Nearly all
franchise agreements are for fixed terms. This common aspect of franchising is often taken for granted, and the ramifications of the limited term of the franchise are often overlooked by the excited franchisee that is going into a new business venture.
Franchisees need to remember the following:
- They do not own the brand and systems - they are only given permission to use the brand and systems in accordance with the terms of the franchise agreement;
- Were it not for the franchise agreement, they would not be allowed to use the brand and systems; and
- When the franchise agreement comes to an end, they can no longer use the brand and the systems.
Therefore, situations can arise where a franchisee - through hard work, effort and toil - can build up a business worth many times the initial outlay, only to face the possibility of that value evaporating when the franchise agreement comes to an end. This is because, that point, the franchisee's only assets are the tangible assets used in the business, such as plant, equipment or motor vehicles.
Very often, franchise agreements will compel franchisees to sell those tangible assets to the franchisor (if the franchisor wants them) upon termination of the franchise agreement, sometimes on a pre-agreed basis (such as written down value) that might be less than market value.
What can a franchisee do to overcome this problem? The franchisee can:
1. Attempt to negotiate a longer-term franchise agreement - ie. much longer than the franchisee may reasonably expect to run the business, and allowing a sufficiently long residue for the purchaser of the business. Advice may be sought from a
franchise lawyer in order to do this.
2. Attempt to negotiate options to renew the term of the franchise agreement;
3. One or two years before the end of the term attempt to negotiate a new franchise agreement, bearing in mind that the franchisor will usually have no obligation to agree; or
4. Sell the business at a time when there is still a reasonable period left in the term, bearing in mind that the purchaser will need to be approved by the franchisor, acting reasonably.
Prospective franchisees also need to consider that:
Option 1 may not be available if the franchisor has fixed ideas as to the terms of its franchises. A higher franchisee fee may have to be paid to entice the franchisor to agree to this.
Option 2 may also not be open if the franchisor has fixed ideas as to the granting of an option for renewal. A willingness to pay a renewal fee, upon renewal, may be required to entice the franchisor to agree to this.
Option 3 is risky, because the franchisee is left to the whim of the franchisor.
Option 4 is always possible, but it may mean that the franchisee has to sell their business at an inopportune time.
Franchisees have to remember that the permission are given to use the franchisor's brand and systems (which might be a substantial cause of the increase in value of the business) is of limited duration and that, once that permission is terminated, any value attributable to the brand and system is immediately lost.
Depending on the franchise system, there may be further consequences upon termination of the franchise, such as a requirement to vacate the business premises, and restraints on conducting a like business for a period of time.
This article appears courtesy of
Mason Sier Turnbull.
15-Sep-2007