchise. This means individuals, limited companies, and limited liability partnerships (‘LLPs’) may become owners of a franchise.
In practice, if a franchise is purchased by a company, the franchisor will seek a personal guarantee from the directors and shareholders of the corporation. Similarly, where a limited liability partnership buys a franchise, the franchisor will seek a personal guarantee from the individual partners, or require all the partners to sign the agreement as separate parties. This ensures all the individuals operating the franchise are bound by the obligations and undertakings of the franchise agreements.
Although an individual can buy a franchise, the franchisor will only accept an individual that shows promise of running a successful business. As the franchisor will require the franchisee to run the business to the same high quality of its other franchisees, it’s essential that the franchisee shows the same passion, dedication and long-term goals as the franchisor and other franchisees. If you can’t show an understanding of the franchisor’s approach to business, it’s unlikely you will be able to buy a franchise. The same barrier would apply for any partnership, LLP and company seeking to buy a franchise.
A franchisor will also require the individual to have sufficient finances to buy the franchise and have capital for the launch of the franchise. This restriction on eligibility may be expressed as limiting payments, made available by way of loan to a percentage of the total amount, for example 25% of the payment may need to be unencumbered (i.e. not a bank loan).
Can you buy a franchise at a young age?
Whilst there is no age restriction on buying a franchise, in practice, a franchisor would be reluctant to sell a franchise to a young franchisee. This is because the franchisor will seek a buyer that has some experience in the market, and has the skills and knowledge required to successfully run a business. As a young franchisee won’t have had as many opportunities to obtain such experience, this reduces the likelihood of a young individual being able to buy a franchise.
A franchisor will also be conscious of barriers arising from selling a franchise to an individual aged under 18. Whilst there is no legal restriction, an under-18 buyer would be unable to open a business bank account for the franchise. What’s more, the young franchisee would also be unable to borrow money or have a credit card. This would severely limit the funds available and threaten the operation and success of the franchise.
Do you need to be a limited company to be a franchisee?
No, it’s is not necessary to be a limited company to be a franchisee. A franchisor would consider selling a franchise to individuals, partnerships, LLPs, and companies, provided the buyer demonstrated an ability to successfully run the franchise at the same quality as the other franchisees.
As we mentioned in the question ‘Can anyone buy a franchise?’, where a company does buy a franchise, the franchisor will seek a personal guarantee from the directors. This is to ensure that the individuals managing the limited company (which will run the franchise) will comply with the obligations of the franchise agreement. Particularly important terms that the franchisor will be concerned about are the clauses requiring the franchisee to operate the business at a high quality which matches other franchisees and the confidentiality clauses. The confidentiality clause ensures that all the individuals with access to confidential information about the franchise don’t reveal or exploit the information (unless permitted under agreed exceptions).
Preparing for the franchise purchase
When buying a franchise, what questions should you ask?
When considering whether to buy a franchise, the first question you should ask yourself is whether you would be happy to run a business within the restrictions and interventions made by the franchisor. If you are, you should then consider whether you have the skills, knowledge and determination to run a business at the same high quality as the other franchisees. A failure to do this would result in you breaching the franchise agreement. You should therefore consider whether there is a risk that you may not have the requisite standard of experience.
If you’re sure you want to buy a franchise, your next question will be which franchise should you buy. One of the greatest advantages of buying a franchise is the possibility of seeking information about the franchise from other franchisees. Good questions can help you find out all the important information about the franchise and make a comparison about the most desirable franchise for you. Some questions you might ask of current franchisees could be:
- What was your total investment and what kind of costs did you face?
- Were the franchisor’s projections for your business performance accurate?
- Did the franchisor provide all the promised help and assistance for the start of the business?
- How useful was the support, training and manual?
- Is the manual easy to follow?
- Is there a high demand for the franchise’s goods or services?
- Is the franchisor prompt and efficient in dealing with problems which arise when running a franchise?
- How much control is exercised by the franchisor in practice?
- Is the franchise providing a satisfactory return?
What general business advice is available on buying a franchise?
If you’re considering whether to buy a franchise, you can find additional information about the process of buying a franchise and whether it’s suitable for you at the ‘Which Franchise’ website. This website is a credible source for general franchising advice, as it’s the official online partner of the British Franchise Association.
What legal advice will you need when buying a franchise? Do you need a specialist franchising solicitor?
You will need legal advice when buying a franchise to ensure you have undertaken adequate due diligence. There are a number of things you should look for when buying a franchise, such as the fees under the franchise agreement, the main assets of the franchise (intellectual property), and the relationship between the franchisor and other franchisees.
You’ll also need extensive legal advice when drafting, negotiating and agreeing the terms of the agreement. In this case, we’d always advise engaging the specialist services of a franchising solicitor. This will ensure there is adequate protection for you, such as ensuring the agreement includes a term granting you the right to terminate if the franchisor sells the entire franchise. Drafting clear provisions concerning matters such as warranties, payment, and termination is important to both parties because it also reduces uncertainty and lowers the chances of a dispute arising about these matters.
Do you need a business plan to buy a franchise?
When you are deciding to buy a franchise, you should have an idea or plan of how long you want to run the franchise business. You should also consider your objectives. Are you buying a franchise to gain more business skills, or to make a profit by running the business and potentially also by selling the franchise?
Once you’ve chosen the franchise you wish to purchase, or the market in which you want to purchase the franchise in, you should have a business plan to ensure you know how you’ll successfully run and develop the franchise business. Whilst your plan will need to be flexible to comply with the operation manual provided by the franchisor, creating a business plan will ensure your franchise business runs more smoothly.
What should you know, or consider, when buying a franchise?
When buying a franchise, you should consider whether you would be happy to run a business under the guidance and monitoring of a franchisor. You should also ensure you will be in a position to procure sufficient finances to buy the franchise, and fund the launch of the franchise business.
You should also ensure that you undertake extensive research into any franchise opportunity. When looking at the franchise business, consider whether the franchise fits with your existing skillset or interests. The more experience and enthusiasm you have for the franchise, the greater success you’ll have running it.
What’s the process of buying a franchise?
When you’ve decided to buy a franchise, you’ll need to find a franchise to buy. Once you’ve chosen a franchisor to enter a franchise purchase agreement (‘franchise agreement’) with, you may enter an exclusivity agreement to ensure the franchisor doesn’t t enter talks to sell the franchise to another buyer during the due diligence and negotiation period.
In addition to this, you should sign a confidentiality agreement to ensure any information revealed during due diligence and negotiations, isn’t used and exploited by the franchisor.
