What to Review Before Signing a Franchise Agreement

A franchise agreement is the foundational contract governing the relationship between a franchisor and a franchisee. It sets out the rights, responsibilities and expectations of each party, including how the business must be operated, the fees and royalties payable, and the standards to be maintained under the franchisor's brand. It is considerably more than a standard commercial contract: it is a comprehensive, long-term document governing virtually every aspect of the relationship, typically prepared by the franchisor and designed principally to protect the franchisor's interests. Careful review before signing is therefore essential, and several areas warrant particular attention.

The first concerns personal guarantees and dispute resolution. Many franchisees assume that incorporating their business will insulate their personal assets from the liabilities of the franchise. Franchise agreements frequently require the owner to sign a personal guarantee, making them personally responsible for the franchise's obligations regardless of the corporate structure through which it operates. Where the business encounters financial difficulty, the franchisor may then pursue the owner's personal assets for unpaid amounts, damages or other contractual obligations. This is among the most significant risks in many agreements. The provisions governing how disputes will be resolved deserve comparable attention. They tend to receive little scrutiny during the excitement of acquiring a franchise, yet they determine the practical realities of enforcing any right the agreement confers.

The second concerns term, renewal and exit. Prospective franchisees often focus on the initial term — commonly ten years or more — and pay far less attention to what happens when it expires. Renewal rights are widely promoted as a benefit of franchise ownership, but the drafting requires scrutiny. A particular warning sign is language providing that renewal will be granted only if the franchisee agrees to sign the franchisor's then-current franchise agreement. This appears innocuous but permits the franchisor to alter the terms of the relationship substantially at renewal, and the agreement available a decade from now may bear little resemblance to the one being signed today. Unless the agreement expressly limits such changes, the franchisor is generally under no obligation to offer renewal on the original terms. The ability to exit requires equal consideration. Most agreements restrict transfers, commonly requiring franchisor approval of any purchaser, imposing transfer fees, granting a right of first refusal, or requiring the purchaser to sign the then-current agreement. The consequences of early termination should also be reviewed, as some agreements impose substantial financial penalties, continuing obligations, or restrictive covenants that affect future business opportunities.

The third concerns performance obligations and compliance. Franchise agreements impose extensive operational requirements: sales or revenue minimums, mandatory purchasing from specified suppliers whose prices cannot be negotiated, staffing requirements, operating hours, fit-out specifications, and compliance with an operations manual that the franchisor may update at any time. The question to ask is what happens on a failure to comply. Review the grounds on which the franchisor may issue a notice of default and, critically, whether there is an opportunity to remedy a breach before further consequences follow. Some agreements permit termination for relatively minor violations. Ask to see the operations manual before signing; although it may not form part of the executed agreement, its requirements are binding.

The fourth concerns territory. Many prospective franchisees assume that purchasing a franchise brings an exclusive territory in which no other franchisee, and not the franchisor itself, may compete. Territorial provisions vary considerably and the details matter. Be cautious where the agreement grants only a right of first refusal over neighbouring territories rather than genuine exclusivity; such a clause gives priority access before those areas are offered elsewhere, but stops well short of guaranteeing they will ever be yours. Consider also whether the agreement permits the franchisor to compete through other channels, including internet retailing, wholesale distribution or company-owned locations. A poorly defined or non-exclusive territory exposes a franchisee to competition that erodes market share and long-term profitability.

The fifth concerns costs. The initial franchise fee represents the entry point rather than the price. Franchisees are generally required to pay ongoing royalties, most often calculated as a percentage of gross revenue rather than net profit, which means they remain payable regardless of profitability and continue during periods of loss. The definition of the royalty base is therefore important, as calculation on gross sales can materially erode margins compared with a net-based structure. Many agreements require contributions to a centralised marketing or advertising fund, over which franchisees often have limited control and a portion of which may be applied to national branding or system expansion rather than local promotion. Additional charges commonly include technology fees, training fees, renewal fees and transfer fees. Initial setup costs — rent, construction, equipment, inventory, licensing, insurance and sometimes a mandatory grand opening campaign — can range from tens of thousands to several hundred thousand dollars depending on the system, and franchisors may retain discretion to increase fees over time.

Given the cumulative effect of these obligations, a complete and detailed written breakdown of all present and potential future fees should be obtained before entering into any franchise agreement.