How long is your franchise agreement?
One of the key considerations in deciding whether or not to purchase a franchise should be the term of the Franchise Agreement itself: the finite period of time for which the franchisee is granted the right to conduct the franchised business.
For a franchisee, the principal concern should be whether the term, together with any options to renew, is long enough to enable the franchisee to obtain an adequate return on investment.
Franchise agreements generally provide for an initial term followed by an option to renew for a further term or series of terms. The renewal option is not a guaranteed right and is generally tied to the franchisee's good behaviour and the payment of a renewal fee.
For those franchises that are conducted from business premises the term of the franchise may also be affected by the term of the lease. Ideally the term of the Franchise Agreement and any option terms should coincide with the term of the lease and any option terms contained in that lease. Unfortunately, in the majority of cases this does not occur.
In some systems the term of the franchise is longer than the term of the lease (for example a Franchise Agreement may provide for a term of, say, 10 years while the lease may be a five year lease with no options); many landlords (especially the major shopping centre landlords) do not offer options for further terms; the sale of a franchised business may mean that a new term is offered to the purchasing franchisee while the term of the lease remains unchanged.
A well drafted Franchise Agreement should deal with what happens if the terms do not coincide. Some Franchise Agreements provide that the Franchise Agreement will end if the lease ends. So a franchisee who has been granted a 10 year franchise but who only has a five year lease may find that the franchise ends after five years.
Even if the Franchise Agreement does not specify, clause 23a of the Franchising Code of Conduct provides grounds for the franchisor to terminate the Franchise Agreement immediately if the franchisee no longer holds a licence necessary to carry on the franchised business. This licence could include a lease or other occupancy right.
In other cases the Franchise Agreement provides an opportunity for the parties to relocate to new premises should the lease of the premises end before the franchise term ends.
While this may seem appealing, a relocation to new premises will often be at the franchisee's own cost and expense and the franchisee should factor such costs into the business plan.
Return on investment
If the Franchise Agreement does end earlier than expected due to the loss of occupancy rights, then the franchisee may not have sufficient time in the business to recoup the initial capital outlay let alone achieve a return on investment.
The term of the Franchise Agreement (especially if there is limited tenure left in the lease) will also affect the franchisee's ability to borrow funds to purchase the franchise and possibly affect their ability to sell the franchised business and the purchase price it can achieve.
Where the lease or franchise term is to expire imminently a bank may not be prepared to advance funds and a buyer may not be prepared to purchase the business or to pay the asking price.
In circumstances where the franchise ends earlier than anticipated due to the lease coming to an end franchisees may be able to negotiate concessions to their Franchise Agreements such as a pro-rata refund of the upfront franchise fee paid by the franchisee.
If the Franchise Agreement provides for a relocation to new premises, a commitment may be sought from the franchisor to contribute to all or some of the costs associated with any relocation that occurs within a certain period of time (for example within the first five years of the term of the Franchise Agreement).
This article was written by Tony Garrisson and Raynia Theodore, principals in the franchising division of Mason Sier Turnbull. Email firstname.lastname@example.org; email email@example.com.