This is a reprint of an ar­ti­cle that orig­i­nal­ly ap­peared on the Ler­man & Szlak web site.

Fran­chis­ing rep­re­sents a well-known busi­ness method where the fran­chisor, who had de­vel­oped a suc­cess­ful busi­ness, shares its know-how, brand iden­ti­ty, as well as dis­tri­b­u­tion and mar­ket­ing strate­gies with the fran­chisees. In oth­er words, fran­chis­ing al­lows new­com­ers to uti­lize a brand’s name, know-how, mar­ket­ing strat­e­gy, and busi­ness pres­ence.

Con­trary to a pop­u­lar be­lief, a fran­chisee is not “pur­chas­ing” a fran­chise, but rather in­vest­ing their as­sets in or­der to legal­ly uti­lize a brand’s name, know-how and well-es­tab­lished mar­ket­ing and dis­tri­b­u­tion plans. The fran­chisor de­ter­mines the terms and con­di­tions of their re­la­tion­ships with the fran­chisees, as well as the in­ter­con­nect­ed­ness, if any, of all the fran­chisees in­volved.

As a fran­chisee, a com­pa­ny choos­es to in­vest in an­oth­er brand that has made its pres­ence known on the mar­ket, in or­der to cap­i­tal­ize on their ex­pe­ri­ence and suc­cess. As a fran­chisor, a brand of­fers their con­tin­u­ous sup­port and op­er­at­ing sys­tem to oth­er com­pa­nies in or­der to re­in­force their busi­ness pres­ence and con­quer the mar­ket. As a team, com­pa­nies in­volved in the fran­chis­ing process must de­fine their co­op­er­a­tion clear­ly, in ac­cor­dance with le­gal ram­i­fi­ca­tions.

To­day, we delve in­to the four core le­gal chal­lenges en­coun­tered in fran­chis­ing.

(1) De­sign­ing a Clear Stan­dard Fran­chise Agree­ment

A strong fran­chise com­pa­ny gen­er­al­ly uti­lizes one stan­dard, uni­form con­tract to de­fine re­la­tion­ships with all their fran­chisees, which at­tends to all the fran­chise source con­cerns.

This way, the fran­chisor cre­ates a strong, re­li­able sys­tem and achieves con­sis­ten­cy across fran­chisees.

A fran­chise agree­ment should clear­ly in­di­cate the reg­u­la­tions re­gard­ing the op­er­a­tions of all the fran­chisees, in­clud­ing ac­tiv­i­ty re­stric­tions and spe­cif­ic rules. By clear­ly stat­ing the “dos” and “don’ts” of the agree­ment, the fran­chisor can pre­vent fran­chisees from tak­ing any rogue ac­tions which could po­ten­tial­ly jeop­ar­dize the en­tire sys­tem.

Manda­to­ry con­trac­tu­al pro­vi­sions pro­tect not on­ly the fran­chisor, its trade meth­ods and well-kept busi­ness se­crets but the as­so­ci­at­ed fran­chisees and their busi­ness­es, as well. Con­tracts are gen­er­al­ly com­ple­ment­ed with fran­chisee man­u­als with clear and de­tailed op­er­a­tional meth­ods, which pro­vide clear stan­dards for fran­chisees and al­low fran­chisors to iden­ti­fy any de­vi­a­tions rapid­ly.

(2) Adapt­ing the Agree­ment to Pre­vent Con­flict

To be able to cre­ate a ful­ly func­tion­ing chan­nel of re­sources, the fran­chisor has to de­vel­op more than just a con­trac­tu­al re­la­tion­ship. Fran­chis­ing is a li­cens­ing agree­ment which al­lows the fran­chisor to dis­trib­ute prod­ucts and ser­vices through the fran­chisees in the sys­tem. In or­der to man­age the net­work of fran­chisees, the brand must es­tab­lish ad­e­quate sys­tems of sup­port and mon­i­tor­ing in their ac­tiv­i­ties.

One of the ques­tions sur­round­ing the or­ga­ni­za­tion of a net­work of re­sources is, which as­pects of their busi­ness will the fran­chisor be di­rect­ly in­volved in? Al­so, how will the com­mu­ni­ca­tion in this chain be man­aged? The fran­chisor is re­spon­si­ble for mon­i­tor­ing all the ac­tiv­i­ties sur­round­ing the fran­chise, ad­vis­ing and di­rect­ing the fran­chisees, as well as im­ple­ment­ing penal­ties, but con­tracts are al­ways more ef­fec­tive when they are de­signed around the prin­ci­ple of pre­vent­ing con­flict.

To ad­e­quate­ly chan­nel the re­sources en­tails pro­hibit­ing po­ten­tial­ly in­ju­ri­ous ac­tions, in­clud­ing not choos­ing the pro­posed providers and there­fore com­pro­mis­ing the qual­i­ty of the prod­uct or ser­vice; con­tin­u­ing to use the brand even af­ter the con­tract had been ter­mi­nat­ed, sell­ing prod­ucts or pro­vid­ing ser­vices that have not been au­tho­rized by the li­cen­sor, etc.

