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Franchising your business - the legal issues print Print

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If you intend to franchise your business then it’s important that you develop clear agreements and standards for franchisees. This guide explores some of the legal issues involved in setting up a franchising programme.

A priority task is to assemble a group of advisors who have in-depth knowledge and experience of the franchising industry. Although this guide looks at the legal issues of setting up a franchise system, be aware that many of the issues also involve a financial and structural aspect. The first advisor you should consult is an experienced franchise consultant who will assist with ensuring you get your franchise structure, including fees and royalties, right from the start.


Getting the structure right

This guide emphasises the importance of building your franchising plans on a sound foundation. Getting the structure right will help eliminate many future disputes with franchisees and also ensure the profitability of your venture. Bear in mind that it may be very difficult to alter basic conditions later. For example, if a few years from now you decided that to increase profitability you had to offer new franchisees different terms to existing franchisees, you would likely face heated opposition from existing franchisees (or vice versa). Thinking through the medium and long-term implications of your structure documents with the aid of financial modelling and forecasting is therefore critical.

The Franchise Agreement

Your aim in drawing up a franchise agreement is to create a document that covers you and your business for any of the many contingencies that may crop up in dealing with franchisees. This document is there to defend your business against possible future claims and attacks. At the same time, this is a balancing act: you don't want the agreement to appear too one sided or unfair.

In addition, it is good (and ethical) practice to encourage all franchisees to consult an independent lawyer before signing the agreement so that they cannot later claim unfair pressure. The result of this scrutiny by another lawyer will certainly be a demand for modification of unfair clauses. It is better to create a fair, ethical and transparent document in the first place, phrased as far as possible in plain English rather than legalese. Remember that the franchise agreement is also a sales document. It should communicate clearly the rights and obligations of both sides.


The franchise agreement

What exactly are you selling?

Some of the issues to consider when you draw up a franchise agreement with help from your franchising advisors are:


What territory or coverage are you offering the franchisee? A tip here is to avoid granting too large a territory at the start. You may regret the decision later. Are the territorial rights going to be exclusive or non-exclusive? This is potentially a major source of disputes especially if there might be overlapping territories. For example, a common cause for complaint from franchisees is that once they have established a profitable franchise outlet, the franchisor wants to offer another franchise in the same area, or an overlapping area. Sometimes this may be justified on the basis of a rapidly growing population in the area, but the result can cause considerable disillusion and even possible legal battles. If you intend offering territories, you need to think the rules through carefully. Appointing a master franchise for an area with the power to create sub-franchisees in that area can complicate matters further.

'Surplus' customers or clients

Also think through the possible sharing of 'surplus' customers or clients. For example, a service franchise (such as an office cleaning franchise) may pick up more customers in its area than the business can cope with. The franchisee may wish to 'sell' these 'surplus' customers to a neighbouring franchise. If so, what would a reasonable commission be? Should it be a one-off referral commission, or an on-going royalty?

Site Selection

Your experience in the business and the industry are what enable you to add value to your prospective franchisees in defining the location, associated demographics and complementary business that will aid in the future success of the franchised business outlet. The parameters of site selection need to be clearly outlined and closely controlled by you as the franchisor.

This is a critical element to the Bank's criteria in assessing each individual franchisee.

Training, manuals and resources

The franchise agreement will typically specify the amount of training and on-going support the franchisee can expect, and whether this is part of the franchise fee or required additional payments. It will specify the Operations Manuals that you will supply and explain the business format and systems that comprise the franchise. For instance, if a software package is included (such as accounting, stock payroll or Point of Sale software, then give details and explain how it makes the franchise easier to run.

Customer base and turnover

What assistance can you offer new franchisees? For example, will you provide an existing customer base, or a guaranteed number of customers per year through referrals? Some franchises advertise nationally and apportion sales leads in response to adverts to franchisees throughout the country.

Another point here: you may wish to create new franchises on the basis of turnover or customer base. For example, if an existing franchise reaches a certain customer base or a revenue target (for instance, $1,000,000 in sales) this could be the trigger for another franchise in the area. If this happens, will the existing franchisee be given first option on this new outlet? Note that many franchisees build their wealth by acquiring multiple franchises, so give some thought to how you might encourage or enable this. It may be advantageous to have future outlets run by successful existing franchisees with whom you have good relationships rather than finding and training new ones.

Products and services

Will franchisees have to buy all products and services from you, or can they source some supplies independently? To avoid future disputes spell out the requirements here as clearly as possible.

