Strategic advice for franchisors in early and mature franchise systems.
Introduction
Negotiating franchise agreements is an art that balances legal rigor, business acumen, and long-term strategic thinking. The stakes are high: a franchise agreement not only governs the relationship between the franchisor and franchisee, but also shapes the culture, financial trajectory, and scalability of the entire franchise system.
Franchisors can either set themselves up for decades of success or unintentionally create obstacles by mishandling early negotiations with prospective franchisees. Let’s look into how franchisors can be best prepared to win.
Understanding the stage of franchise system development
Before entering negotiations, a franchisor must honestly assess the maturity of their franchise system. Is this a fledgling brand with only a handful of locations, or a well-established network with robust operational standards and brand recognition? The answer will profoundly influence the negotiation strategy.
- Emerging franchisors: In the early stage, franchisors often face pressure to make concessions to attract their first franchisees. The temptation to “do whatever it takes” to build initial traction is understandable. However, each concession becomes a precedent that may be referenced by every future franchisee. Overly generous terms in these foundational agreements can erode profitability, weaken brand control, and hinder future growth.
- Mature franchisors: Established franchisors typically have more bargaining power and can afford to be less flexible with terms. In these cases, consistency becomes paramount – variations between agreements can lead to inconsistencies in how franchisees are treated and undermine the perceived integrity of the system.
Key negotiation touchpoints
There are several critical elements in a franchise agreement where negotiation commonly occurs:
- Initial franchise fee and royalties: These are the lifeblood of the franchisor’s revenue model. While negotiating lower fees may seem expedient for rapid growth, it can have significant long-term consequences on cash flow and the ability to invest in system development. Any deviation from standard fees should be carefully justified and, ideally, tied to performance milestones. While occasional discounts or reductions to the initial franchise fee may be more justifiable at the outset, it is very difficult to recover value in your franchise system if you offer royalty fee concessions.
- Territory and exclusivity: Granting exclusive territories is often requested by new franchisees. However, overly broad exclusivity can limit the franchisor’s ability to expand and optimize market coverage. Consider drafting “performance-based”
- exclusivity, where continued exclusivity depends on meeting certain benchmarks, such as in territory exclusivity protections for area or multi-unit developers.
- Training and support: Promising extensive training and ongoing support can help close deals, but overcommitting can strain resources and dilute the quality of assistance provided system-wide. Clearly define the scope and limits and avoid vague promises.
- Renewal and transfer rights: Franchisees will always want flexibility to renew or transfer their agreements, but unrestricted rights can destabilize the system. Implement clear conditions for renewal and transfer, such as qualification criteria and transfer fees, to protect the brand and ensure ongoing compliance.
- Brand standards and operational control: Consistency is the cornerstone of franchising. While some franchisees may push back on strict brand standards, any dilution can weaken the value of the brand overall. Provisions should be explicit and enforceable, with clear remedies for non-compliance.
Business and legal implications of concessions
Negotiating concessions is often necessary, but each comes with a price. From a legal perspective, concessions made to one franchisee may need to be disclosed to others or even to regulators, depending on jurisdiction (e.g., California). There is also the risk of “most favored nation” clauses, where other franchisees can claim the same beneficial terms, leading to a race to the bottom.
In addition, inconsistent agreements can result in legal disputes, confusion over rights and obligations, and damage to the brand’s reputation. From a business standpoint, overgenerous concessions may reduce the franchisor’s revenue, make operational management more complex, and hamper future scalability.
Long-term strategic considerations
Every negotiation should be approached with a long view in mind. Early concessions may help to seed the market but can create legacy issues that are difficult to unwind. The way in which the first handful of franchise agreements are drafted will influence the tone of future negotiations and the overall value of the franchise system.
The ideal approach is to create a standard form franchise agreement that is both competitive and sustainable, leaving room for limited, well-documented exceptions rather than wholesale customization. These exceptions should be tracked meticulously and, where possible, be time-limited to the existing term of the franchisee’s initial franchise agreement (or a shorter period of time, if applicable).
Maximizing franchise system value
To maximize the value generated within the franchise system, franchisors should:
- Maintain consistency in agreements while allowing for strategic, limited exceptions on a case-by-case basis.
- Document all concessions and their rationale, ideally linking them to quantifiable performance goals.
- Educate franchisees on the mutual benefits of compliance and system uniformity.
- Regularly review and update the franchise agreement as the system evolves.
- Consult with experienced franchise counsel to ensure each agreement advances the broader business objectives.
Conclusion
Negotiating franchise agreements is a balancing act between growth and discipline, flexibility, and consistency. By understanding the legal and business implications of each concession, being sensitive to the stage of system development, and keeping a watchful eye on the future, franchisors can craft agreements that fuel sustainable expansion and maximize the value of their brand.
