In the past few years I have noticed a trend toward five year franchise terms in the Franchise Agreements, as opposed to the traditional ten year terms. What is driving this trend, and whom does it benefit?
In my opinion, the shorter term is not beneficial to the Franchisee. Consider the numbers, alone. It does not make sense to half your earnings period from 10 to 5 years. Given the amount of your franchise on-boarding investment, which is typically in the $100+k range, you will need the first few years of franchise revenue just to catch-up. And once you have gained back what you had invested, then you have perhaps 2-3 years left to make a profit. Is all that investment and sweat worth five years? Especially if, for whatever reason, you are not able to renew the franchise.
I have heard franchise candidates tell me that they like the fact that there is less exposure in a five year term. If the franchise business does not work out, then they are only on the hook for five years worth of liquidated damages.
I get this concern and I understand the common sense in limiting the legal and financial risks. However, consider what happens at the end of the first five year term, in fact, at the end of each term. Franchisors universally require you to execute a new franchise agreement. Will the Franchisor insist that you to pay a renewal fee? What other changes will there be in the new agreements? (I guarantee that over five years, there will be numerous amendments, as these agreements tend to transform organically as the Franchisor gains in industry experience.) Will the monthly fees under the new franchise agreement be higher? (Chances are, the answer is yes.) This is an unknown factor and impossible to forecast. As a rule of thumb, though, the costs will generally be higher. Further, will the new agreement require you to upgrade your brick and mortar store? What will this cost you?
Freezing these fees (beware that there are some triggers in the franchise agreement allowing for increases during the term) over 10 years is certainly beneficial to the Franchisee; especially, when budgeting and having to deal with the ever evolving employer obligations, assuming you will have employees. If there are provisions for increasing fees during the term, will the Franchisor agree to a cap?
On whole, it is the Franchisor who benefits most under a five year term.
Please consider these points when deciding on which of the many thousands of available franchises you should invest your time and money.
BE ADVISED that these comments are not intended as legal opinions and are not to be relied upon as legal advice. If you need franchise-related legal advice, please contact us to discuss the specifics of your franchise business.
© KilcommonsLaw, P.C. 2019