How to franchise your business (UK): group structure, master franchise agreement and terms

How do you set up a franchise business from a legal perspective? In short, you separate the company that owns your brand and know-how from the company that deals with franchisees, you connect them with a master franchise agreement, and you make sure the franchise agreement itself protects your intellectual property. I have advised franchisors and franchisees for many years and studied franchising at master's level, and this is the structure I would walk a new franchisor through.

Franchise group structure

The starting point is an overview of the kind of structure you might want to implement. There are three layers: the franchisor at the top, a master franchisor in the middle, and the franchisees at the bottom. Each layer has a different job and a different contract connecting it to the next. If you get the structure right at the outset, the contracts follow naturally; if you start signing franchisees up from the company that owns your brand, you will find it difficult and expensive to unpick later.

What is a franchisor?

The franchisor is the business, the legal entity, that owns all of the most important assets. That means the intellectual property, such as the trademarks, and also the know-how of how to run the business. Everything of value in a franchise network ultimately sits in this entity, which is why the rest of the structure is designed to protect it. The franchisor should do as little as possible other than own those assets and license them downwards.

What is a master franchisor?

The master franchisor can be one of two things.

• Your own separate legal entity. This is most common if you are starting your franchise business now and starting it in your home country, for example the UK. You set up a second company, wholly owned by you, to deal with franchisees.
• A third party. If you are expanding into different territories or countries, you may want to appoint someone who is local to that country and understands how to find and recruit franchisees there.

Either way, the job of the master franchisor is almost to act as a sub-franchisor. Its real job is to find franchisees and franchise your business to them. When you expand overseas, a local master franchisor brings knowledge of the market, the language and the local way of recruiting that you are unlikely to have from the UK.

Why separate the franchisor and master franchisor

Why set up a separate legal entity as master franchisor even if it is completely owned by you in your home country? The reason is to create separation between you as the franchisor that owns all the important assets and the franchisees.

Ideally you do not want a direct contractual relationship between the franchisor and the franchisee, because the franchisees carry too much risk. If a franchisee relationship goes wrong and ends in litigation, you want that litigation to be with the master franchisor company, not with the entity that owns your trademarks and know-how. Distance protects the assets. The same logic applies to any claims that a franchisee's customers or staff might bring: they should land on the operating layer, not on the company holding the brand.

What is a master franchise agreement?

Between the franchisor and the master franchisor you will want a master franchise agreement. This is quite similar to the typical franchise agreement, with one main difference: the sales targets, which are expressed as targets for recruiting franchisees. The master franchisor is being measured on how many franchisees it signs up, because that is the whole point of appointing one: if the territory is not being developed, you need to be able to act.

In practice this is only really applicable if you are expanding into a separate territory and appointing a master franchisor that is not you. If the master franchisor is your own company, the recruitment targets have little purpose, although you will still want the agreement in place so that the licence of your brand and know-how down the chain is properly documented.

Franchisees and the franchise agreement

At the bottom of the structure are the franchisees. A franchisee represents your business and sells your products or services according to your franchise system, your handbook, your processes and your brand. The contract between the master franchisor and each franchisee is the standard franchise agreement. I cover the basics of that document in what is a franchise agreement.

Franchise agreement: the operations manual

The first of the three things you must include in your franchise agreement is an obligation on the franchisee to follow your handbook, sometimes called the operations manual. The handbook is usually a chunky document that tells the franchisee exactly how to run the franchised business.

Its purpose is consistency. Anyone from the public who deals with any of your franchisees, whether clients, customers or consumers, should have the same experience every single time. That consistency is what the brand stands for, and it is what new franchisees are paying to join. Without a contractual obligation to follow the handbook, you have no way of enforcing that. Drafting it as an obligation also means that a franchisee who ignores the handbook is in breach of contract, which gives you leverage and, if it comes to it, a basis for termination.

Licensing your IP to franchisees

The second thing to include is a licence of your intellectual property to the franchisees. You are licensing the right to use your trademarks and to benefit from your know-how.

Word this as a licence, not a transfer. A licence can be revoked, for example at the end of the term of the franchise agreement, so that when a franchisee leaves the network they lose the right to use your brand. If you gave the rights away outright, you could not take them back. The licence should also be limited to the purposes of the franchised business, so a franchisee cannot use your brand for anything else.

Territorial exclusivity and sales targets

Third, you will want to ensure that franchisees get exclusivity over a specific territory. This is something they will expect, and it is a normal part of a franchise offer.

As a pro tip, I advise all of my clients to at least consider making territorial exclusivity subject to, or conditional upon, the franchisee meeting a specific sales target. The advantage is that you avoid a scenario where you grant exclusivity over an important territory to a franchisee who turns out not to perform, and for five years, for example, you are unable to monetise that territory as much as you could have. If the target is missed, the exclusivity falls away and you can bring in someone else. Franchisees will push back on this, but a reasonable target that a competent operator should comfortably meet is hard to argue with.

Tip: lease step-in rights for franchise premises

A bonus tip. Consider including in your franchise agreement a template set of clauses that the franchisee must negotiate into their lease with the landlord of the premises they will be using. These clauses should allow you, as franchisor or master franchisor, to take over the premises if the franchisee does not perform.

The benefit is that a good location may be valuable to your network regardless of who is running it. Step-in rights mean that if a franchisee fails, you can keep the site rather than losing it along with them. This needs to be agreed with the landlord at the time the lease is signed, which is why the franchise agreement should oblige the franchisee to negotiate these clauses in.

Protecting your intellectual property

Everything in this structure is designed to protect the franchisor from the franchisees, and the reason is to protect the intellectual property, which is the most valuable asset in a franchise business. The structure does part of the job, and registering your rights does the rest. I explain how to register a trademark in the UK and how to build the surrounding group structure on their own pages.

Next steps

Start by deciding which entity will hold your trademarks and know-how, and set up a separate master franchisor company to contract with franchisees. Get the trademarks registered in the franchisor's name before you start recruiting. Then have a franchise agreement drafted that includes the handbook obligation, a revocable IP licence and conditional territorial exclusivity. Franchising involves several interlocking contracts, so work with a commercial solicitor who has done this before.