No uncertain terms: planning for the end of your franchise agreement

Preparing for the end of a franchise agreement is vital for franchisors and franchisees alike

No uncertain terms: planning for the end of your franchise agreement

Franchise agreements will always be for an initial, fixed term as it is important that the franchisee is given a guaranteed initial period to build the business. However, the length of the term can vary greatly across different networks.

The majority of franchise networks in the UK are for an initial term of five years, with the option for the franchisee to renew for a further five years after that. However, networks occasionally offer only 12 months, whilst at the other end of the scale some networks offer 15, 20 or even 25-year terms. So what factors are important in setting the term?

The first and perhaps most obvious consideration is that the term must be long enough to enable the franchisee to establish their new business and recover their investment. Depending on the type of business, the franchisee may well make a loss in their first year of operation and not break even until the second or third year. In that scenario, a franchisee would expect a term of at least five years so that they have at least the fourth and fifth years to make a profit and – hopefully – a return on their investment.

As a general rule, it follows that the higher the initial investment, the longer the term that would be expected. Allied to this, if the franchisee is using bank borrowing to fund the business, most banks won’t lend funds for any longer than the initial term. Consequently, the more the franchisee has to borrow, the longer the initial term will need to be to pay back the loan.

Some networks are more complicated than others in that it will take longer for the franchisee to complete the training and become fully familiar with the business systems and processes. Similarly, it will take some businesses more time than others to become established in the franchisee’s local area.

Having said this, shorter terms offer both franchisor and franchisee greater flexibility to exit if required. Franchise agreements don’t contain a right for the franchisee to serve notice and terminate during the term. This means that the shorter the term, the shorter the amount of time the franchisee is committing to in terms of how long they’ll have to operate the business before they can leave.

Equally, from a franchisor’s perspective, renewal at the end of the initial term provides an opportunity to introduce a new franchise agreement, update equipment and, in a worst-case scenario, get rid of an underperforming franchisee. Shorter terms mean this opportunity arises more frequently.

Renewal

Franchise agreements with shorter terms – those less than ten years – should always contain a right for the franchisee to renew at the end of their initial term. This will be subject to the franchisee satisfying certain conditions. The conditions usually include giving written notice of the desire to renew within a certain window – typically between three and six months prior to expiry of the initial term.

The right to renew will be subject to the franchisee having complied with the franchise agreement and manual during their current term. The terms of the agreement may also allow the franchisor to require equipment, vehicles and premises to be refurbished and for the franchisee to undertake refresher training. The franchisee should therefore to be prepared to foot the bill for this.

Often the franchisee will be required to enter into a new franchise agreement based on the franchisor’s terms as they stand at the point of renewal. This means that the terms of the new franchise agreement could be different from the original and include, for example, different levels of royalties.

There will also be a condition that the franchisee is not in breach of the franchise agreement. Usually, this will relate to both the point of renewal and also to whether the franchisee has complied with the franchise agreement throughout the initial term.

The effect of the renewal conditions is that, although the franchisee technically has a right to renew, in some circumstances franchisees may not qualify for renewal. And, in others, they may simply choose not to, for example if the franchisee does not want to invest in carrying out of refurbishments or if the new franchise agreement is on terms that they’re not willing to accept. As a result, the initial term becomes fundamental. Franchisees should only enter into a franchise agreement if they are comfortable that they will recover an appropriate return during the initial term. Any subsequent renewed terms can then be seen as a bonus or an additional investment opportunity.

All franchisees approaching the end of their current term should review the terms of their franchise agreement and check what the renewal criteria are. Additionally, dates when renewal notices must be given should be diarised so that the relevant window is not missed. It’s often helpful to start a dialogue with the franchisor well before the term is due to expire. This gives the parties plenty of time to consider their position, understand what requirements the franchisor is likely to have at renewal and start budgeting for any costs incurred.” /></p>
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ABOUT THE AUTHOR
Kate Legg
Kate Legg
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