Why it pays for a franchise buyer to link a lease and a franchise agreement
When you buy a franchised business, the franchise agreement is one of the most important documents you will need to sign. However, if the potential franchised business is premises-based, the lease of the premises will be equally important.
What you must ensure is that the provisions in the franchise agreement and the lease correlate with each other to ensure that there is no conflict between them.
During the due diligence period in reviewing all the legal and financial documentation of the potential franchised business, you must pay close attention to any provisions that could affect your performance as a tenant.
What to look out for
1. Franchisor’s approval of the premises. The franchisor may be helping you in choosing a suitable site or you may need to present the site to the franchisor, once it has been found, and obtain their written approval.
2. The term of the lease, and any renewal options, should be aligned with the term and the options contained in the franchise agreement. If the lease runs longer or shorter than the term of the franchise agreement, then you may have one of the two very unnecessary and expensive scenarios:
- having a business and no premises to operate it from
- or no longer having a business to operate (as the franchise agreement expired) and being stuck with the lease, which would still be on foot.
_3. Franchisor’s approval of the fitout of the premises, which often includes the franchisor or its approved contractors performing the fitout works. Some franchisors chose to charge franchisees a fixed fee for a turnkey operation, where they undertake all the fitout work themselves.
4. Franchisor’s approval of the lease itself. Franchise agreements often contain provision that a lease taken out by the franchisee must contain specific clauses. The franchisee will need to ensure that the landlord is notified of such clauses during the lease negotiation and such clauses subsequently are present in the lease.
5. Franchisor’s option to take the lease in their name (or in the name of a related party) and then sublease or licence the premises to its franchisee under the licence agreement. In this case, a licence agreement will merely state that all provisions of the lease will apply to the franchisee under the licence agreement. This option is less flexible, as the franchisee will not have any say in the terms of the lease, which will be negotiated by the franchisor, apart from choosing to agree to it.
There are other matters in relation to the lease, which need to be considered side by side with the franchise agreement, which include:
- Is there a requirement for any refurbishments or upgrades of the premises within the term of the lease or the term of the franchise agreement? Are they consistent in both documents?
- What are the provisions of the lease in the event that the franchisor becomes bankrupt and you can no longer use the franchisor’s brand?
- Can you assign the lease to a third party? What are the provisions of such assignment? How does it relate to the assignment clause within your franchise agreement? You must ensure that both the franchise agreement and the lease contain a provision that the franchisor and landlord act reasonably with respect to granting approval as to whom you may assign your rights and obligations under the franchise agreement and lease. This point is extremely important for your future opportunity to sell your business.
All of the above considerations must be addressed during the negotiation process, but they do not exhaust the countless ways in which the franchise agreement and the lease may influence one another. You must ensure that you review the terms and conditions of both documents before signing either of them.