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Why franchise agreement is important

A franchise agreement is a legally-binding contract between the parties to a franchise relationship. In order to take ownership of a franchise as the franchisee, you sign a franchise agreement. A franchise agreement protects both sides. It protects you as the franchisee and also protects the franchisor brand. When buying a franchise you will be making a large financial investment. A signed agreement gives you rights to help safeguard your investment in your business.

What is a Franchise Agreement?

A franchise agreement is the master legal document that sets forth the rights and obligations of the two main parties to a franchise: franchisor and franchisee.

In legal terms a franchise agreement is a license from the franchisor to the franchisee. A license simply means one party gives permission to another party to do something or use something of value. In the case of franchising agreements, this means:

  • The franchisor licenses to the franchisee the right to use the franchisor’s intellectual property, systems and brand.

  • The franchisee acquires the rights to open a business using the franchisor’s intellectual property, systems and brand, provided it meets certain conditions.

Although the definition of franchise agreement is simple enough, the documentation can be complex. A typical franchise agreement is 25 to 30 pages long. After attaching all exhibits and addenda, the final agreement can be two or three times as long. Clarity, rather than ambiguity, should be the goal when addressing the franchisor and franchisee's rights and obligations. For example, if a franchisor does not grant any form of territory protection, then the franchise agreement should clearly state that the franchisee has the right to operate at the authorized location only and the franchisor can develop additional locations or use alternative methods of distribution in any way it deems appropriate. If the franchisor does not want to expressly reserve those rights, then include the appropriate language that provides some limitations--just do it clearly and avoid ambiguity.

Beyond the foundation, however, the franchise agreement is a living, breathing document that must allow the franchise system to change over the life of that agreement. Franchisors often compete with larger companies with corporate locations as opposed to franchised locations. Those companies can implement new product lines or new marketing campaigns with executive decisions. If a franchisor cannot compete effectively with those competitors, it and its franchisees will not survive. Accordingly, a franchisor must reserve rights in its franchise agreement to implement system wide changes and otherwise evolve the system.

The franchise agreement also is the document that balances the interests of the franchisor, the franchisees, and the system as a whole. Using an economic analogy, it's the franchisee free rider who refuses to play by the rules who potentially creates great risk to all the other stakeholders in the system. The franchisee who refuses to contribute to a marketing fund, who uses unapproved vendors or products, or who violates the non compete covenants, is the franchisee who hurts not only the franchisor, but also the franchisees who play by the rules and the system as a whole. All stakeholders in the brand should want a strong franchise agreement to allow the franchisor to effectively deal with free-riding franchisees.

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