Franchising = the way to smoothly expand of your business

Many entrepreneurs (be they individuals running a small business or legal entities with a multi-million turnover) would like to expand into new locations and thus gain new customers and increase their prestige. However, such expansion involves time-consuming, financially, and administratively demanding tasks, such as market research in the given territory, recruiting new employees, finding a location for a new establishment, obtaining the necessary official permits, etc. If you, as an entrepreneur, want to avoid these distressing tasks, but also want to experience the sweet taste of expanding your business to new locations, franchising might be a suitable solution for you. This post introduces in more detail what franchising actually is all about and how it can be used.

1. A brief history and introduction to franchising

Although franchising may seem like a present-day affair, its roots can be traced back to the Middle Ages and the early modern period, when rulers gave certain trusted persons the responsibility of administering colonies or regions. On the one hand, these trustees had a relatively strong position within the territory, but on the other hand, they paid the rulers part of the taxes and other levies they received from the local population.(1)

Over time, franchising moved into the commercial sphere, and today, because of its undeniable advantages, it is used by multinational chains such as McDonald's or Subway, as well as for example Marriott. But there is nothing to prevent franchising from being used by small entrepreneurs, such as a rural motorcycle repairer with a large customer base, a company that specializes in carpet cleaning, or the production of nut butter.

2. Definition of franchising

Franchising generally refers to the way in which a particular, usually renowned, producer of goods or service provider (called a franchisor) allows a certain other person (called a franchisee) to use its trade secrets, know-how, goodwill, etc., and to independently offer its goods and services further. In return, the franchisor receives remuneration from the franchisee, usually both in the form of an initial fee and in the form of regular (royalty) fees, usually calculated as a percentage of the franchisee's revenue.?

3. Advantages of franchising

The relations between the franchisor and the franchisee are governed by the franchise agreement.

The franchise agreement allows the franchisee to distribute (or produce) the franchisor's goods or services, taking advantage in particular of the franchisor's long-standing knowledge and experience in the business and its reputation. The franchise agreement will usually allow the franchisor to use the franchisee's business concept, trademarks, and other industrial property rights or established brand and many other useful features that will help the franchisor to achieve a successful and profitable business. In addition, the franchisor also assists the franchisee with technical assistance and may, for example, provide various training for its franchisees.?

For the franchisor, the advantage of a franchise agreement is that by working with the franchisee, its products or services can reach more customers and can be expanded to other locations. Another advantage, of course, is that the franchisor receives money from the franchisee in the form of an initial fee and regular (royalty) fees.

4. Recommendations on the franchise agreement

It is important to mention that the business concept and other benefits that the franchisee receives from the franchisor are essentially the result of many years of effort by the franchisor and also significantly increase the franchisor's competitiveness. Therefore, they are existentially important to the franchisor.?

If the franchisee were to breach its obligations under the franchise agreement (and, for example, disclose the franchisor's trade secrets to competitors), this could cause significant damage to the franchisor. To avoid such a highly undesirable situation, the franchisor must carefully choose with whom and on what terms it enters into the franchise agreement. It is logical that if the franchisor was the aforementioned motorcycle repairman and entered into a franchise agreement with a baker?who cannot drive and is not skilled in manual labor, such cooperation would probably not work.

A franchise agreement is not explicitly regulated in any Czech statute and therefore the legal relationship between the franchisor and the franchisee must be regulated autonomously (similarly this is the case e.g., in Austria). The franchise agreement itself should help to prevent disputes and should therefore anticipate the various situations that could arise and provide for an adequate solution. It is therefore not uncommon for the scope of a franchise agreement to run to several dozen pages. On the other hand, it is almost inconceivable that two entrepreneurs would start a franchise partnership without first signing a franchise agreement.

If the franchise agreement dealt with a smaller range of situations, it would be shorter and probably also more readable. However, on the other hand, in case of any extraordinary situation, there would be a risk that it would not be clear how to deal with it. In such cases would the franchisor and franchisee then be at risk of years of disputes, which are undesirable for both of them and could paralyze the business activities of both of them. The purpose of a franchise agreement should be to ensure that if any (albeit unpredictable) issue arises, the parties to the franchise agreement find an answer to how to resolve the issue.?

