Franchise Legal Agreements
There are a number of pieces of legislation that affect franchising, however you do not need to understand these acts in any depth in order to invest in a franchise.
What you need to know is that to enter into a franchise arrangement it has legal implications.
When buying a franchise, you can expect to come across the following documents:
- Secrecy undertaking or non-disclosure agreement (NDA) signed by the franchisee prior to receiving detailed information on the franchise
- Disclosure document provided by the franchisor
- Franchise agreement
- Operations manual
- Lease agreement over premises
- Funding agreements
We also strongly recommend that you consult professional advisors with experience in franchising before you sign any binding agreements or make any payments. A franchise arrangement requires long-term commitment and a substantial investment. The money you spent on professional advice will help you make this a sound investment.
For a list of professionals in law, accountancy and consulting, visit the Franchise Association of South Africa’s (FASA) website – www.fasa.co.za.
We have also enlisted leading franchise legal expert, Maria D’Amico to provide guidance on legal issues.
In our FAQ section, she’s helped entrepreneurs understand:
- Their rights as a franchisee when a franchise is de-franchised
- When they’re entitled to receive a network’s disclosure document
- What to do should they what to leave a franchise network
If it’s legally permissible for a franchisor to reject a franchise application without furnishing reasons for the decision. Read through this section and feel free to also pose her a question.
The documents you encounter when buying a franchise are:
1. Secrecy undertaking/Non-disclosure agreement (NDA)
Before you enter into a relationship with a franchisor, you (franchisee) must do research on all aspects of his/her business. The franchisor will also gather background information on you as the potential franchisee. Once this is complete, both you and the franchisor will be ready to into serious negotiations.
At this stage, the franchisor will ask you to sign a secrecy undertaking. The aim of this agreement is to ensure you don’t disclose confidential information to the competition, for instance financial projections or margins.
Does signing a secrecy undertaking mean you’re obliged to get into business with the franchisor? No. Signing the document shouldn’t bind you in any way. If you want to walk away from the deal, you have a right to do so. Your only obligation when you’ve signed is to respect the confidentiality of the information that’s made available to you.
It’s important to read the secrecy undertaking before you sign it. This will help you make sure it doesn’t limit your right to walk away from the deal if you want to.
2. Disclosure document
A disclosure document is meant to give prospective franchisees detailed information on all aspects of the franchise offer. This helps ensure franchisees know what they’re getting themselves into, so to speak. The document essentially allows franchisees to make an informed decision.
Here are the important details that must be in the disclosure document, a disclosure document must have:
- Full and traceable information about the franchisor company, its owners and its geographic location
- Details of the background, qualifications and business experience of the franchisor’s officers
- Full details of criminal and/or civil proceedings taken against the franchisor or its officers, either in the recent past or still pending
- A full explanation of the way the business works and what the franchisee’s role is expected to be
- The franchisor’s rights and obligations under the franchise agreement
- The franchisee’s rights and obligations under the franchise agreement
- An explanation of the main clauses contained in the franchise agreement
- Full financial details. This includes a schedule of initial and ongoing payments the franchisee has to make. And how these will be calculated and by when they fall due. It has to be clear what the franchisee can expect to get in return for these payments. In addition, there must be details about when the franchisee can expect to have to invest additional sums.
- Financial projections for the business to be franchised. There has to also be an explanation of how the figures were calculated.
- A list of existing franchisees, their contact details and information on terminations (if any took place over the past three years).
- An auditor’s certificate stating that the franchisor company is a going concern. And that it’s financially sound and likely to be able to meet its financial obligations.
In terms of the FASA Code of Ethics and Business Practices, this information must be updated at least annually. This is especially important if there are changes that happen in the franchisor company.
3. Franchise agreement
A franchise agreement outlines the terms and conditions the franchisee and franchisor must adhere to. Before you enter into any binding commitment, you should get professional assistance.That said, here’s an overview of what’s involved when it comes to a franchise agreement, a franchise agreement has to be substantial–A franchise agreement has to deal with:
- Intellectual and commercial property issues
- Operational details
- Financial arrangements
- The initial and ongoing rights and obligations of franchisor and franchisee respectively
It also needs to set out what will happen once the arrangement ends.
The important point is the agreement has to be written in a language ordinary human beings without legal background can understand. Legal jargon has no place in a franchise agreement!
A franchise agreement must be balanced – Franchise agreements must reflect a balanced approach. This means they must take the interests of the franchisor and the franchisee into account.
The terms must be clear in the franchise agreement – If, for example, the franchise agreement is for a period of 10 years, this must be clear. If there will be an option to renew, this has to be spelled out as well. If terms aren’t clear, there will be misunderstandings later on. And that’s the last thing you want as the franchisee or franchisor.
4. Operations manual
The operations manual is often described as the bible of a franchise as it contains everything on how the franchise operates.
A good operations manual aims to address all eventualities. This includes:
- Corporate identity issues
- Operating instructions
- Maintenance guidelines for production equipment that’s used in the business
- Guidelines for dealing with staff
In short, the operations manual must provide answers to all questions a franchisee might have. This helps ensure a franchisee doesn’t call head office at every turn.
5. Lease agreement over premises
If a franchise operates from commercial premises, these will usually be rented. It’s common for the franchisor to help with site selection and lease negotiations. But in the end, the lease agreement will usually be between the owner of the premises and the franchisee.
In some cases, franchisors insist there be a clause saying they can take over the lease if the franchise agreement ends.
Other options are that the franchisor takes out the head lease and sublets the premises to the franchisee. Or the franchisor may be the owner of the premises and let it to the franchisee.
The important point is you must know what you commit yourself to. Our recommendation is that before you sign the lease, you have it examined by a competent attorney.
6. Funding agreements
Franchisees who need funding have to enter into one or more funding agreements. In most cases funding agreements are with banks. But in some cases, you may have to source private funding. For example, getting a friend to invest.
Whatever you do, make sure everything you agree on is in writing. It’s advisable to get a lawyer to draft the agreement. In addition, read the agreement to make sure you understand the fine print and ask for clarity.