How to Negotiate with a Franchisor?
It is important to understand that a franchise agreement is typically drafted in favor of the franchisor. That is because the franchisee will be granted the rights to use the franchisor’s name, brand, intellectual property, confidential information, services and products, such as, for example, custom recipes, manuals, services and products, system information, production knowhow, and/or other trade secrets of the franchisor. While contract negotiations typically revolve around each party making certain concessions or giving up certain rights, in the franchise context, franchisors are usually not willing to jeopardize their rights and interests with respect to their intellectual property or the operation of third-party businesses under their name and brand. This is not the only reason, however. Franchisors generally also intend to maintain uniformity among the franchise system and equal treatment of all franchisees. As such, franchise negotiations should be approached differently.
What Terms to Negotiation when Purchasing a Franchise and why?
The terms to negotiate when purchasing a franchise vary depending on factors such as the relevant industry, geographical area, and even the specific reason for purchasing the franchise. Other than such transaction-specific points for negotiation, franchisees often try to negotiate (1) the right to renew, (2) personal guaranties, (3) non-compete restriction, (4) minimum performance requirements, and (5) territory size.
A right to renew is a contractual provision that allows the franchisee to renew the franchise agreement for an additional franchise term. A right to renew is important because a franchisee will be investing significant time, effort, and resources to bring the franchised business to fruition over the course of several years. If there is no right to renew the franchise agreement, the franchisee’s right to own and operate the franchised business, and thus the franchisee’s investment, would cease upon the expiration of the franchise term. At that point, the franchisee will have to surrender its fully operational and healthy business to the franchisor and will typically be restricted from operating or owning a similar or competitive business for several years. Moreover, where there is no (or only a short-term) renewal option, the franchised business’s resale value would be significantly less in the event that the franchisee would like to sell its business with the franchisor’s consent. The industry standard is a one-time renewal option for the same amount of time as the original term.
A personal guaranty is a contractual provision that is almost always required when purchasing a franchise. A personal guaranty in the franchise context is an enforceable promise by the owner of the franchised business to personally assume the obligations, both monetary and non-monetary, of the franchised business in the event that the business itself is unable to satisfy its obligations under the franchise agreement. A franchisor may require the personal guaranty to be signed by the individual owners of the franchised business and even by their spouses. This provision can be unduly intrusive where the spouse is not involved in the franchised business. As such, it is wise to negotiate the issue of personal guaranties and there are other ways in which franchisors can protect their interests with respect to spouses, for example.
A non-compete is a contractual provision that restricts the franchisee and its owners from working with, for, and/or on behalf of, or to own an interest in, any business or person that is engaged in the same or similar industry and business within a certain geographical area both during the franchise term and for a set amount of years after the expiration or termination of the franchise. Non-compete agreements are enforceable as long as they are reasonable and not otherwise against public policy. A franchisee may thus wish to negotiate their relevant non-compete provision, for example so as to reduce its scope, duration, or the geographic area. Such a restriction will directly have an impact on the franchisees’ ability to perform their trade and earn a living, so this clause should not be overlooked.
A minimum performance requirement is a contractual provision obligating the franchised business to meet certain minimum performance standards, typically with respect to certain sales level or client volume. Failing to meet these minimum performance requirements usually constitutes a default under the franchise agreement, entitling the franchisor to terminate the agreement. This provision can be negotiated to have more flexibility, such as providing a right to cure if found not in compliance, having a longer period to be in compliance, and excluding acts of God or factors beyond franchisees’ control.
Territory size refers to the radius within which the franchised business is allowed to operate. The rights granted to franchisees under the franchise agreement will, for the most part, be limited to their specific territory. Typically, franchisors will grant exclusive territories, meaning no other franchisees will be permitted to operate within another franchisee’s territory. This provision can be negotiated to be increased or decreased. Franchisees may wish to negotiate a right to increase their territory size, also known as expansion rights. Expansion rights can be beneficial in instances where there is a bordering territory that is unclaimed, as it presents an untapped market for potential additional revenue.
The above-mentioned provisions are not an exhaustive list of terms that may be negotiated. As mentioned above, the relevant contract provisions that are negotiated during franchise negotiations depend on the type of the franchise, the industry of the franchised business, the size of the franchised, location, and, most importantly, the terms that are of significance to the franchisee.