Once you’re aware of the finance required, and you’re sure you’d like to proceed with the purchase, you should ensure you have the required funds to make the payment required under the franchise agreement. If you will be financing the purchase by way of a bank loan, it’s important to ensure that the bank have committed to provide the loan if the purchase is completed.
If a deposit agreement is used, you may also be required to pay a deposit at this stage of the purchase.
The next stage is to negotiate a draft franchise agreement, which contains detailed terms of the arrangement. If the franchisor has a large network, the franchisor may have a standard franchise agreement which you will be requested to sign. However, if you are able to negotiate the terms of the agreement, you should seek to ensure the terms protect not only the franchisor but also the franchsiee.
Terms that the franchisor will reasonably expect include:
- The right to monitor the performance of the franchisee
- A restrictive covenant that the franchisee will not undertake competing business during the term of the franchise
- A provision protecting intellectual property of the franchisor
- Limitations on the rights granted to the franchisee
Terms which the franchisee will reasonable expect include:
- A provision where the franchisor provides the franchisee and its staff with training
- Provision on whether the franchisor or a third party will supply the goods and services, and the quality of these goods and supply
- A provision detailing the responsibility for marketing, advertising, and promotions
- The franchisee’s right to sell the business and whether the franchisor has pre-emption rights
You will also need a term specifying the duration of the franchise agreement, whether the franchisee has the option of renewal, and methods of early termination (termination before the termination date specified in the agreement).
After the agreement is finalised, you will sign the agreement. To allow you to successfully operate the franchise, you may also need to agree and enter into supplementary documents and agreements. For example, if the franchisor is sub-leasing the business premise, a separate sub-lease will also need to be entered into.
Upon signing, you’ll be able to start running the franchise; convert any business premises into a franchise outlet and begin the franchisor’s training.
Can I buy a franchise from an existing franchisee? What’s the process?
Yes – it’s possible to buy a franchise from an existing franchisee. This sale is known as a franchise resale, and is possible because under the franchise agreement, a franchisee usually has the right to sell the business if the buyer is approved by the franchisor.
The process of franchise resale is very much the same as a franchise sale. Once you’ve identified a franchisee to buy the franchise from, you should enter negotiations to ascertain the price and manner in which the franchisee will be transferred (such as via share sale or asset sale).
One practical difference resulting from you buying from an existing franchisee is that you will be charged a premium on the franchise – as it has an added benefit of already being set up. Upon buying the franchise, you’ll have suppliers, trained employees, customers and cash flow on your first day. To account for this added value to the business, the price will be higher than buying a franchise from a franchisor. You may also be subject to additional fees such as a transfer fee.
If you and the current franchisee are happy to proceed with the sale, the franchisee will need to obtain the consent of the franchisor because the franchisor must consent to the sale and approve the buyer. You shouldn’t be too concerned with this requirement as the franchisor is under an obligation not to unreasonably withhold consent to such a transfer.
Once consent has been obtained and the franchisor has approved the buyer, you will enter either a share purchase agreement, or an asset purchase agreement with the franchisee, in addition to a franchise agreement with the franchisor.
Upon all the documents being signed, you should receive training from the franchisor to help you run your franchise. You’ll then be able to continue management and operation of the franchise.
Can I buy a franchise from overseas? What’s the process?
Yes – you can buy a franchise from overseas. There are a number of ways you can buy a franchise from overseas.
One option is to buy a franchise from a UK franchisor, which grants you the right to run the business in an overseas territory. The franchisor will then have the responsibility to train and support the franchisee either through long-distance control, a subsidiary office in that country, or an appointed agent.
Direct franchising (franchise arrangement with long-distance control) is not common because tax difficulties arise when an overseas franchisee pays fees to a franchisor in the UK. The franchisor may also struggle to provide adequate training, support, and control to ensure the franchisee is complying with the franchise agreement.
Purchasing a franchise overseas where a subsidiary office is located in the overseas country is more common. That’s because the subsidiary of the UK franchisor will be the franchisor entering into the franchise agreement with you. This means you’ll receive training and support from the subsidiary, instead of the parent company located in the UK. As the subsidiary will have greater resources and experience in the market of that country, this will be more beneficial for you when compared to a direct franchise.
A second option is to buy a franchise from a master franchisee. This would allow you to receive training directly from the master franchisee, who will be based in the overseas territory. They will have the resources and experience to provide adequate support to the franchisee. As the franchise agreement would be entered into with the master franchisee, the master franchisee will take the role of franchisor in the arrangement.
A third option is to buy a franchise by entering a franchise development agreement with a franchisor. This will grant you the right to develop the franchise business in an overseas territory. The arrangement is very similar to entering a direct franchise agreement, except that in a franchise development arrangement, the franchisee is known as the developer and has the obligation to develop the franchise brand.
You should also note that you can buy a franchise from a non-UK franchisor to run a franchise in the UK. Similarly to the options we’ve just mentioned, the overseas franchisor will have a number of opions to enable you to receive the support and guidance, to run your franchise business within the UK. As with any franchise, you should conduct detailed research to ensure the franchise is credible. If the franchise you are buying is the only franchise within the UK, you should ensure you have the skills and confidence to operate the business with more limited support compared to running a UK-based franchise.
Do you need a licence to buy a franchise?
No – you generally don’t need a licence to buy a franchise. However, if you’re buying a franchise which undertakes activity that does require a licence, then you must obtain a licence to run the business and continue that activity. Under most franchise agreements, the obligation to comply with applicable laws and obtain the correct licence is specified as the franchisee’s responsibility.
You may seek legal advice to determine which licences you need and what other laws you need to comply with. Alternatively, you may check Gov.uk’s licence finder to find out yourself whether the business of your prospective franchise requires a licence.
Can you buy a franchise online?
It is possible to find franchises being sold online. Whilst there are many websites online advertising opportunities to buy a franchise, the ideal place to find opportunities is on the British Franchise Association (‘BFA’) website.
The BFA is a regulatory body that grants credible franchises with BFA membership status. To gain this status, the franchise will have passed a standards-based accreditation.
Once you’ve identified a franchise you’re interested in, you can contract the franchisor and proceed with negotiations. To affect the transfer, you would still need to enter a franchise agreement.
Financing the purchase of a franchise
What are the financing and funding options if you don’t have the upfront capital available to buy the franchise?
If you have no funds to purchase a franchise, you may be able to still buy a franchise if you can successfully obtain finances from a bank. However, if the funds required are high, and the bank considers your proposed franchise purchase as a high-risk option, you may struggle to get funds from the bank.
