What is the ideal length of a franchise agreement?

Author: f.alepin@alepin.com

Date: AUG 23rd, 2012

Topic: Industry Experts

Whenever an entrepreneur is considering creating a new franchise network, one of the inevitable questions is the term of his franchise contract. You may not be surprised to learn that there is no objective answer to this question, as the answer must take account of all the particular details of each situation. The establishment of the ideal term of a franchise contract will be the result of the goals of the franchisor, which will become clear during his discussion of this question with his lawyers.

Before I compile a summary view of the advantages and disadvantages of short term or long term franchise agreements, allow me to underline the fact that an entrepreneur may choose to become a franchisor for a specific period of time and for specific reasons. There is nothing to oblige an entrepreneur who has a business project to establish a franchise network. In fact, the entrepreneur may prefer to grow his business by the branch model, wherein the company owns the stores or the points of sale, instead of a franchising model wherein the entrepreneur must deal with a number of different, independent entrepreneurs. If the entrepreneur has decided to follow the franchising route, it may be because he wishes to profit from the franchise model’s multiple advantages, whether on a financial or operational level, which, for example, permits him to enter a lucrative market possibly more quickly via the franchising model rather than if he only deployed his own personal and financial resources.

However, the franchisor may wish to rapidly gain a position in the market via the franchise system and, later on, change to a branch model, because he no longer wishes to share with the other independent entrepreneurs, the franchisees, the profits from the network that he was primarily responsible for creating. We can, for example, foresee a case where the entrepreneur decides to establish a franchise network for his business for a period of approximately 15 to 20 years and thereafter, gradually, not renew the franchise contracts of the franchisees, but continue to operate the points of sale as branches with employee-managers instead of franchisees. In that case, it becomes understood that, if this is the long term goal of the entrepreneur, the term of the franchise agreement becomes very important and must therefore be managed in consideration of the entrepreneur’s above-said long term objectives.

Advantages of a short term franchise contract

1. The franchisor may more frequently charge the initial investment fee;

2. The franchisor may more frequently and more significantly modify the franchise contract;

3. It is easier for the franchisor to end a relationship with a problematic or underperforming franchisee without having to prove that the franchisee is in default of his obligations, thereby permitting a termination of the franchise contract;

4. It is easier for the franchisor to withdraw from the franchising business model more rapidly;

5. It creates pressure on franchisees who wish to obtain new or renewed franchise contracts to perform and to be as profitable as possible.

Disadvantages of a short term franchise contract

1. The franchisor is obliged to find new franchisees if the franchisor decides to not renew a franchise contract or if the franchisee decides to not renew the franchise contract;

2. The franchisor is obliged to constantly supervise the training of new franchisees and/or key members of the franchisee’s personnel;

3. The clientele at certain points of sale may not be stable because of the frequent change in the identity of the franchisee;

4. Both the market, as well as the franchisees, may believe that the franchisor does not take into consideration the interests of his franchisees because he does not permit the franchisees to truly «build a career» in the franchise network;

5. This may create a situation where the former franchisees who are no longer part of the network may be in possession of some of the operating secrets of the network, that is to say, the system and the concept, which may permit competition, whether fair or unfair, so that the said former franchisees, now competitors, may or may not violate the non-compete clauses contained in the franchise contracts.

Advantages of a long term franchise contract

1. The franchisor should be able to generate the interest of persons looking to be involved on a long-term basis with the network;

2. The franchisees will be more apt to identify themselves with the franchise business when they are connected to it for a longer period of time, as opposed to those franchisees who would only be connected, for example, for a period of 3 years;

3. Creating a business relationship with franchisees who have a long term vision, wherein they will own or operate more than one franchise because they have demonstrated their ability to operate satisfactorily and profitably;

4. It permits the franchisor to maintain long term business relationship, but the franchisor also knows that he may terminate such relationship if the franchisee’s operations are unacceptable, because the franchisor may always invoke one of the default clauses in the franchise contract;

5. It favors greater stability in managing human resources;

6. It allows the franchisee to build up the equity in the franchised business, that he may consider thereafter selling to third parties;

7. Significantly reduces the changes needed to the franchise documentation, including not only the franchise agreement but as well the lease agreements or the subleases;

8. Creates a situation where the franchisees are very familiar with the functioning of the franchise system;

9. Franchisees remain in the franchise system for a longer period of time and, therefore, there is less risk that they may become competitors.

Disadvantages of a long term franchise contract

1. Makes it more difficult for the franchisor to transform his network rapidly into a branch model if he so decides;

2. The franchisor risks being stuck with franchisees who, although they operate adequately, have lost the fire or enthusiasm of the initial years of operation;

3. Reduces the number of occasions for which the franchisor may require initial investments for a particular site;

4. The franchisor will find it difficult to modify his franchise contract during the term of the contract.

Of course, there are other advantages and disadvantages with regard to either a short term or long term franchise contract, which will have to be analyzed for each individual case being considered.