This article is written by Nuthanaganti Tejaswini pursuing a Diploma in General Corporate Practice. This article has been edited by Ojuswi (Associate, Lawsikho). 

This article has been published by Sneha Mahawar.

Introduction

Expanding the brand value and its branches in any business is the most crucial part on top of that strategizing the idea would be the core object to discuss. Since many business modes can help to grow and expand any entity, however, franchising is one of the best strategies for expanding the brand value of your business. McDonald’s is one of the top money-making franchises, its iconic symbol of fast food, sandwiches, burgers, chicken nuggets, and a wide variety of other signature food items expands its brand value. It operates more than 37,000 restaurants all over the world. 

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This article covers how a franchise works, the type of bankruptcy the franchisor chooses, the franchise agreement, the advantages and disadvantages of the agreement, and required documents. 

What is a franchise

A franchise is a strategy of distributing products and services of a business, which have a good brand value in the market. In simple terms, creating a brand and distributing that brand is referred to as franchising. It includes both a franchisor and a franchisee. The Franchisor, distributes and sells the franchise opportunities of their business to a franchisee. The franchisee duplicates the franchisor’s business for a certain period and has the right to open stores and sell products or services using the franchisor’s brand, strategy, business idea, intellectual property, and expertise. The franchisor provides continual guidance and support concerning general business strategies such as hiring and training staff, setting up shop, advertising its products or services, sourcing its supply, and so on. The franchisor’s parent role is a continuance commitment until the termination of the franchise agreement. The Franchisor always makes sure that the franchisee’s maintenance is up to the mark.

To become a franchisor, one must have a well-recognized business, and a valuable brand, so the business can expand through the franchise. Franchisees must pay royalty and some initial fee to obtain the right to do business. Well-known corporate franchisers include KFC, McDonald’s, and Subway. The relationship between a franchisor and a franchisee is like an advisor and advisee, however, the franchisor’s advising role is not at all free; it is part of the purchase by the franchisee. Hence franchising is the best method of expanding the brand value and the theme of any entity.

If any franchisor or a franchisee wants to enter a franchising business, they can enter into an agreement or a contract called Franchise Agreement.

Generally speaking, a franchisee is not protected by the agreement if the franchisor becomes bankrupt and a court stay will be imposed on all activities of the franchisor and there the franchisees aren’t allowed to take any legal action against the franchisor.

Type of bankruptcy the franchisor chooses

According to chapter VII of the Bankruptcy Code, the franchisor’s assets are liquidated to pay creditors. The companies usually opt for this route because it’s flat going out of business and it is highly unlikely that the franchisor will be able to meet its franchise agreement obligations. Hence, it is unlikely that the franchisee will be able to stay in business. 

As per the Chapter XI of the Bankruptcy Code, the franchisor reorganises the debt obligations and continues to operate as a going concern. By this reorganisation plan, a franchisor works with its creditors in reorganising and continuing to meet at least some of its franchise contract obligations. In both cases, the franchisor’s bankruptcy will likely have a significant impact on the franchisee.

Franchise agreements

A Franchise Agreement is a legal agreement or a contract that binds a franchisor and a franchisee. The agreement clearly explains what a franchisor expects from a franchisee, how a franchisee operates the business, how much royalty shall be paid by the franchisee, terms, and conditions to be followed during the time of their agreement. There is no specific format for a franchise agreement as it can be purely based on the negotiation between a franchisor and a franchisee. 

What shall be included in the franchise agreement

Franchisor and franchisee details

The clear details of the franchisor and a franchisee must be outlined before beginning with the business, including the agreement.

Location

The franchisee has to select a location, in which the franchisee is going to start his franchise business, and that must be approved by the franchisor before signing the agreement.

Royalties

The agreement outlines the franchisor’s royalty structure, and a fixed percentage in the total sales out of the franchise business.

Duration

It is a validity period of a franchise agreement until the franchisee has a right to continue the business under the franchisor’s brand and trademark.  

Initial fee and related matters

Matters related to initial fee, deposits, etc. That includes payment mode and due dates to pay. This is purely negotiable before signing the agreement.

Trademark

This section helps the franchisee use the trademark of the franchisor business, and it will also prohibit the franchisor from using this after the expiry of the agreement.

Training & support

The Franchisor must help train and support the franchisee’s staff, which will bring uniformity among the entire business brand.

Operations

It completely deals with the responsibilities of the franchisee and the support extended by the franchisor. That includes types of goods and services that a franchisee can offer, which he exclusively buys from the franchisor etc.

Termination Mechanism

This section in the agreement deals with the termination of the franchise agreement. It will also deal with the provisions if any party to the agreement breaches the terms, which may include penalties and fines.

The agreement contains the details mentioned above of the business.

It is one of the best strategies for expanding the brand value, albeit, the franchisor has both advantages and disadvantages in establishing the franchise business.

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Advantages of franchise agreements

  • A corporation typically uses franchising to enable its brand value as a global presence for which it also allows sub-franchise. In consideration, the franchisee takes the financial burden of maintaining the unit and pays the franchisor royalties for access to its time-tested business model, brand name, and established market power.
  • The original business will expand its geographical reach, it can also minimise its capital expenditure and increase the market share by opting for the franchise.
  • The franchise can be more profitable than any corporate-owned chain. Since the franchisees are always motivated to maximise their profitability and held responsible for their overheads, fewer overheads can make the franchise more profitable than the chain stores.
  • The franchisor always keeps receiving royalties in the name of the overall percentage of the gross sale, startup fee, monthly fee, and some other payments depending on the agreement.

Disadvantages of franchise agreements

Many of us think only a franchisee bears all the expenses and risk, but, in reality, a franchisor also bears the significant risk.

  • All a franchise requires is a sizable investment of both time and money, the franchisor needs to plan a business development, flagship store, documentation work, recruiting and training part, and marketing.
  • There cannot be a guarantee, even on a proven business, that the franchise could become successful and bring profits.
  • There could be a chance of disagreement with their ideas and temperaments and that might lead to significant changes.
  • If a franchisee refuses to cooperate or proves to be a poor choice in other ways, legal action may be necessary and it can be both expensive as well as damaging to a franchisor’s reputation. 

Documents required for franchise agreement

We do not have any specific documents required to execute a Franchise Agreement, however, the franchisee must oblige to the fact that the franchisor holds the power to delegate the franchisee and allied benefits to the franchisee. For the safer side, the franchisee must scrutinise all the relevant documents relating to the agreement and identity of the party. 

Conclusion

McDonald’s is one of the top money-making franchises, its iconic symbol of fast food, sandwiches, burgers, chicken nuggets, and a wide variety of other signature food items expands its brand value. It operates more than 37,000 restaurants all over the world.

In the event of a franchise, the franchisee must manage the network with at least two individuals, one of whom must be the franchisee or another partner, shareholder, or a designated representative, and devote continuous efforts to developing, managing, and operating the business. This means devoting sufficient time and resources to ensure complete compliance with their obligations to the franchisor, their customers, and others.

Reference

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