Even if all the funds can be provided by the bank, the franchisor may be reluctant to sell where the purchase is funded wholly by a loan. This is because the franchisor may lack confidence that you have sufficient funds to successfully continue the operation of the franchise business.
If you’re considering buying a franchise with financial support, alternative methods of finance include:
- Pulling equity from your home by using a home equity loan or a home equity line of credit (HELOC). If you wish to consider this option, you should seek the advice of a financial adviser; or
- Finding a business partner who could provide finances.
You may want to read our advice, The Honest Guide to When You Do and Don’t Need a Solicitor – Part 2: Financing A Business.
Can you buy a franchise with a loan or on credit?
Yes – you can buy a franchise with a loan or on credit. It’s quite common for at least part of the franchise to be funded by way of loan. When procuring a loan or credit, you should research the costs associated with getting your franchise business up and running. These costs should include the initial cost, premise costs, training, stock, equipment and so on.
You should then create a franchise business plan. This will convince potential franchise lenders that you’ve thought carefully about the business and have considered measures to ensure its success.
The key elements you should include in your business plan are:
- Executive summary
- Personal details
- Your experience and skills
- Overview of the franchise
- Business operation
- Marketing strategy
- Financial projections
- Borrowing needs
- Capital stake
- Personal finances
Once you’ve completed your business plan, you should consider the best franchise lender for you.
How does a franchisee get paid?
A franchisee is not paid under a franchise agreement. Instead a franchisee will make a profit from the business of the franchise. As a result, if your franchisee business is making a loss, you will not get paid.
Given that you’ll still need to pay royalty fees when making a loss, you should think carefully what you’d do in this situation, and indeed, if buying a franchise is appropriate for you.
How much does buying a franchise cost? What price should you expect to pay for a franchise? How do you judge whether it’s the correct price?
There is no average cost of a franchise because it depends on the franchise and its reputation. A small franchise may require a minimum investment of £500, whereas a large reputable franchise like Clarks may cost £150,000.
It’s therefore important to conduct detailed investigation into the franchise, in order to ascertain its success and ability to generate revenue. You might achieve this by approaching existing franchisees and asking them what their profits and costs are. Of course, we would advise seeking legal advice (and financial advice) to judge whether you’re paying the correct price for the value you’re actually obtaining.
How profitable is buying a franchise?
The profitability of the franchise will depend on a combination of your business management skills, and the reputation of the franchise. A well-known brand will make it easier to sell services and goods, meaning the franchise is more profitable. However, it’s also important for you, as the franchisee, to have the necessary skills to run the business efficiently and sell the goods and services in the market. Part of this will also include having adequate capital to launch the franchise (if you don’t buy from an existing franchisee).
What are the main things a franchisee will expect to pay for?
A franchisor will be conscious of ensuring the fees are not too burdensome that the franchisee’s business will be deprived of important start-up capital investment. Potential fees that the franchisor may expect from the franchisee include:
- Development fee, exclusivity fee, or initial franchise fee. These are upfront fees charged for either the granting of territorial exclusivity to the franchisee, or the right to operate the franchise.
- Store opening fee. This is an upfront fee payable on opening each franchised outlet.
- Service fee or royalty. This is usually a charge calculated as a percentage of the franchisee’s gross turnover, or a fixed amount.
- Marketing contribution. This fee is charged for the marketing campaigns the franchisor develops and runs on behalf of the franchise. This fee is usually a percentage of the gross turnover. However, the franchisor may also require the franchisee to commit to a minimum spend on its own local marketing campaigns.
- Training fees. This is a charge for the training the franchisee will receive to operate the business. The franchisor may choose to arrange periodic training of franchisees.
- Other fees. These fees could include lease rentals, software licences and support fees.
Employment law and franchisees
Can a franchisee be considered an employee of the franchisor?
There is no clear law that would classify a franchisee as an employee of a franchisor. As the relationship between a franchisee and franchisor is one where the franchisor grants the other the right to use its brand for business, it is unlikely to be considered an employment relationship.
A distinction could potentially be made between a company franchisee and an individual franchisee. Whilst a company could never be an employee, an individual franchisee who is subject to significant control of the franchisor, may be interpreted as an employee. This would extremely rare as the level of control required to establish an employment relation is much higher than the level of control a franchisor would exercise.
If you do have a complex query about how employment law applies to the relationship between the franchisor and franchisee, it’s best to ask one of our expert employment law solicitors.
Types of franchise
What is a business format franchise and why would you want to buy one?
A business format franchise (also known as a second-generation franchise), has two key elements:
1) The franchisee operates its business under the franchisor’s trade name or trade mark, so the outside world views the franchisee as the franchisor; and
2) The franchisor must be able to exert substantial influence or control over the way the franchisee operates its business.
By buying a business format franchise, you get the benefit of buying a business with an established reputation. This means it will be easier for your business to trade in the market and subsequently generate a profit.
Choosing to buy a franchise also provides independent traders with a name to operate under. This allows traders to continue profit making through sales, whilst avoiding the hassle of setting up their own business and building its reputation.
What is a master franchise? Why and how do you buy one?
A master franchise is an arrangement where the franchisor grants a franchisee the right to sub-franchise within a territory. A master franchise is therefore a good opportunity for investors with sufficient finance to develop a network of franchises in a territory. To successfully develop the network of franchises, it’s important for the master franchisee to be familiar with the local market, to have relevant experience in the industry and good management skills.
When a master franchisee sub-franchises, the master franchise agreement requires the master franchisee to accept only the highest quality of franchisees. This obligation is supported by the requirement to maintain high standards in relation to all obligations under the franchise agreement with the franchisor.
A master franchise can be bought by entering a franchise agreement. This will detail the rights and obligation of the parties and the fees payable by the master franchisee. The franchisor may also choose to require the master franchisee to open and operate a specified numbers of plot operations under the master franchise agreement.
What is a franchise resale? Why would you buy one and what is the process?
A franchise resale is when a franchisee sells the franchise business to another individual, corporation, partnership or LLP.
To buy a franchise resale, you would enter an agreement to purchase the business, usually a share purchase agreement or an asset purchase agreement, and also enter a franchise agreement with the franchisor.
The process of entering a franchise resale agreement is the same as entering a franchise purchase agreement, which we discuss below in What is a franchise purchase agreement?.
A franchise resale is particularly useful if you would prefer to avoid the slow process of launching the business. This is because the franchise will already have an established customer base, contracts with third parties for supply of goods, and fully trained employees. Once you’ve signed the agreement, you will be running a profit-making business from day one.
