Practical advice for franchisees
Michelle Goodrum, senior associate at Sykes Anderson Perry Limited
Please note that the information herein is of a general nature and you should not act or refrain from acting on it without professional advice on the specific facts of your case. No liability is accepted by the authors or Sykes Anderson Perry Limited in respect of this article. Commercial and property law are complex subjects and the above is a basic outline only and is intended only as a general guide. Nothing herein constitutes financial advice.
Taking over a franchise need not be a complex matter if you have the right legal support and a positive attitude. It is important to understand that as a franchisee, you will have little bargaining power because the franchisor will want to ensure consistency in its operation and to protect its reputation. That said, the franchisor will also want the franchisee to be successful because the more money the franchisee makes, the more the franchisor makes. And ultimately, if the franchise is successful then it will only add value to the goodwill of the franchise.
Having a development plan is essential. It is important to consider that you will have overall responsibility for the success of your business. You will need to carefully consider your business plan and running costs. It is essential to have a considered target relating to sales volume and customers. This will help with the marketing and advertising as there will usually be a term in the franchise agreement for the franchisee to spend a minimum amount on these. It will also help pin point the key issues that need to be dealt with in the franchise agreement.
This article looks at some of the key terms you will negotiate with the franchisor and points to consider in respect of both the franchise agreement and the letting of the franchise premises.
A franchise agreement is essentially a licence to run an existing business. It is an important legal document which governs the relationship and sets out the parties’ obligations and liabilities.
If you have not already done so, you are likely to need to register for VAT.
The manual sets out the franchisor's operational method for the successful running of a franchise business, and deals with day-to-day matters not covered in the agreement. You, as the franchisee, will usually be expected to follow the manual, and as such the manual is incorporated into the agreement, so that compliance with its provisions has contractual status.
Company franchisee and Guarantees
In most cases, the franchisee will operate via a limited company for various reasons, including tax advantages. In these circumstances, the franchisor will expect certain guarantees from the individual (namely the principal) to guarantee the obligations of the franchisee company.
There will be other things to consider if a company is involved, such as the obligations and duties of a director. The company will need to keep certain records and file a confirmation statement every year confirming the company’s details with Companies House.
You are likely to need an accountant and you may also wish to instruct a professional company secretary or solicitor to assist with your company filings.
You should also consider taking out insurance, such as public liability and directors’ insurance. It would be advisable to consult a broker in this regard.
Third party involvements
In most cases, the franchisor will have a number of individuals working with them including accountant and agents. These individuals will have an understanding of the operation of the franchisor and what the franchisor expects. As such, if the franchisee is new to running such a business, they may want to consider using these individuals. It may be cost effectively. That said, there is nothing to stop the franchisee from looking around to see if they can get a better deal.
Usually, there will be an agreed exclusive territory granted to the franchisee. It is not sensible to have the same business running close to one another. That said, depending on the business and the area, the territory may not be as wide as the franchisee would like. For example, there are several pret a manger in very close proximity to each other, and in spite of this, the franchise does very well because of the nature of the business.
Generally, the franchisor will have no objection to considering a new location, unless it is completely inappropriate.
The burden is on the franchisee to do some research on the territory and identify any issues from the outset. It is worth considering other similar businesses in the territory as well as they too will be competition. Consider how long these similar businesses have been around and other businesses that have set up and failed. Consider the reason it has failed. People are creatures of habit so unless the business you are proposing has something more to offer, clients are likely to stay with the business they are used to.
Term and renewal
Usually franchisees will want a lengthy period to allow them to maximise the return on their investment. The length of the term is a question of negotiation. However, franchise agreements often have an initial term of five to ten years.
Sometimes the franchise agreement may provide for automatic renewal of the franchise, subject to the franchisee's performance and meeting certain conditions. More often than not there will be a right to renew and the franchisee will need notify the franchisor of his or her intention. It is best to have a right to renew to enable the franchisee to, perhaps, negotiate more favourable terms with the franchisor. If the franchise has been running successfully then the franchisee may have a little more bargaining power as the franchisor will want to keep the franchisee and continuity of business
There will be an initial fee and an ongoing management fee. The latter will usually be a % of the turnover.
The initial fee will usually include training and the setting up of the business. For example, the franchisor will have certain IT systems that it will want the franchisee to use and so the initial fee will include this.
It is a good idea to get a break down of what is and what is not included in the initial fee. Having that knowledge will help in negotiating better and reasonable terms.
