Franchising can be a good way to expand a business as well as an opportunity for someone to run a business that has been tried and tested.
We look at how the franchising model works, what you need to know if you are thinking of franchising your business and some of the key legal considerations in setting up a franchise.
What is Franchising?
Franchising is when a business owner, referred to as the franchisor, gives the right to an individual, known as the franchisee, to operate a branch of the business. The franchisee pays a fee to the franchisor. In return the franchisee can run a branch of the operation themselves, using the franchisor’s branding, business knowledge, trademarks and products.
Well-known examples of franchises include McDonald’s, Domino’s and Starbucks. The franchisee is required to pay a management or royalty fee, which may be a monthly fee or a percentage of the sales or profits. There is also an upfront fee payable to buy the franchise.
The Advantages of Franchising Your Business
There can be a range of benefits for a business owner of offering one or more franchises, including:
- The opportunity to expand without having to invest heavily or set up the new centre of operations yourself, although you do need to be prepared to put in some time and effort and there is a substantial set-up cost, particularly with creating your franchise model and putting your first franchise in place
- Franchisees can be highly motivated and may be settled in the location, with local connections and local knowledge that will help the business flourish
- The franchisee will cover a large portion of the costs of the new set-up
- Your brand will become better known
- The extra income may give you the opportunity to benefit from economies of scale
- It can be helpful to have other individuals working in your business who may come up with ideas and provide useful feedback
What are the Advantages of Taking on a Franchise?
Franchisees choose this business model for a variety of reasons, including:
- The opportunity to take on a tried, tested and successful business that is generally less likely to fail than a start-up
- The support of the franchisor in dealing with issues such as suppliers, training, advertising and marketing
- Stepping into a business that is effectively ready to operate straightaway, particularly if the franchisor provides the equipment, business plan, advertising strategy and products
- Help from the franchisor with difficulties, which could be by speaking directly to the franchisor or by way of a databank containing answers and assistance
- Taking on a recognisable brand that customers are familiar with and that can provide a solid customer base right from the start
- The franchisor may be able to buy goods and services at a lower price because they will be buying large quantities and these savings can be passed on to the franchisee
- Starting a business without having to come up with your own idea, business plan and strategy
What is a Franchise Agreement?
A franchise agreement is a legal document that sets out the terms and conditions of the deal. It is a complex contract and whether you are the franchisor or the franchisee, you will need legal advice before signing.
The franchisor will give the franchisee a range of rights to use the business assets, such as intellectual property, systems and know-how.
What Goes into a Franchise Agreement?
Key clauses commonly contained in a franchise agreement include:
- How payments will be dealt with – the payment clauses will cover matters such as how payments are calculated, when they will be due, and what they will cover, for example, if the franchisee is required to contribute towards advertising or staff training, and penalties for late payments.
- Use of intellectual property (IP) – IP is a crucial part of franchising and the franchisee will want the right to use the business’s branding, logo, products, processes and trademarked goods. However, the franchisor will also want to protect and control their IP. These clauses should set out the extent to which the franchisee can use the relevant IP while preventing unlicensed use.
- Location of the franchise – this clause defines the geographical area in which the franchisee can operate and can also state whether they have exclusive rights in the location
- Franchisee obligations and the standards to be maintained – It is important to ensure that franchisees adhere to minimum standards while operating the franchisor’s business. If customers are dissatisfied it could be damaging to the franchisor’s brand overall.
- Including details of the behaviour required of the franchisee will protect the business and keep standards high across all franchised branches. It will also give the franchisor scope to take firm action should the franchisee not meet the required standards.
- Clauses requiring the franchisee to secure goods and services from approved suppliers can also be included.
- Franchisor obligations – the franchisor can provide advertising, training and other support to the franchisee. The extent of this should be clearly set out in the agreement.
- Representations and disclosures – the franchisor will generally require the franchisee to confirm that they are not relying on any representations made by the franchisor in entering into the franchise agreement. The courts are not always willing to uphold such widely drafted clauses, as they can be unfair to the franchisee, so the clauses need to be drafted carefully to give them the best chance of being enforceable.
- Franchisors should also make disclosures to the franchisee before the agreement is signed, drawing the franchisee’s attention to issues that could affect their decision to go ahead with the deal.
- Restrictive covenants – the franchisee will need to agree to a range of restrictive covenants aimed at protecting the business. Examples include not setting up a similar business near the franchisor’s territory for a set period after the end of the franchise agreement and not poaching the franchisor’s clients.