This added benefit does come at a price. It is common for a premium to be charged for the additional value provided with the franchise being sold.
What is a buy to let franchise? Why would you buy one and what is the process?
A buy-to-let franchise is a specific type of franchise in the property market. By buying a buy-to-let franchise, you will be purchasing a letting agency where your profits will be made through a commission on the sale of property.
The process of buying a buy-to-let franchise is the same as buying a franchise from a franchisor. You would need to enter a franchise agreement, in addition to obtaining the relevant licences required by law.
What is a franchise buy out?
A franchise buyout is when a franchisee buys out the franchise. As a result of the buyout, the franchisee will become the owner of the entire franchise. This includes any franchisees existing under franchise agreements with the franchisor.
Buying out a franchise is more expensive than buying a franchise because the seller is selling complete ownership of its business. This transaction takes place by entering into a sale and purchase agreement, adopting new articles of association for the target company, entering into an investment agreement and any additional documents for finance.
What is a pilot operation or a pilot franchisee?
A pilot operation is when a company intends to franchise but establishes a pilot operation which tests the business format/idea, to ensure the franchise system will work. The established pilot operation will subsequently be known as the pilot franchisee, and will enable the franchisor to learn about the strengths and weaknesses of the business format in different markets and market conditions.
When a franchisee buys a franchise, it’s important for the franchisee to ascertain whether the franchisor has conducted a pilot operation. A franchisor that has run a pilot operation will have gained insight into the business and identified areas of improvement, the level of demand for services and goods in a location, and the strengths and weaknesses of the business. This means the business will be thoroughly tested and more likely to be successful.
Similarly, it’s also important to ensure the franchise you are buying is not the franchisor’s pilot operation. A pilot operation usually only operates for a year or two. As the full strengths and weaknesses have not been identified, there will be a higher risk when buying a pilot operation.
Rights, responsibilities and franchisee agreements
What should be in a franchise agreement?
A franchise agreement should include the date it is entered into (once signed), and must name the parties to the agreement. As with all agreements, a background should be included to outline the purpose of the arrangement.
Another key term that should be included at the start of the agreement is the commencement date and term. This enable the parties to know how long you have the right to run the business and when the arrangement will terminate.
Other key terms include:
|Fees||Details all the fees that are payable by you to the franchisor. This will include the manner of payment as well as the calculation of payment. The franchisor may also impose interest on payment. The interest rate should be detailed to avoid any uncertainty and dispute in the future.|
|Franchisor’s initial obligations||Specifies the franchisor’s initial obligation to grant you the right to use its software, use its brand name, and provide support and advice on your launch of the franchise business. The franchisor will also have an obligation to provide a manual which provides detail instructions and insight into the running and management of the franchise.|
|Franchisor’s continuing obligation||These provisions will detail the franchisor’s obligation to provide continuing support, know-how, and guidance for the business, as well as updating the manual. If the franchisor is supplying any product or stationery, this will also need to be a continuing obligation for the term of the agreement.|
|Franchisee’s obligations||Specifies the franchisee’s obligation such as operating the franchise in accordance with the manual and improve the business when requested by the franchisor. The provisions also oblige the franchisee to use ‘best endeavours’ to promote and extend the business, and to protect and promote goodwill in the branded business.|
|Employees||Requires the franchisee to ensure employees are adequately trained, professional and appear in accordance with the requirements contained in the manual.|
|Advertising||Requires the franchisee to promote the brand of the franchise, usually by expecting the franchisee to spend a specified minimum amount on local advertising. As the franchisor will be running its own advertisements on behalf of the franchisee, an advertisement levy may also be payable.|
|Premises||The franchisor will want to include provisions monitoring the appearance of the premise used to run the business. This may include restricting alterations by requiring the franchisor’s consent, and by requiring the premise to be kept clean and refurbished regularly to a specified standard. A clause may also address the hours during which the premises should be open for. It’s likely that the franchisor will also include a provision preventing the franchisee from leaving a premise without consent of the franchisor. If this is the case, you should ensure the contract states that the franchisor’s consent is not unreasonably withheld.
An additional term should be included to reflect the parties’ positions with regards to the business premise. If the premise is sub-leased or licenced to you, the franchise agreement should record this.
Additionally, you may want to get expert advice from our commercial property solicitors on any legal aspects of the franchise’s business premises.
|CRC Energy Efficiency Scheme||As the franchisor must participate in the Carbon Reduction Commitment (CRC) Energy Efficiency Scheme, the franchisor will impose an obligation on the franchisee to provide it with information about its electricity and gas supply.
A clause may also be included requiring the franchisee to indemnify the franchisor for any failure to comply with obligations under this clause, in addition to having to pay a ‘fair and reasonable’ proportion of costs that the franchisor may incur for participating in the CRC.
|Intellectual property||Provisions will be included to permit the franchisee to use the trade mark and intellectual property of the franchisor. With regards to any trade marks, the franchisee will be required to pay a registration fee and must agree to comply with the terms in the trade mark licence.
A provision will also be included stipulating that the franchisee has no right or title to the intellectual property of the franchisor, save for that which is set out in the agreement.
The terms will also give the franchisor the right to pursue proceedings relating to intellectual property, and will require the franchisee to inform the franchisor of any infringements of intellectual property committed by the franchise on a third party’s rights, or a third party’s infringement of the franchise’s rights. You may want to consult our intellectual property solicitors for advice on IP strategy or IP disputes.
