If you plan to buy a franchise which requires retail space, your business activities will be governed by at least two major contracts - the franchise agreement and the lease. In your dual roles as franchisee and tenant you will want to know how the provisions in the franchise agreement and the lease interrelate to lessen the chances of conflicts between them and to maximize your successful performance under each.
Because the franchise agreement and lease bind you for anywhere between five to twenty years, and because the future business climate cannot be accurately predicted, a major goal when you negotiate either document is to preserve as much flexibility as possible so that you can better respond to unexpected changes in circumstances. However, a major goal of the franchisor and the landlord will be to restrict your options because they want to see the royalty fees and rents come in like clockwork regardless of the changing business environment.
Most likely, because you are selecting the type of business you want to operate, you will first be confronted with the franchise agreement. Keep in mind that just because the franchisor seeks to assert some influence over your leasing arrangement, such is not necessarily a bad thing. Rather, if handled properly, the franchisor can be your ally in obtaining better terms with the landlord. A point to ponder, however, is who will be your ally to obtain better terms with the franchisor?
During your general review of the franchise agreement, note provisions that could affect your performance as a tenant. As you examine the franchise agreement, some provisions influencing your leasing options may appear more obvious than others. However, it is still critical to understand why those provisions can be influential. At the same time, it is important to delve for the less obvious terms. Here are some examples of apparent and less apparent terms in the franchise agreement that could affect you future lease with explanations of some of their likely effects.
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Most franchise agreements call for the franchisor to approve the location of your store. If the franchisor is on the ball, he should be able to help you identify the most strategic site for your premises. Your real estate broker is not necessarily going to have that special insight for what location will work best for the specific franchised business. However, in many cases, the franchisor's approval may merely be perfunctory. Therefore, just because the franchisor must okay the location, you cannot count on this requirement to assure yourself the selection of the most workable site.
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Franchise agreements frequently require the franchisor to approve construction and layout of the premises. This can be a good thing if the franchisor provides practical information as to the optimum size and configuration of your space. In the long run, you can save a great deal of time and money if you do not take more or less space than you actually need to achieve your business objectives. If you take too much space, you will pay more in rent over the life of the lease than necessary because most rental calculations are based on square footage. If you initially contract for too little space, you can be well into the build-out phase and find you need more space resulting in tricky negotiations, delays, and needless expense.
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Your franchise agreement may call for the franchisor to approve the lease itself. Does such a provision mean that the franchisor will work closely with you during the lease negotiation state or will you merely be handed a list of provisions that the franchisor wants to see in the lease? If your franchisor is well established, his assistance in the negotiation of the business and other terms of the lease can be invaluable in that his reputation and staying power can lend more credibility to your proposals to the landlord. For example, some franchisors will not approve a lease that calls for the collection of percentage rent (i.e., rent above the minimum rent that is based on gross sales above a certain sales figure). This is understandable given that franchise royalties are calculated from gross sales as well. If the landlord knows that his choice is between renting to an operation that is likely to draw and keep customers in his shopping center and foregoing percentage rent, more than likely he will opt for no percentage rent. Such a result, of course, is a considerable cost saving to you. However, if the franchisor does not back you up in this way, you may find the combination of royalty fees, base rent and percentage rent is prohibitive.
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Consider the relationship between the expectations of your franchisor and landlord as to when you should begin to conduct business and realistically how much time it will take to find and negotiate for your space, obtain building permits, and then build your store according to the franchisor's specifications. You do not want to find yourself in a time bind with the possibility of losing any franchise fee or rent security deposit, due to the fact that you cannot open for business by any specific dates set in the franchise agreement or the lease.
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Sometimes franchisors will want the option to enter into the lease with the landlord and then sublease the space to you. In fact, the franchisor may have already found a location and negotiated the lease claiming the deal is a "turn-key operation." This is a clear example of the franchisor trying to restrict your maneuverability. If later you wish to disengage from the franchise system, or any disputes develop between you and the franchisor, he will have another level of control over you as he stands in the shoes of the landlord.
After you have entered into a franchise agreement, your next big tasks will be to identify space and negotiate a lease. You will probably have more bargaining success with the landlord than with the franchisor who is aiming to develop a highly uniform system of operations across a large geographic area. Consider the following kinds of terms in a lease and how they can affect your franchise agreement and vice a versa.
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Are the duration of the lease and franchise with any options to renew consistent? If they are not, you could find yourself paying unnecessary franchise renewal fees and opening yourself tosubstantial site renovation costs.
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Does the lease call for periodic site renovation? If so, is the time frame for such repair consistent with any similar requirements in your franchise agreement?
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Under the lease must you contribute to an advertising fund? Your franchise agreement may also require such participation. Can you obtain credit for one by participating in the other program?
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Are the uses you can make of the space so narrowly defined that all you can operate is the specific franchised business? Can you use any other trade name beside that of the franchisor without obtaining the approval of the landlord? If you are so highly restricted, what would happen to your business if the franchisor goes into bankruptcy or you otherwise wish to disengage from the franchise system?
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How do the assignability provisions in the two contracts interrelate? You do want to insist that both the franchisor and landlord act reasonably with respect to granting approval as to whom you may assign your rights and obligations under the franchise agreement and lease. This is to preserve your options to sell your business should the right opportunity present itself. Additionally, in the case of the landlord, it is good to obtain pre-approval of any new franchisee qualified by the franchisor.
Needless to say, the items listed above do not exhaust the ways in which your franchise agreement and lease may influence one another. Because they definitely will affect one another, your review of them to identify and to avoid possible conflicts between them is a critical part of your analysis of the business opportunity in which you are considering to invest.
