The Franchise Business Model: Contractual Obligations

When a prospective franchisee is evaluating a potential franchise investment, they need to do their due diligence to ensure they understand the contractual obligations that will be required of them as an owner. Investing in a franchise provides franchisees with a proven business model, support infrastructure, brand recognition and several other benefits — but they don’t come for free. In addition to startup costs, there are several requirements that franchisees are expected to meet as legally binding terms of their agreement. 

1851 Franchise spoke with a few franchising experts to break down some of the main obligations prospective franchisees need to keep in mind before signing on the dotted line.

Franchise Captain founder Corey Elias says that, first and foremost, franchisees need to remember that a franchise agreement is a big commitment. “The average agreement is for 10 years, some are a little less, some a little more,” he said. “So, no matter what, it is a major commitment and will be what franchisees are focused on for a decade of their lives at least.”

Another one of the primary obligations franchisees should keep in mind is royalty payments — the fees franchisees pay franchisors in exchange for the business model. “The royalties are a big piece of that decade-long contract,” said Elias. “You are going to be paying a percentage of your gross sales to the franchisor for those 10 years. It is important that you are ready to do that.”

Some of the other requirements that may come up, Elias says, include both local and national marketing efforts. Another obligation that may come as a surprise in a franchise agreement is that a personal guarantee and spousal personal guarantee may be required. A personal guarantee is a binding contract that makes you personally liable for performing every term of the franchise agreement, including not only operational terms, but also financial terms liability for lost future royalties and attorneys' fees and non-competition covenants.

Each franchise concept will have slightly different obligations when it comes to the day-to-day operations and running the actual business. Charlie Bever, the Entrepreneur Authority Senior Franchise Consultant, says franchisee prospects need to consider the lifestyle of running the business and the culture of the brand.

“How would acquiring the franchise impact one's everyday lifestyle? Would it involve more hours, fewer hours, nights, weekends, etc.? Franchise prospects often overlook exploring the culture of a franchise,” said Bever. “It's really important not to mix ‘oil and water’ when it comes to the cultural workplace. Perhaps it's a competitive culture, maybe a creative culture or a control culture. A savvy franchisor will actually address this early on in their process by administering a profile assessment tool to the prospective franchisee. They benchmark the profile of their top franchise owners and compare it to the candidate's profile. If the profiles are polar opposites, this could actually lead to a disqualification of the candidate.” 

Before signing with the brand, Elias says prospects need to be able to envision themselves in the role of running the business. “Prospects should talk to other franchisees to understand what it really takes to run the day-to-day business and be successful,” he said. “Most people are getting into business ownership to find that freedom and become their own boss, so they need to make sure that the business model will allow them to do that and feel satisfied.”

Also, Bever notes it is very important for the prospective franchisee to consider their exit strategy and what that potentially looks like with their franchise of interest.

Overall, Bever says prospects need to remember that the franchise agreement terms will almost always be written "in favor" of the franchisor. While that is not necessarily a bad thing, prospects need to understand that these obligations are not up for debate. 

“It is highly unlikely the franchisor will negotiate any terms found in their franchise agreement, because they want to instill and maintain integrity for their system,” said Bever. “It would not be fair to make concessions to someone if hundreds before them that signed the same agreement did not receive the same concessions.”

But that doesn’t mean franchisees don’t get anything in return for meeting these obligations. As prospects go through their research, Elias says they should focus on the potential earnings, the lifestyle benefits of a concept and the possibility of growth. 

“A franchise is a partnership, and at the end of the day, you don’t want to have to bring out the franchise agreement and FDD every month to remind yourself what you can and can’t do,” said Elias. “There should be communication from the beginning, and the business should be a partnership where everyone works together. By understanding their contractual obligations right from the start, franchisees will be better positioned to achieve their goals.”