|Sale of business and assignment||The franchisor will include a provision restricting the right to sell or assign the franchise business by requiring its consent for sale/assignment, and requiring its approval of the buyer/assignee. The provision should specify the procedure for sale/assignment and procuring consent and approval.|
|Termination||A detailed clause is needed to specify the events in which the franchisee and franchisor can terminate the agreement. Common events include a breach of the agreement including a default of payment by the franchisee, a wind-up or dissolution of the franchisee, a bankruptcy petition of the franchisee individual, and change of control.|
|Consequences of termination||Following on from the above provision, a term detailing the consequences of termination should also be included. This will usually provide for all rights granted by the franchisor to be revoked, and will require the franchisee to cease trading immediately. The franchisor may also include a clause on step-in rights, so it can enter the franchisee’s premise and operate the business in place of the franchisee. When acting for the franchisee, we’d recommend imposing a notification period that must pass before the franchisor can exercise this step-in right.|
|Restrictions||This part of the contract will include restrictive covenants which protect the commercial interest of the franchise. Common covenants include a prohibition on use and exploitation of confidential information, prohibition on soliciting of customers and employees, and a prohibition on engaging in competing business. However, to be binding, these terms will need to be reasonable and necessary to protect the legitimate interest of the franchise. To be considered reasonable, the terms will need to be limited in time to generally no more than 12 months after termination, and ideally restricted in geographical scope.|
|Individual’s guarantee and covenants||Where a company enters a franchise agreement with the franchisor, it’s common for an individual’s guarantee and covenant to be included. This binds the individual and requires the individual to ensure the franchisee performs its obligations under the agreement. If the franchisee fails to comply, the franchisor can then demand the individual to perform the obligation, take action against the individual, or require the individual to compensate the franchisor for the failure.|
|Expert determination||This clause may be included to allow an expert to be appointed to resolve a dispute matter under the agreement. The procedure of appointing such an expert must be agreed and recorded in this term. This allows the parties to efficiently resolve a matter and continue business.|
|Alternative dispute resolution||The agreement may include an obligation to attempt arbitration to resolve a dispute. There may also be a provision detailing the mediation process if the parties volunteer to attempt mediation during the arrangement.|
What is a franchise purchase agreement?
A franchise purchase agreement (or franchise agreement) contains the terms upon which the franchisor grants you the rights to its assets and property. This means the franchisor will allow you to use its brand, trademark, and/or intellectual property exclusively within a territory defined in the franchise purchase agreement.
An important element of buying a franchise is arranging the business premise. There are a number of options for the parties. The franchisor may have ownership of a premise, or a lease which it would make available for the franchisee. You would therefore need to agree whether the franchisor sub-leases or licences this premise to you. Alternatively the franchisor may agree to seek a premise for you to lease or licence. Another option may involve the franchisor leaving the responsibility to arrange a premise to the franchisee. You would then need to find a third party to lease a premise for your franchise business.
Whichever option is agreed by the parties, it will be recorded in the franchise purchase agreement. If, for example, a sub-lease is agreed, an additional lease document would be signed by the parties.
What is a franchise development agreement?
A franchise development agreement (FDA) involves an arrangement where the franchisor appoints a licensee to develop the franchise within a particular territory by operating a franchise outlet. This is different to a master franchise because under the FDA, the licensee cannot grant sub-franchises. Instead, the licensee operates multiple outlets by establishing subsidiaries.
What are the franchisee’s rights when buying a franchise?
In the franchise agreement, the franchisor grants the franchisee the rights to:
- Carry on a branded business
- Use the intellectual property of its business
- Use the benefit of the franchisor’s accounting, management, and marketing knowledge and experience
- Use the trade mark of the franchisor (occasionally by way of entering a separate trade mark licence)
- Gain support, know-how and guidance from the franchisor
These rights are usually granted exclusively to the franchisee within a specified geographical location. This enables you to operate the business with limited competition.
You may also have the additional right to renew the franchise agreement, and to sell and assign the franchise business with the consent and approval of the franchisor.
Why is a franchise agreement necessary?
A franchise agreement is essential because it specifies the rights granted to the franchisee, and the limitations of these rights. The franchisee can then plan how to manage and run the business within the powers and limitations granted.
The agreement also deals with important elements of the arrangement. In addition to specifying fees payable to the franchisor, it also reflects the agreement between you and the franchisor regarding premises and ownership of intellectual property rights.
Having detailed rights and obligation also ensures that the parties to the agreement know the extent of their liability, and can identify when a party has breached the agreement. This makes resolving disputes easier and therefore increases the chance that the parties settle the matter without recourse to a costly court procedure.
What are a franchisee’s rights and responsibilities concerning advertising?
The franchisor will usually promote the franchise brand on behalf of all of its franchisees. To compensate for the expenses, the franchisor will charge you an advertisement levy which may be expressed as a percentage of the costs, or may be a fixed amount. The franchisor is also obliged to provide you with promotional display literation which it considers suitable.
With regards to your responsibilities, the franchisee must promote and advertise the franchise brand and business within the territory it operates. It’s common for the franchisor’s operation manual to detail the procedure of such promotion. The franchise agreement may specify a minimum spend to advertise in the territory, as this will allow the franchisor to ensure sufficient advertisement has been undertaken.
What are a franchisee’s rights and responsibilities concerning intellectual property rights, including trade marks, patents and licences?
With regards to intellectual property rights (‘IP’), the franchise agreement will usually contain provisions such as:
- The right for the franchisee to use the IP
- Reservation and limits on the use of IP
- Non-disclosure and confidentiality provision
- Grant back of the ancillary IP developed by franchisee to franchisor for use in its network
- Franchisee’s obligation to return the manuals and other confidential materials on termination
- Provision that only the franchisor has the right to take legal action against a third party that infringes on the franchisor’s IP
What are a franchisee’s rights and responsibilities concerning property leasing for any business premises?
Where a franchisee obtains a lease from a third party, or obtains a sub-lease from a franchisor, the franchisee will have numerous rights and responsibilities under the arrangement. You may want to consult our specialist commercial property lawyers for specific advice on your lease situation.
These rights and responsibilities include:
- Conducting a health and safety risk assessment in the workplace. This includes responsibility for fire safety, safety of electrical equipment, gas safety, managing asbestos;
- Providing a reasonable temperature for employees and customers of the business;
- Providing adequate space, ventilation and lighting;
- Providing toilet and washing facilities;
- Providing drinking water;
- Providing safe equipment; and
- Maintenance and repair of the property as agreed in the lease. This may require the franchisee to maintain both internal and external repair. Read our advice, Is a tenant responsible for repairs and maintenance in a commercial lease?
Is it better for a franchisee to have a licence or a lease for their business premises?
The difference between leasing and licensing a business property is that a lease (or sub-lease) will create an interest in the property whilst a licence creates rights which are exercisable over the property.
The distinction is important in practice because if an interest is created by a sub-lease, and the franchisor is the landlord, law stipulates that as the tenant, you are entitled to continue occupation of the premise after the expiration of the lease. The franchisor will insist on excluding this right by following a statutory procedure. If the parties would prefer to make a quick arrangement, entering a licence would not include this right, therefore would allow the parties to avoid having to complying with unnecessary additional procedures.
However, a franchisee may prefer to benefit from the added protections of the business premises being leased. Where the franchisor leases the premise, the agreement will contain protections such as a covenant from the franchisor guaranteeing quiet enjoyment. What’s more, a lease will usually be exclusively granted whereas where a license is granted, a franchisee may not be granted exclusive possession of the business premise.