- Extreme care needs to be taken when including restrictive covenants, as they will not be enforceable if the courts find that they are too onerous. The covenants must be reasonable in duration, scope and location, and intended to protect a legitimate business interest.
- Details of how the franchise agreement can be terminated – these clauses should set out the circumstances in which the franchisor can end the agreement. They need to be comprehensive and give the franchisor wide scope to protect their brand and business interests by terminating the contract if they feel this is necessary, for example, because of the way the franchisee is running their operation.
- Right of renewal and how renewal arrangements will be dealt with – setting out the length of the initial franchise period and the terms on which the franchise agreement can be renewed at the end of this term.
- The right of first refusal to buy back the franchise – if the franchisee decides to sell, a right of first refusal clause can give the franchisor the option to purchase it if they want, before it is offered for sale elsewhere.
- The right to approve or veto a potential purchaser – this allows the franchisor the opportunity to vet a buyer, should the franchisee decide to sell, and to set out any conditions they may have in respect of future buyers.
What Laws Regulate Franchising?
While there is no specific franchise legislation in the UK, normal business rules apply to issues such as contract terms, competition and data protection. These will need to be taken into account by the franchisor when setting up their franchise model and implementing the franchise documentation.
There are also a range of best practices that can help franchisors put an ethical business model in place that can assist their franchisees in achieving success. The British Franchise Association has a Code of Ethics that can be followed, while the Quality Franchise Association offers a Code of Conduct.
Legal Documents Needed to Franchise a Business
As well as the main franchise agreement, you will need several other documents in place in support. These include:
Franchise Disclosure Document
This is information provided upfront to allow the potential franchisee to consider the franchise in the light of relevant facts, figures and background information. It can include financial details, details of how the franchise will be run, the history of the business, information about key personnel and disclosure of any liabilities or legal issues the business or key personnel are involved in.
The Franchise Operations Manual
This is an essential document that will provide a clear roadmap for the franchisee. It will detail how the franchise will operate, how the new business should be set up, what training will be provided, what standards must be adhered to by the franchisee and their employees, how recruitment will be dealt with and what is expected of both the franchisor and franchisee. The manual should provide comprehensive guidance for franchisees so that they can handle day-to-day operations without the need to contact the franchisor.
An IP licence
This may be needed to allow the franchisee to use relevant IP.
A Commercial Lease for the Premises
If the franchisor is leasing premises they own or lease to the franchisee, then a commercial lease or sub-lease will be required.
How Do You Sell a Franchise?
The franchise agreement will usually set out the requirements if you wish to sell a franchise to another franchisee. The franchisor may have a right of first refusal, in which case you must offer the business to them first.
If they do not wish to buy it back or they do not have the right to do so, then you can offer the franchise for sale in accordance with the terms in the franchise agreement.
You will need to give the franchisor notice that you intend to sell and obtain a professional valuation of the business. Once you have a potential buyer, the franchisor will generally need details about their experience and financial situation. They can vet the candidate and decide whether to give their consent to the sale. There is generally an assignment fee payable to the franchisor. You will also need to ensure that all transfers are made correctly, such as the transfer of IP licences or of commercial premises.
What Does the Franchisor Need to Give the Franchisee?
A franchisor should give a franchisee reasonable support throughout the term of the franchise. This can include help with problems, training, marketing advice and assistance and the provision of resources. This will help the franchisee make a success of the business.
Franchisors should also make full disclosure of relevant information to franchisees before the franchise agreement is signed. As well as being a fair way of operating, this will prevent the franchisee from claiming later on that they were not provided with crucial details that would have affected their decision to enter into the contract.
The franchisor must act in good faith when dealing with the franchisee, ensuring that any representations are true and not misleading and not withholding any relevant information when dealing with disclosure.
Our Franchise Legal Services
We offer franchise legal services to franchisors and franchisees. We can draft robust franchise agreements together with all necessary supporting documentation. We also advise franchisees who have been given franchise paperwork to sign.
We have experience of franchising across a wide range of sectors, including food, retail, manufacturing, property, health and fitness, travel and professional services.
We work with both new and existing franchisors and franchisees, offering advice and representation at all stages of the business cycle.
To speak to one of our expert franchise law solicitors, ring us on 0330 173 3980, email us at info@witansolicitors.co.uk or fill in our contact form and we will talk through your situation with you and discuss how we can help.