The individual articles of the franchise agreement should be carefully formulated so that they comply with legal regulations and, as far as possible, with the European Code of Conduct for Franchising developed by the European Franchise Federation.?In such a case, there is no risk that the contract or part of it will be found to be invalid or inefficient.

A certain part of the franchise agreement also includes contractual penalties, liability for damages, and other provisions that are at first sight inconvenient?for the franchisee. These provisions are included in the franchise agreement because disclosure of the franchisor's business secrets, misleading advertising, damage to the franchisor's reputation, or similar breach of duty by the franchisee could have far-reaching, even existential consequences for the franchisor.?

In the event of proper and timely performance of all obligations by the franchisee, these, by their nature punitive, provisions will not be followed and contractual penalties, etc. are not at risk in such a case. Penalty arrangements will only come into play if the franchisee's breach of its obligations so disturbs the confidential relationship between the parties that further harmonious cooperation is at least difficult.?

Metaphorically, it can also be said that the benefits conferred on the franchisee by the franchise agreement are the 'sugar', whereas the penalty provisions described above are the 'whip' - their purpose is also to stimulate future activity by the franchisee and to prevent unwanted disputes.

5. Franchise network

Large entrepreneurs typically have several hundred to thousands of franchise agreements with franchisees across the world. While such franchise networks understandably enable extraordinary business expansion for the franchisor, they also create new problems. For example, the problem may be that the legal framework?for doing business is different in each country. The requirements for what the franchise agreement must cover may also differ. In addition, in some countries, franchise cooperations may require approval by the relevant authority. Even the boundaries of the so-called non-compete clause, which is indispensable for the operation of a franchise, vary from one country to another.

6. Example of franchising

In order not to stay only with theory, let's see what franchising could look like in practice:

A certain Mr Fleischer runs a local but very popular network of butcher shops in Germany called "Beim Würstchen". These butcher shops are popular mainly because Mr Fleischer handcrafts sausages according to a proven family recipe that is unknown to the competition. Customers who are not local often complain to the butcher's shop that it is a pity that the delicacies from the butcher's shop are not offered in other countries.

Mr Lehrling, who comes from Dresden, would like to open a butcher's shop in Prague, but he fears that he will not be very successful as a beginner. Mr Fleischer, therefore, arranges with Mr Lehrling to allow him to open a butcher's shop in Prague called "Beim Würstchen", where he will offer the products for which the brand 'Beim Würstchen' is famous. To this end, he will enter into a franchise agreement with Mr Lehrling. Mr Lehrling will then get a precise description of the recipes used and Mr Fleischer will also give him valuable advice on how to talk to customers to their satisfaction, for example, and general support. He will also allow him to use the same logo. However, Mr Lehrling must himself (according to the conditions specified in the franchise agreement) find a suitable location for the establishment, obtain all official permits, maintain the proper running of the establishment, etc.

Once Mr Lehrling has opened the shop, he can use the 'Beim Würstchen' butcher's shop sign. In exchange for this possibility, as well as for the possibility of using the butcher's proven recipes and other benefits, Mr Lehrling is obliged to pay Mr Fleischer a regular monthly payment of 2% of the net turnover he has achieved, but always at least EUR 700. Moreover, Mr Fleischer has the right to continuously inspect Mr Lehrling and his establishment - he can therefore go to Prague and buy the famous sausages incognito. If Mr Fleischer finds serious misconduct (such as that the ham offered is moldy or that the premises are not properly cleaned), he can terminate the contract with Mr. Lehrling. On the other hand, if this model proves to be successful, Mr Fleischer can conclude further contracts with other franchisees and open a branch for a change in, for example, Poland, Hungary, or Switzerland.??

7. Conclusion

The franchise agreement means for the franchisee the possibility to get on a moving train, which is driven by the franchisor and whose fast and smooth running is facilitated not only by the trust but also by the franchise agreement. Thanks to the franchise, the franchisor can take the train to new, originally unreachable stations. The franchise agreement helps, among other things, to keep the train from derailing, and even to accelerate.?

If you are interested in taking advantage of the benefits of franchising, or if you just want to find out more about franchising, please do not hesitate to contact us. At ZVOLSKY ADVOKáTI, we specialize in franchising and will bring you a solution that best suits your needs.

(1) SEID, M. H., MAZERO J. Franchise Management for dummies. New Jersey: John Wiley & Sons, 2017, s. 11.