Additionally, as a licence can be terminated by either party for reasons more flexible than a lease, a franchisee may wish to obtain a lease which is harder to terminate. This would give the franchisee more certainty about the rights and access to the property for the duration of the franchise agreement.
Can a franchisee be required to complete works on the business property, such as rebranding or installing certain technologies and so on?
It’s common for the agreement to require the franchisee to complete works such as refurbishing, redecorating, and improving the business premise. As the franchisor will have imposed a specified standard of the premise, you must ensure such works are carried out when the condition of the premise falls below this standard. For more information, read our advice Is a tenant responsible for repairs and maintenance in a commercial lease?
However, you will likely need written consent from the franchisor to carry out alterations on the premise. Therefore, when completing works on the business premise, you should ensure you obtain this consent if the refurbishment involves any alterations.
With regards to installing certain technologies, the franchisor is under an obligation to provide the software and technology to be used for the franchise. In addition to this, the manual should advise you on how to install the technology. If you struggle with the instructions in the manual, the franchisor is obliged to provide support to help the franchise install relevant technologies. However, you should be aware that the obligation to update and replace the technology usually lies with the franchisee.
A franchisee isn’t allowed to rebrand the franchise, and must ensure all branding of the business complies with the instructions of the manual. However, it’s common to find an obligation on the franchisee to inform the franchisor of any potential improvements in the brand.
What legal protection is a franchisee entitled to?
There are a number of provisions which can be included in the agreement to grant a franchisee legal protection.
One way to obtain protection is to include thorough warranties and representations which confirm the financial information provided regarding the franchise. This ensures you have recourse to remedies if the warranties are breached or the representations are false.
Another way to obtain protection is to include a limitation of liability clause which ensures any liability to the franchisor, caused by the franchisee’s employees, is limited to a maximum sum. This ensures the franchisee doesn’t incur significant liability under the arrangement.
You may also seek a confidentiality undertaking from the franchisor, to not reveal and exploit any confidential information revealed during the negotiation of, and during the, franchise agreement. This protects the business interest of the franchisee during and after the franchise arrangement.
A final way to obtain protection is to include a term which requires the franchisor to notify and consult you in the event that the franchisor decides to sell the entire franchise. This will ensure you can prepare for a change in the franchisor, and potentially consider if you would like to terminate the franchise early by selling the franchise business before the franchisor’s sale of the entire franchise.
How does the CRC Energy Efficiency Scheme (and its abolition from 2019) affect franchisees?
Organisations which must participate in the CRC Energy Efficiency Scheme, must buy an allowance for every tonne of carbon they emit. Where a franchise is an organisation which falls within the scope of the scheme, the franchisor must obtain information about all franchisees’ electricity supplies, and aggregate this when calculating the total amount of carbon emitted.
Under this scheme, the franchisor is entitled to pass the costs on to the franchisee. This means taking measures to limit carbon emission is in the franchisee’s interest as it will reduce the overall emission of the entire franchise.
There are some circumstances in which a franchisor is not responsible for the carbon emission of a franchisee under the CRC. These include circumstances when:
- The franchisee is a tenant at the premises and the landlord is responsible for procuring the franchisee’s energy supplies. In this event, the landlord is responsible for the carbon emission.
- The franchisee carries on the franchise business and another unconnected business from the same premise, and a franchise agreement does not exist. In this event, the franchisee is directly liable for its carbon emission.
An important update which franchisees should be aware of is the Government plan to abolish the CRC Energy Efficiency scheme from 2019. This means businesses will be required to surrender their allowances for the final time in October 2019. A CRC contribution would therefore not be necessary for any franchise agreements entered into after October 2019.
Which laws and specific legislation apply to franchisees and their activities?
There is no direct legislation that governs franchises. However, there are a number of different laws which regulate certain areas of a franchise. See how legislation affects each area:
|Advertisement||Consumer Protection from Unfair Trading Regulations 2008 and Business Protection from Misleading Marketing Regulations 2008||These two pieces of legislation prohibit a business from engaging in unfair commercial practice against consumers. The legislation includes misleading advertisements used to coerce consumers to buy a product or service, as an unfair commercial practice. It’s therefore important to ensure any advertisement undertaken by a franchisee, in order to promote the business of the franchise under the franchise agreement, is not misleading.|
|Broadcast Advertising Code (BCAP Code)||The BCAP Code requires the advertisement on radio and TV to be ‘legal, honest and truthful’, and must not mislead, cause harm, or cause serious or widespread offence.|
|Non-broadcast Advertising, Sales Promotion and Direct Marketing (CAP Code)||The CAP Code encompasses three key principles. It requires advertisements to be:
1) legal, decent, honest, and truthful;
|Trademarks||Trade Marks Act 1994||Where a franchisee enters a separate licence agreement to gain the right to use the franchisor’s trade mark, the legislation requires the licence to be registered with the Trade Marks Registry.|
|CRC Energy Efficiency Scheme||Climate Change Act 2008||This Act requires eligible organisations to buy an allowance for the amount of carbon it emits.
The Government have proposed to abolish this requirement, meaning that after October 2019, organisations will not need to buy an allowance. Instead, there is likely to be an increase in climate change tax.
|General Regulation||The Trading Schemes Act 1996||Most franchises fall within this legislation. Under this Act, the franchisor is subject to advertising restriction.
Additionally, this Act provide protection for franchisees by granting them a 14-day cool-off period before being bound by the franchise agreement. This means a franchisee can avoid a franchise agreement if the franchisee changes its mind before the end of the 14-day period.
|Bribery Act 2010||This Act makes states that an organisation will have committed a criminal offence if a person associated with the organisation, bribes another person, for a business advantage.|
|Modern Slavery Act 2015||This provision requires organisations with a global turnover of over £36 million to publish an annual slavery and human trafficking statement for each financial year. This statement should include measures taken|
Can a franchisee sue a franchisor?
Yes – under the franchise agreement, the franchisee can sue a franchisor. The most common claim against franchisors is a misrepresentation claim. A misrepresentation claim can arise where the franchisor has sold the franchise business to the franchisee using information which is not accurate and is misleading. Most misrepresentation claims usually involve the franchisee entering the franchise agreement on reliance of financial information which is not complete or inaccurate.
A common remedy for misrepresentation is damages. A successful claim for misrepresentation would therefore result in the court ordering the franchisor to pay damages. The damages will seek to put you in the position you would have been in before the contract was entered into.
