Development Arrangements in Franchising
Many franchisees and even some franchisors do not clearly understand what a development arrangement is. In its simplest form, a development arrangement is an agreement whereby a franchisee (commonly known as a developer) agrees with a franchisor to open and operate multiple franchised units of the same type. Typically, a development arrangement involves the opening of those franchised units within a set geographical area. The issues around development arrangements can be complicated and prior to entering into an agreement to develop multiple unit franchises, both the developer and the franchisor need to carefully consider a number of important issues, including the following:
- How many unit franchises will the developer have to establish? Both developers and franchisors are often overly optimistic as to how many unit franchises the developer can open and operate. It is not uncommon for developers to have insufficient financial resources to open the number of unit franchises anticipated in their development agreement with a franchisor. Given this, both franchisors and developers should be realistic in determining: (i) how many unit franchises the developer is really capable of opening; and (ii) how much money it will actually cost to open the number of required unit franchises.
- How many years will the developer have to build and open the franchised units? Developers and franchisors are often overly aggressive when considering the length of time the developer will need to open the required number of unit franchises. Some developers are very excited to obtain the rights to open 10 unit franchises but are entirely incapable of opening those 10 franchises in the time period that the franchisor requires. For example, for many franchise systems opening 10 unit franchises in a two year period is simply unrealistic from a construction, labour, capital and operational perspective.
- What form of exclusivity will the developer be granted within the territory in which it is going to open unit franchises? Some development arrangements provide that as long as the developer is in compliance with the development agreement itself and the development schedule (being the number of unit franchises to be opened by set dates) the franchisor will not either directly itself or through one of its franchisees operate any unit franchises within the development territory granted to the developer. Obviously, most developers will want some form of exclusive territory granted to them. However, there are development arrangements whereby the developer actually obtains no exclusive territory and the franchisor or other franchisees of the system may open unit franchises in the area in which the developer has obtained rights to develop unit franchises.
- Will there be any financial incentive for the developer opening multiple unit franchises? In some circumstances, franchisors will provide reduced initial fees, reduced royalties or other financial incentives to developers who open a significant multiple of unit franchises. There is really no standard amount for these incentives. The amount of the discount to initial franchise fees or royalty fees that a developer can obtain varies widely from system to system and is truly subject to the negotiations of any particular development arrangement.
Franchisors and franchisees who are considering entering into a development arrangement should ensure they fully understand what a development arrangement is and the particular issues that commonly arise when development rights are granted. Failure to consider these issues at the outset often leads to disputes down the road.