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Understand these 9 terms in a franchise agreement

Read between the lines so you know what you are getting into before buying a franchise.
By Toni Antiporda |

“The franchise agreement is important because it’s the heart and soul of the business,” said Armando “Butz” Bartolome, president of GMB Franchise Consultants.

 

Everything you need to know about managing your franchise and maintaining a good relationship with your franchisor can be found in the contract. Yet, most first-time franchisees take it lightly and often misunderstand the document.

 

While franchise agreements contain standard provisions, terms will differ depending on the nature of the franchise and the franchisor. “Franchise agreements have gone through more than 20 years of development to ensure that franchisors have the appropriate rights to do their job within a framework of fair and reasonable treatment for franchisees,” said Rudolf Kotik, founder of RK Franchise Consultancy.

 

And over the years, it has also gotten longer—ranging from 35 to over 100 pages—which can be a little intimidating, especially for first-time franchisees. A thorough investigation of the franchisor should also have been made. If not, it would be a lot harder to understand and appreciate the terms.

 

“Franchisees should do their due diligence before entering into a franchise agreement. They should look into all aspects of the franchise. They should not be afraid to ask questions,” said Manuel Siggaoat Jr., managing director at Francorp Philippines.

 

Stumped? Here is a guide to some areas in the document that usually raise a lot of questions.

 

 

1. Fees

Perhaps part of the reason why you became interested in investing in a certain franchise is because of its low franchise fee. “A lot of franchise buyers think everything is included in the franchise fee, but it’s not the case,” said Kotik.

 

The franchise fee is the flat rate you pay to get the rights to franchise the concept. It does not include the expenses you will incur while setting up the whole business. So, while going through the franchise agreement, do not just look at the franchise fee. Look at the total investment cost and its inclusions, plus the other fees you have to pay after you have signed the agreement, like royalty, advertising, and even the renewal fees. 

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2. Training

While the franchisor will train you and your employees, it is not entirely free. “Some franchisees think they can get training any time for as many people as they like. Only the initial training is free, repeat training has to be paid,” said Kotik. Still, it has to be clearly stated in the franchise agreement which training would be provided for free, and which training would already be shouldered by the franchisee.

 

 

3. Operations

The operations manual, which is loaned to the franchisee over the course of the contract term, is part of the franchise agreement. The manual, which details how you would operate the business, is already made known to you even prior to signing. Yet, while the franchise agreement cannot be modified, “the franchisor can modify anything that has to do with operations,” said Bartolome. So, it is best to keep abreast of the operational changes and updates given by the franchisor, even though they were not originally found in the franchise agreement. Failure to do so might lead to a violation.

 

 

4. Products

Being a franchise, you are doing business “for yourself but not by yourself,” said Bartolome. The moment you buy a franchise, there is an understanding that you would be selling your franchisor’s authorized products and services. Yet, “some franchisees think that they are functioning as their own business,” he observed. Some franchisees also “think that they can sell or offer whatever they want to offer,” noted Kotik, and this is a violation of the franchise agreement.

 

 

5. Supply arrangements

Franchisees are usually required to buy products from the franchisor and their approved suppliers, mainly to safeguard quality and get discounts. “You have authorized suppliers because you are networking with them. You are getting more leverage for credit, discounts, [and] support,” noted Bartolome. Franchisors usually have a deal with suppliers that allows you to return the goods if anything goes wrong—something you cannot do if you get supplies from outside sources, like supermarkets.

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However, remember that supplies still have to be priced fairly. “The prices at which franchisees buy these items should be competitive with sources outside the system, or should give the franchisee adequate margins,” Siggaoat stressed. Remember that, unless otherwise stated, you are not allowed to buy supplies from cheaper outside sources.

 

 

6. Territory

The franchise agreement should define your territory, which touches on two other provisions: exclusivity, and right of first refusal, said Siggaoat. If you are granted exclusivity, it means that no other store, whether it is company-owned or franchised, will be allowed in your territory.

 

And under the right of first refusal, you would only be given the first offer to invest in an expansion store in the territory. In the event you refuse, the said expansion store could be developed by the franchisor or offered to another franchisee, which could be bad for your business. “This new store may cannibalize some of [your] sales and customers,” reminded Siggaoat, so your rights and privileges with respect to territory should also be clear to you before signing.

 

 

7. Renovation  

Renovating your franchised outlet is not merely a friendly suggestion; it is mandatory as per the franchise agreement. “Franchisors differ with the timetable, but most [prescribe it] yearly, while others [require it] before you renew,” said Bartolome.

 

Yet, franchisees should try to get an idea of the extent of renovation required of them, said Siggaoat. Do you need to repaint and replace worn-out fixtures, or do you redesign and install new equipment? Being clear on the renovations needed not only spares you the added cost, but also saves you from violating terms of the contract.

 

 

8. Renewal

Satisfied franchisees usually renew their contracts. Yet, what they fail to realize is that there are also conditions for their renewal. “It’s not at the whim of the franchisor to renew you, because there are certain conditions [for renewal],” said Bartolome. Renovation of the franchised outlet, for example, might be cited as a condition, said Siggaoat.

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It should also be clear to the franchisee whether a renewal fee would be charged. Francorp Philippines usually advises clients to waive renewal fees. “There are very little costs associated with renewing an ongoing franchise, unlike in the beginning where a franchisor incurs substantial costs in evaluating, training, and marketing to a new franchisee,” Siggaoat explained.

 

Franchisees tend to forget that they should express their desire to renew well before the contract ends. In most cases, a 6-month notice is required by the franchisor. Once you renew, you will sign a new franchise agreement, which contains modifications made by the franchisor over the course of your term, so you have to familiarize yourself with it all over again—no two franchise agreements are the same. 

 

 

9. Termination

The date when your franchise term will begin and end is specified in the franchise agreement. But the franchisor can end the contract any time if you fail the performance evaluation three times, said Bartolome.

 

The contract will also prevent you from putting up a business that directly competes with the franchisor. “There is usually a prescription of two to five years during which you can’t compete [with the franchisor] directly or indirectly,” he cautioned.

 

Yet, Bartolome said some franchisors are kind enough to let you go. “Sometimes, you just have to talk to them. If you don’t want [their] business anymore, and you’ve been good and you want to put up your own, it’s okay with them as long as you tell them so.”

 

*****

Toni is the deputy associate editor of Entrepreneur.com.ph. Follow her on Twitter, @toni_antiporda

 

This article was originally published in the May 2014 issue of Entrepreneur Philippines magazine.

 

Photos from Getty Images 

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