Where there is a significant misrepresentation or a fraudulent misrepresentation, meaning the franchisor deliberately and intentionally misrepresented the franchise to induce you into buying the franchise, you would also be entitled to rescind the contract and to be put into the position you would have been if you had not entered the contract.
Other common claims include a breach of the agreement by the franchisor. This may include:
- Failing to provide support, training, and know-how, contrary to the initial and ongoing obligations of the franchisor.
- Where terms of the agreement specify the franchisor must promote the franchise business but fails to do so.
The common remedy for breach of contract is also damages. Where you make a successful claim for breach of contract, the court will award damages for the loss you have suffered. The damages will seek to put you into the position you would have been in if the terms of the agreement had not been breached.
If the breach of contract is fundamental, such as failure to provide a manual and training to give you the agreed support to launch and run the franchise business you purchased, you may be entitled to repudiate the contract: meaning you can terminate the agreement and claim damages.
A final claim may be a breach of warranty, as the franchisor may incorrectly warrant that the trademark and intellectual property rights granted to the franchisee do not infringe the rights of a third party, for example.
A breach of warranty will entitle you to damages which seek to put you in a position that you would have been in if the warranty had not been breached.
If you do find yourself having problems with the franchisor, you may want to consider resolving the matter without litigating in court. Harper James Solicitors has a number of expert lawyers who can advise you on your franchise arrangement, and help resolve any disputes which arise during the arrangement. Our team of dedicated lawyers have a deep understanding of the commercial needs of a business; meaning we can help you resolve disputes both in court, and out of court through alternative dispute resolution procedures.
What happens to the franchisee’s business if and when the franchise comes to an end?
When a franchise agreement comes to an end because the duration of the agreement has passed, you’ll have a number of options as to how to proceed. These include:
- Renewing the agreement in order to continue running the franchise business on either the same or new terms. This will usually require a payment of a renewal fee, as well as the parties entering a revised franchise agreement.
- Let the agreement expire and de-brand the entire business. Choosing this option means you will need to remove all items and property which enabled your business to identify with the franchise. It therefore includes signs, paint colour or colour themes, uniform, and branded accounts on social media.
- You could sell the franchise business to either a third party or back to the franchisor. Where you sell to a third party, you’ll have to seek the franchisor’s consent to the sale, and the franchisor’s approval of the third party. For this reason, you may find it easier to sell to the franchisor. As the franchise agreement will usually contain a step-in clause, the franchisor can give written notice and step-in to run the franchise without issue. This means the management transition for the business when transferred to the franchisor is slightly easier than the transition to a third party.
Where the franchise agreement ends for reasons other than the passing of duration, such as a franchisee’s breach of agreement, or winding-up/dissolution of the franchisee, the agreement will usually contain a provision outlining the consequence.
A common consequence of termination for the reasons we’ve discussed is that the franchisee must immediately cease running the business and de-brand. As we’ve mentioned above, this will require removal of everything that allows the business to identify with the franchise. In addition to this, the franchisor usually has the option to buy back any equipment or fittings and fixtures it sold to the franchisee. The price of the buy-back will be at a price the franchisor reasonably considers to be the market value. If this option isn’t exercised, the franchisee is free to sell these items to third parties.
A distinction must be made between items sold to the franchisee and items hired or loaned. Any items hired or loaned from the franchisor must be returned to the franchisor. You must therefore ensure you don’t sell these loaned items.
It’s also common for the step-in right to be included. On early termination of the franchise agreement, the franchisor will be entitled to give notice to the franchisee and take over management and running of the franchise business. The only circumstance in which such right is not exercisable is when the early termination is caused by the franchisor’s breach.
How does the franchisee go about renewing their agreement with the franchisor?
The franchise agreement will usually contain a term which allows the franchisee to renew the agreement with the franchisor. The term commonly requires the franchisee to give written notice to the franchisor, not less than 6 months before the end of the agreed term. The notice should specify the period for which the franchisee would like to renew.
As part of the renewal process, the franchisee will be required to pay a renewal fee. In addition to this, the franchisee may need to warrant there is no existing material breaches of the franchise agreement.
The franchise agreement may also contain a clause stating that where the franchisee continues the business without complying with the renewal procedure, the continuation must be on the same terms and conditions of this existing agreement. However in such circumstances, the provision may state the franchisor has the right to terminate the agreement with written notice.
What if a franchisee wants to leave the franchise? How would an agreement be terminated?
A franchisee can leave the franchise before the natural termination of the franchise agreement (passing of the duration period), if the franchise agreement includes a provision enabling early termination.
It’s common for franchise agreements to allow termination in the following circumstances:
- A breach by the franchisor
- A breach by the franchisee
- On the passing of the fixed term of the agreement, where the option to renew isn’t exercised or isn’t included in the agreement
- When the parties both reach an agreement to terminate; and
- When the franchisee sells the business (where the franchisee has the right to sell)
What are restrictive covenants and how do they affect the franchisee after they’ve left the franchise?
A restrictive covenant is a clause that restricts the franchisee’s activities during and after the termination of the franchise agreement.
Examples of restrictive covenants found in a franchise agreement include:
- A non-compete clause which prohibits a franchisee from being involved in a competing business during the franchise;
- a non-solicit clause which prohibits a franchisee from taking employees, customers, and suppliers with them when the franchise terminates;
- a confidentiality clause which prohibits the franchisee from using and exploiting confidential information about the franchise, for reasons such as competing with the franchise; and
- a non-compete clause which prohibits the franchisee from engaging in competing business after 12 months of termination of the franchise, potentially only within a specified territory.
When such restrictive covenants are included, they affect the franchisee by limiting the franchisee from continuing business in the same market. If you’re buying a franchise to learn more about the market and gain more experience in preparation of running your own separate business, it’s important to check the restrictive covenants don’t prevent this long-term goal. Additionally, where you’ll be continuing business after the termination of the franchise, it is important you do not solicit any franchise customers or suppliers.
It may be possible for you to reduce the scope of non-solicitation clauses by drafting the term to prohibit only solicitation of ‘Key Customers and Suppliers’. This means you won’t be in breach of such provisions where small customers and suppliers decide to continue working with you when you end the franchise and run your own business. Getting legal advice will help you negotiate such narrow restrictive covenants and protect your interests.
It is important for franchisees to be aware that all restrictive covenants included in the franchise agreement should be reasonable and necessary to protect the legitimate interest of the franchise. If a restrictive covenant fails either of these requirements, it will not be enforceable against the franchisee. As a result, you will not be affected by the covenant. To be reasonable, the restrictive covenant should be limited to geographical scope, and should not restrict activity for more than 12 months. However this depends on the circumstances such as the size of the franchise: meaning for a small franchise, restricting for longer than 6 months may be unreasonable.