When the con­tract takes in­to ac­count the prac­ti­cal al­lo­ca­tion of re­sources of both par­ties, it helps min­i­mize and pre­vent risks. There­by, the con­tract helps to avoid con­flict sit­u­a­tions which can harm the fran­chisor-fran­chisee re­la­tion­ship.

It is im­por­tant to state that, de­pend­ing on the laws of a coun­try, there may be dif­fer­ent le­gal re­quire­ments when it comes to fran­chis­ing. In ad­di­tion to these reg­u­la­tions, the li­cen­sor (fran­chisor) ap­plies their own meth­ods in or­der to en­sure that the fran­chisees are ad­her­ing to the pro­posed busi­ness guide­lines. Po­ten­tial sit­u­a­tions must be ad­dressed and de­fined time­ly in or­der to avoid non-com­pli­ance with ac­tiv­i­ty re­stric­tions.

(3) Im­ple­ment­ing the Fran­chise and Man­ag­ing Pric­ing Is­sues

Pro­vid­ing a fran­chise is a com­plex mat­ter which stretch­es far be­yond the reg­u­la­tions and le­gal mat­ters. When pro­vid­ing a fran­chise, the fran­chisor of­fers much more than just prod­ucts and ser­vices. In fact, a fran­chise rep­re­sents an en­tire sys­tem con­sist­ing of a wide va­ri­ety of el­e­ments, in­clud­ing meth­ods, strate­gies, train­ing, brand stan­dards, qual­i­ty con­trol, and op­er­at­ing man­u­als.

When it comes to the fi­nan­cial as­pect, there are gen­er­al­ly two fees de­ter­mined in a fran­chise agree­ment: a one-time ini­tial fee and a con­tin­u­ing fee — com­mon­ly re­ferred to as roy­al­ty. The ini­tial fee is the cost of en­ter­ing the fran­chis­ing process, while roy­al­ty is a fee charged for the use of the brand’s name and the en­tire op­er­at­ing sys­tem. Pri­or to set­ting the pric­ing and re­quest­ing in­vest­ments, a brand’s per­for­mance, ca­pa­bil­i­ty, and worth must be eval­u­at­ed.

In or­der to im­ple­ment a suc­cess­ful fran­chis­ing strat­e­gy, the fran­chisor should make sure that the fran­chisees are pre­pared for this enor­mous step in their busi­ness ex­pan­sion. The prepa­ra­tion process gen­er­al­ly en­tails re­quir­ing a busi­ness plan from the fran­chisee which should out­line their busi­ness path and some­what de­ter­mine their “el­i­gi­bil­i­ty”.

Fran­chisors nor­mal­ly de­cide pric­ing strate­gies, and they need to be wise to de­sign pric­ing strate­gies that are prof­itable for both fran­chisor and fran­chisee. Oth­er­wise, the fran­chise will not suc­ceed.

(4) Man­ag­ing the Re­la­tion­ships with Sup­pli­ers and Oth­er Third Par­ties

Sup­ply chains con­sist of ap­proved sup­pli­ers that have been rec­og­nized and thor­ough­ly in­ves­ti­gat­ed by the fran­chisor. Choos­ing ap­proved sup­ply chains en­ables the fran­chisor to close­ly mon­i­tor the qual­i­ty of the prod­ucts or ser­vices, and set high stan­dards for their fran­chisees, as well. It is safe to say that form­ing a strong net­work of sup­pli­ers rep­re­sents one of the biggest chal­lenges in fran­chis­ing, con­sid­er­ing the fact that the qual­i­ty de­ter­mines the con­sumers’ ex­pe­ri­ence.

In or­der to set high stan­dards for their fran­chisees, a brand must have high stan­dards when choos­ing the sup­pli­ers. Some of the con­di­tions the fran­chisor must take in­to con­sid­er­a­tion in­clude the ex­is­tence of war­ran­ty pol­i­cy, ad­e­quate de­liv­ery sched­ule, rea­son­able pay­ment terms and pric­ing for fran­chisees, sup­pli­ers’ re­la­tion­ship with the fran­chisees and the ex­is­tence of a train­ing pro­gram, as well as their will­ing­ness to as­sist the fran­chisees when it comes to mer­chan­dis­ing.

Fran­chisors, as well as fran­chisees, en­gage in an on­go­ing re­la­tion­ship with sup­pli­ers, which makes the choice of the sup­ply chain cru­cial for the brand’s con­sis­ten­cy and pros­per­i­ty. Be­sides the se­lec­tion, it is al­so the com­mu­ni­ca­tion and co­op­er­a­tion be­tween the sup­pli­ers and the brand that re­quires a great deal of at­ten­tion, to pro­tect the fran­chise and the fran­chisees.