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How does a Franchise Agreement work?

How does a Franchise Agreement work?

Legal & Compliance

Vakilsearch Staff

Vakilsearch Staff

26 May 2022, 11:13 — 11 min read

A franchise is a marketing and distribution strategy that many businesses adopt for quick business expansion. In the case of franchising, an established company- known as a franchisor, gives license to other small partners- known as franchisees, to use its brand name and proprietary knowledge for selling its trademark product or service. All of these are duly mentioned in the franchise agreement.  In exchange, the franchiser charges a license fee and a start-up fee.  On the other hand, the franchisees can carry on their businesses without worrying about the product/service, quality, supply chain, branding, etc. 

Thus, it is a perfect win-win situation for both franchisors and franchisees. Both partners can gain from such business collaboration if they follow a legitimate business contract or franchise agreement. Adhering to such a contract is crucial for the smooth running of the business of both the Franchisor and the Franchisees.  

What is an Agreement of Franchise? 

The Agreement of Franchise layout determines the terms and conditions, obligations, and restrictions of both the partners involved in a business. The franchise agreement also ensures that the franchisor remains committed to disclosing its key operating information to its franchise partners. Simultaneously, it also provides an ongoing royalty fee that needs to be paid by the franchise partners to its parent partner, that is, in this case – the franchisor. 

This Agreement protects the interest of both partners and makes sure they both remain committed to working in collaboration to improve the service. Take-aways of the partners from an Agreement of Franchise: 

  • Apart from getting a lumpsum amount at the beginning of such contract signing, if the franchisees’ business goes well, the franchisor will benefit further as it receives a share of the franchisees’ profit in the form of royalty.

  • On the other hand, paying a lump sum in a license fee or start-up fee to a good franchisor will benefit the franchisees’ business. Small businesses do not have to immediately bother about their product /service or branding and manage overall marketing strategy. 

 

Also read: Choosing the right franchise - how to do it?

 

Role and Responsibility of Franchisor According to the Franchise Agreement 

  • A franchise agreement typically assigns the responsibility of initial training to the Franchisor. The Franchisor will provide an Operations Manual and other start-up packages to the franchisees. With this initial support from the Franchisor, the franchisees are allowed to carry on their businesses within a delineated area (which is also mentioned in the franchise agreement) using the trademark of the Franchisor.

  • The franchise agreement confirms that the Franchisor will retain the right to control the trademark.

  • The franchise agreement also confirms that the Franchisor will have the final say on how its products or services will be marketed and sold.

  • The franchise agreement assigns the responsibility of ensuring the quality and standards of the overall business to the Franchisor.

 

Role and Responsibility of Franchisees According to the Franchise Agreement 

  • There is a validity period mentioned in the franchise agreement during which the Franchisees can enjoy the right to carry on business using the trademark or brand name of the franchisor. Thus, this is a temporary right. This duration lasts typically for 5 to a maximum of 30 years.

  • Franchise agreement directs that the Franchisees are liable to adhere to the contract and follow the terms and conditions thoroughly; failing to do so can lead to severe penalties and non-renewal of the contract or even premature termination of the contract.

  • The franchise agreement also clarifies that to derive maximum benefits for their businesses, franchisees must build a robust customer base without crossing over the limits set by the franchisor. Thus, they must sell only the products or the services approved by their Franchisor.

  • The franchise agreement specifies that it is in the best interest of both parties; all the time, franchisees must try to protect the franchisor’s brand name by aligning themselves with the existing operating standards of the franchisor.

  • Thus, according to the franchise agreement, the franchisees are responsible for ensuring that their employees must be trained to perform and maintain the standard expected of them by the franchisor.

  • The franchise agreement also mentions that the franchisees need to take the responsibility of promoting the business by following the guidelines or templates which are to be provided by the franchisor within its defined jurisdiction, which is mentioned in the franchise agreement.

Origin of Franchising 

The earliest history of the franchise form of business can be traced back to the middle of the 19th Century in the United States. The I.M. Singer Company and the McCormick Harvesting Machine Company were reported to have joined hands to manage their organisational, marketing, and distributional system. It identifies as one of the earliest forms of the franchising model. 

This model introduces to handle their very high-volume manufacturing. This collaboration also helped the partners, namely Singer and McCormick, trade their mowers and sewing machines over a large geographical area. Thus, it helped them in business expansion and establishing business dominance. 

The food and beverage industry has had a long history of gaining franchisee business. A&W Root Beer launched its franchise way back in the 1920s & 1930s. The restaurant chains of Howard Johnson expanded their restaurant business across the country. They have a pioneering vision of franchising which defined the future roadmap for the fast-food business of America.  

Even today, the word ‘franchise” quickly reminds the name of many famous fast-food chains like McDonald’s or Subway or   Taco Bell and Dunkin’ Donuts. Even though undoubtedly the fast-food sector sees the dominance of franchise business, the grocery business, hotel business, nowadays even the fitness or wellness clinics predominantly run following a franchise model. There are nearly 8 million franchise establishments in the US, which reports contributing almost $500 billion to the economy.

Types of Franchising 

The term ‘franchising’ encapsulates various kinds of business relationships.

Business Format Franchising

Franchising is most used to refer to as Business Format Franchising. In this case, a business first licenses its trademarks for its already proven business methods to other small partners. In exchange, the smaller partners are liable to pay a licensee fee and a recurring fee in the form of a percentage of their gross sales. 

The company or business which lends such licenses and, in exchange, receives payments is known as a franchisor. And the partners who pay the license fees and part of their earnings in exchange for the selling rights of the product/services using the franchisor’s trademark are known as the franchisees. 

Job-Franchise 

This is a low-investment franchise. It can be managed from home, and the number of parties involved can be as low as 5.  This can be started by paying a small token amount as the start-up cost for procuring some essential equipment and other materials to run the business.  This franchise business model shows in skill-based or semi-skill-based services. For example, artisans, cleaning, or other maintenance services fall in this category. 

Product Franchise

A product franchise is also known as Distribution Franchise. This type of franchise business is product-driven. Here the franchise partners work mainly as the distributors of the products possessed by the franchisor.  This form of a franchise business can be seen in the case of large product dealers. Presently they constitute the highest percentage of total US retail sales. Dell, Hewlett Packard, Ford, and Caterpillar are all famous businesses run by product franchising.  

Investment Franchise

A large-scale business uses an investment franchise model. Franchises require huge capital investment. For this business and franchisees undertake major monetary and human resource investments. This collaboration expects to yield a high return on investment and a potential capital gain on exit. Usually, hotel businesses run following the Investment franchise model. 

Conversion Franchise

This is a hybrid form of the franchise model. Here the franchisor selects partners who were in the business before. However, now they are willing to convert their business into a franchise unit for an already established player in that field. Thus, they do not have to start the business from scratch. Instead, they can modify their previous business and start using the parent company’s trademarks, marketing, and advertising programs by signing the franchise agreement and following their service protocols.

Conclusion

Thus, to summarise, the franchise form of business is one of the most common and most popular strategies for business expansion. However, the success of this form of business lies in the franchise agreement, which defines the basic premises for both the partners – the franchisor and the franchisees. For a sound and smooth sailing of businesses of both these partners, each must adhere to the terms and conditions laid out in the contract.

 

Also read: The relationship between Branding and Funding

 

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Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views, official policy or position of GlobalLinker.

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Vakilsearch Staff

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