Can a franchisee gain exclusive rights in a territory? How is this achieved?
It’s very common for a franchisee to gain exclusive rights in a territory, as this enables the franchisee to operate the business with reduced competition. Exclusive rights in a territory can be acquired by specifying the rights are granted exclusively in a territory. This is commonly included the clause with details the nature and extent of the rights granted to the franchisee, and will also be supplemented by the definitions which specify the boundaries of the territory.
How is being a franchisee different to…
What is the difference between franchising and distributorship (ie, with a distribution agreement)?
A distributorship involves an arrangement where a manufacturer or supplier of goods (the ‘Principal’) appoints third party (the distributor) to market and resell its goods, with a distribution agreement. Alternatively, the distributor may act as contact point between the supplier and customer. Here’s an exploration of the key differences between franchising and distributorship:
|Purchase and resale||Whilst a franchisee may choose to purchase particular goods for resale for its own trade, there is no obligation to do so for the relationship to exist between the franchisor and franchisee.
The franchisee also has no obligations as to where it obtains its raw materials for its business. Instead, there is emphasis on the raw materials being of adequate quality to comply with the quality control procedures imposed by the franchisor.
|Whilst a distributor buys the goods on its own account to resell, the distributor must buy the goods from the principal in order for the relationship to exist between the principal and distributor.|
|Exclusivity||In a franchise arrangement, if there is no risk of the franchise brand being confused with other brands, the franchisor may not require the franchisee to enter an exclusivity agreement to deal with just the franchisor’s brand.||As a distributor may be appointed by multiple principals at the same time, a principal may require the distributor to enter an exclusivity agreement. This will prevent the distributor from dealing with competing products, thereby protecting the principal’s commercial interests.|
|Trade name and branding||A franchisee will always use the trade name and branding of the franchisor, as the purpose of the arrangement is to operate a business with the franchisors brand.||The distributor will trade under their own name and will show any connection to the principal to the outside world.
A rare exception includes car distributors in which the car manufacturer will give the distributor permission to display its brand on the distributor’s premise.
|Know-how transfer||A franchisee will need the know-how of the franchisor as this enables the franchisee to provide services and goods which are of the same quality of the other franchisees.||A distributor does not need any know-how from the principal in order to resell the goods.|
|Control||The franchisor has a great deal of control over the franchisee, as it must ensure the quality and brand image is consistent with the other franchisees.||The principal usually has very limited control over the manner in which the distributor operates his business. This is because the distributor buys the goods from the principal on its own account.|
|Royalties||A franchisor will expect a royalty in return for the know-how and goodwill that it has provided to the franchisee. There will also be a royalty for any profits made from using the franchisor’s brand and distinctive raw material.||No royalty is paid to the principal. The principal’s profits are based on the sale of the goods to the distributor.|
What is the difference between being a franchisee and a licensee (ie, with a licensing agreement)?
A licence grants a party (the ‘licensee’) the right to use intellectual property rights and know-how of the licensor, usually to manufacture to produce and sell goods.
This differs to a franchise, as the franchise agreement does not usually relate to the manufacture of products. Instead, a franchise agreement regulates the manner in which the franchisee runs the business – which is made possible through using the franchisor’s brand, intellectual property and know-how.
What is the difference between being a franchisee and a reseller (ie, with a reseller agreement)?
A reseller is a party that finds buyers for a seller or supplier of goods. Although similar to a distributor, the reseller does not take inventory of goods. This means that the reseller will not buy the goods from the seller/supplier on its own behalf, to subsequently sell on. Instead, the reseller acts as the middle-man, helping you find buyers for your product.
Whereas a reseller has very little connection with the seller/supplier, a franchisee will build a close relationship with the franchisor to ensure its business is similar, if not identical, to the whole franchise. The franchisee will also be using the intellectual property rights and software of the franchisor, whereas the reseller has no access to a supplier’s technologies.
A franchisee also owes greater obligations towards a franchisor. For example, the franchisee must promote the franchise brand and inform the franchisor of potential improvements for the business. In contrast, a reseller has no such obligation to promote and improve the business of the seller/supplier. Instead the reseller provides a means for a seller/supplier to access a customer base.
The formalities of becoming a franchisee and reseller are also different. To become a franchisee, you may either enter a franchise purchase agreement with the franchisor, or buy a franchise from an existing franchisee through a sale and purchase agreement and also enter a franchise agreement with the franchisor.
In contrast, to become a reseller, you will enter a reseller agreement with the supplier or manufacturer.
What is the difference between being a franchisee and operating an outlet?
An outlet is a store that sells products or services to the general public after buying the goods or services from a manufacturer or wholesale supplier. As the outlet buys a quantity of goods, the manufacturer/wholesale supplier will usually sell the goods and services at a discount. The outlet can then sell at a higher price to make a profit from its sale.
This is different to being a franchisee where the franchisee shares the brand of the franchisor, and provides the same service as the other franchises. A franchisee also receives a great deal more support from the franchisor, and receives training and know-how to help the franchisee’s business.
When operating an outlet, you may be buying goods from a number of different suppliers to sell through your outlet. You will, therefore, not receive any additional support when running the outlet, or any additional training. It’s also unlikely that you will have the obligation to promote and develop the brand of any manufacturer, unlike your obligations as a franchisee.
The formality for becoming a franchisee and for operating an outlet are also different. An outlet is usually purchased by entering a sale and purchase agreement.
What is the difference between being a franchisee and being part of a joint venture?
A joint venture involves two or more parties pooling resources to complete a specified business activity or project together. By entering an arrangement where the losses are distributed between the parties, the parties are able to increase their resources and technology to pursue a profitable venture.
As a joint venture party, you will be entitled distribute profits according to the arrangement detailed in the joint venture agreement, and share the costs between yourselves as agreed in the agreement. This is different to being a franchisee where you retain your own profits and incur your own losses, independent from the franchisor and the other franchisees. Moreover, as a franchisee, you must pay an ongoing fee to the franchisor for using the franchisor’s brand for business. Contrastingly, a joint venture party does not usually have to pay an ongoing fee for having access to the other parties’ resources. Read more about our Joint Venture Agreement services here and check out our Joint Venture Agreement FAQs.
The formality to become a party to a joint venture requires you to enter a joint venture agreement. This is in contrast to becoming a franchisee, where you usually enter a franchise agreement with the franchisor.