These are limitations placed on a franchisee following the termination of a franchise. Usual restrictive covenants include a restriction not to operate (or have an interest in) a business competing with the franchise, for specified times and areas. Because these restrictions prevent people from earning a living, the English courts will not enforce them unless they go no further than is reasonably necessary to protect the franchisor’s trade secrets or goodwill.
When running a franchise, you will need to have a place from which to run it. The norm is that the franchisee will rent a property. The terms of the lease will need to be agreed with the landlord. These are normally set out in an agreement called a head of terms. Below we set out some points to consider when agreeing heads of terms for a commercial lease, with some specific considerations for franchisees.
It should be confirmed whether any guarantor is required.
A description of the property should be included. It is important to check that this accords with the franchise agreement.
This is the length of the lease. You will need to tie this to the length of the franchise agreement.
4. Break clause
The timing of any break clause should be confirmed, together with any requirements for exercising same. You will want to timing of any break clause under the franchise agreement and lease to be similar.
5. Security of tenure
The Landlord and Tenant Act 1954 offers tenants occupying a property for the purposes of their business a certain degree of security, so that upon the expiry of their lease the landlord can only refuse to renew same in limited circumstances. It should be clarified whether the tenant will have the protection of the Landlord and Tenant Act 1954 or whether the protection will be excluded.
In most cases these days the statutory protection will be excluded. However, if your franchise renewal is linked to a specific area, you may wish to push for the automatic right to renew your lease of the property if you require.
6. Rent, rent free period, rent review and rent deposit
These should all be set out in the heads of terms. You will need to consider the affordability of the rent. It is advisable to seek advice from a specialist commercial valuer on the market rates.
7. Services and service charge
The basis of the service charge should be set out, for instance a percentage, fair proportion or share based on the floor area. Any service charge cap arrangements should be set out in the heads of terms. It is advisable to agree a cap, particularly in the event of a short lease, so that you don’t find yourself having to contribute to larger works, such as a replacement roof, the benefit of which to you may be limited.
The heads of terms should confirm which party is responsible for insurance; this will normally be the landlord. If the landlord insures, then it is helpful to clarify the share payable by the tenant.
The permitted use of the property should be stated. It is helpful to ask the landlord to confirm any restrictions on, and to put to them any requirements in respect of, use at the outset. You should check that the use permitted under the lease accords with the franchise agreement. You should for instance check that the trading times in both are the same.
You should check that the property has planning permission for the use. You may need to consult a planning consultant in this regard.
10. Assignments and underleases
The position in regards to assigning the lease or underletting the property should be clarified. Any restrictions should be confirmed at this stage.
11. Repair and reinstatement
The responsibility for repair will normally lay with the tenant, who will have to maintain the property to a certain standard. At the end of the lease the tenant will normally be required to put the property back to a certain standard. The standard required should be confirmed. If the standard required is stated to be along the lines of good or tenantable, it could require the tenant to put the property into a better condition than when let. Therefore, unless the premises are newly refurbished it is advisable to consider limiting the obligations by reference to a schedule of condition; an expert surveyor should be instructed to prepare same.
12. Alterations, fit out works and signage
It should be confirmed which alterations the tenant can make and whether consent is required for same. The position will offer differ dependent on the nature of alterations; in particular whether they are internal or external and/or structural or non-structural may affect whether they are permitted. If the franchisor has any requirements about fit-out or signage, you should check these will be permitted. You may need to instruct a surveyor and/or contractor to assist with plans and works.
13. Landlord’s works
If the landlord is to undertake any works to the property then this should be set out in the heads of terms. Any agreed time-frame for same, should also be set out. It is also advisable to say something along the lines of works should be undertaken to the tenant’s satisfaction.
If the agreement to enter into the lease is subject to survey, mortgage or consent this should be confirmed.
It should be stated who will be responsible for the legal costs. If either party is bearing the other’s costs, or making a contribution to same, this should be stated.
Any agreed, or important, points on timing should be set out (e.g. if a tenant needs to vacate alternate premises by a certain date). You will need to ensure the timescales for the franchise agreement and lease tally.
There are a number of complex issues involved and you are likely to need a network of experts to assist. It is advisable to consider building that network at the outset. At Sykes Anderson Perry our company/commercial, employment and property teams work together to provide a comprehensive package of legal advice tailored to your needs, dealing with all of the aspects involved in running a successful franchise.