Opting out and cooling off period

Does the agreement include a 'cooling off' period (say 14 days) in case the franchisee changes their mind? You should make sure that potential franchisees get a copy of your Disclosure Document well before they need to sign the franchising agreement.

Sale of franchises

Are there rules if the franchisee wishes to sell the franchise? For instance, will you require the franchisee to offer the franchise back to you first or to existing franchise owners before advertising it?

Or will you be able to approve the new owner before there is an agreement to sell. If so, who will establish a fair market value for the business?

Skills and experience

Do you specify certain levels of skills and experience for franchisees? It's a mistake to assume that 'anyone with the cash' will make a suitable franchisee - they may not. For example a fast food outlet franchise requires strong people skills. It would certainly not suit someone with a retiring disposition. It may be better to specify exactly what level of skills, business experience and personal attributes you require. For example it would be hard for someone with no feeling for cars to run a Mag & Turbo Warehouse franchise.

Fundamentally, the business needs to satisfy the three areas of:

  • Solving a problem that customers are consciously or unconsciously aware of;
  • Allowing franchisees the ability to do what they do best; and
  • Ensuring they can enjoy what they do in the business.

This allows for the business to operate in a market niche and aids in the ongoing success of the business.

Targets, rules and standards

What are the targets for a franchisee and the restrictions? For example:

  • Does the franchisee have to achieve a set sales figure within a set period to retain the franchise?
  • Does the franchisee have to achieve agreed standards of décor, signage, shop layout, uniforms, customer service, etc., in order to retain the franchise?

Defaulting and unsuitable franchisees

Under what conditions can you buy out or get rid of unsuitable franchisees? For example, if the franchisee:

  • Defaults on royalty payments.
  • Generates numerous customer complaints.
  • Brings the brand and franchise into disrepute.
  • Fails to meet agreed standards.

Include some details on your right of termination and remember to also specify the time span of the franchise contract.

Disputes and arbitration

What agreed process do you have for mediation or arbitration in the event of a dispute? It is better to reach joint agreement on this now than argue the point later.


What level of reporting do you want to see from your franchisees, and how often?



The financial obligations of franchisees need to be clearly set out in the franchise agreement. The exact nature and level of the fees and royalties you will require from franchisees are best worked out in conjunction with your panel of advisors.

The fees and royalty analysis from a franchising survey undertaken by John Paynter of Auckland University may help clarify your thoughts:

Most (65%) on-going royalties are calculated on the basis of a Percentage of Sales (average 6%) usually paid monthly (58%) or weekly (26%). Fees based on product mark-up and purchases are typically 25% and 5% respectively. 11% of systems charged a flat fee. Other methods included charging per unit, charging a percentage of bankings, using a mixture, and by contract. [Only] 7% of franchise systems did not involve an ongoing royalty. The typical National and Territory Marketing or Advertising fees are set at 2-3% each. Other fees may include management/accounting and computer fees.

Most franchisees are likely to query the fees and royalty structure so it's important that you spell out the purpose and benefits of all payments as clearly as possible. Your aim is always to make them aware that they are getting fair value for money.



The franchise agreement is an important document that outlines the rules of the relationship between you and your franchisees. It's important that you get it right. An analysis of disputes between franchisor and franchisees in a franchising survey undertaken by John Paynter of Auckland University showed that '27% of respondent franchisors had been involved in a substantial dispute'. Almost twice as many disputes were initiated by the franchisor rather than the franchisee. The main causes were:

  • Fees.
  • Non-adherence to the business system.
  • Misinterpretation.
  • Profitability.
  • Communication issues.

Time spent on the franchise agreement is therefore a worthwhile investment in the smooth running of your franchise programme.




Visit your bookseller for the latest copy of the Franchise New Zealand magazine or visit its web site for many useful articles and tips on franchising.

Franchise association and book

The Franchise Association of New Zealand (FANZ) (call 09 523 4452 or visit offers a helpful publication, The New Zealand Franchisor's Guide, with a more comprehensive account of the advantages and disadvantages of franchising. You could also ask to be put in touch with someone who has franchised their own business and who might be able to give you some valuable tips and guidance.

Joining FANZ also entitles you to some free initial consulting on legal, accounting, coaching and consultancy topics. Other useful ANZ Biz Hub articles include:


Further information:

To talk to an ANZ Business Specialist:
Call 0800 269 249
Visit your nearest ANZ branch


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