What is a franchise agreement? Standard vs master agreements and the clause to include

What is a franchise agreement, and what are the two main kinds of franchise agreement? In short, a franchise agreement is the contract that lets someone run a business under your brand and system, it comes in a standard form and a master form, and there is one clause about territorial exclusivity that every franchisor should think hard about before signing.

What is a franchise agreement?

A franchise agreement is a contract whereby the franchisor grants the franchisee the right to use the franchisor's brand, know-how and business model to run a business.

The two sides come to the table with different things. Typically the franchisor will have developed a significant brand that people recognise and a proven business model, a business that works. The franchisee is looking to start a business but typically does not want to take on the risk of finding out by trial and error what works and what does not. That is where franchising comes in, and the franchise agreement is the document that details that relationship: what the franchisee gets, what they pay for it, and how they have to operate. Because it governs a relationship that can last many years, it is worth getting right at the start rather than trying to fix it once a dispute has arisen.

Standard franchise agreement

The first of the two main kinds is the standard franchise agreement. This is the agreement between the franchisor and the franchisee that I have just described. It governs the day-to-day relationship: the licence to use the brand, the obligation to follow the business model, the fees, the territory and the term.

What is a master franchise agreement?

The second kind is the master franchise agreement. A master franchise agreement is typically used by a franchisor who is looking to expand into new territories, for example into different countries.

Instead of trying to do the legwork themselves in the new country, recruiting and finding new franchisees from a distance, the franchisor appoints what is called a master franchisor in that territory using a master franchise agreement. The master franchisor is then responsible for finding and recruiting new franchisees locally. In effect the franchisor franchises the right to franchise.

If you are looking to franchise your business, there are quite a few legal aspects that must be considered and scrutinised so that your franchise agreement properly protects you. The structure you choose, and whether you need a master franchise layer at all, is one of the first decisions. I cover the full structure in how to franchise your business.

Key clause: territorial exclusivity

So what is the number one thing to include in your franchise agreement? To understand it, two features of a typical franchise arrangement need to be recognised first.

• Exclusivity. Typically a franchisor will grant exclusivity over a specific territory to each franchisee. Nobody else in the network can trade in that territory.
• Term. A franchise agreement is typically for five years, and then extends for additional periods of five years.

What does that mean for you as a franchisor? In short, it means you are giving a franchisee who you think is good exclusivity over an important territory for a period of five years. If it turns out that the franchisee is underperforming and not as good as you had hoped, you are losing out on a substantial amount of revenue from that territory, and you are locked in for the term.

To protect your business against this risk, you might want to specify in your franchise agreement that if the franchisee is grossly underperforming, you have the right to place a new franchisee in the same territory, and therefore remove the original franchisee's exclusivity. The franchisee keeps their business, but they no longer have the territory to themselves.

In my experience this is the clause that franchisors most often wish they had included once a territory has gone quiet. It costs nothing to negotiate at the outset, when the franchisee is keen to sign, and it is very hard to introduce later.

Franchising and your group structure

Before you get started with franchising, it is worth learning about the kind of group structure you might want to deploy for your franchising business, so that the company holding your brand and know-how is kept at a distance from the companies dealing with franchisees. I explain the options in how to create a group structure.

Next steps

If you are planning to franchise your business, decide first whether you need a standard franchise agreement only, or a master franchise layer for new territories. Then make sure your franchise agreement deals with exclusivity in a way that protects you if a franchisee underperforms. Franchise agreements are detailed documents, so have a commercial solicitor draft or review yours before you grant anyone a territory.