By Peter Snell
This column will continue to explore different aspects of the franchise agreement, to give you a better understanding of its basic elements. We will look at who is responsible for building and outfitting the franchise location, so it will be ready for opening day.
Please note it is extremely important for you to take the time to fully analyze and review a franchise agreement before you sign it. While the following information serves as a general overview, as always, you should also seek your own legal advice when reviewing a franchise agreement. Only then can you obtain specific information and advice relevant to your particular circumstances.
Time to build!
One of the most exciting stages of developing a successful franchise is initial construction. (This article assumes a physical location is required for the operation of the franchise, though not all franchises have a ‘brick and mortar’ business model.) At this point, you will have signed a franchise agreement and your location will have been selected.
It is important for each franchise system that comprises brick-and-mortar locations to have a distinctive look and feel. If you were blindfolded and led into the middle of a McDonald’s restaurant, for example, you would likely know upon removing the blindfold exactly where you were standing, even if you didn’t see any McDonald’s logos or trademarks.
Legally referred to as ‘trade dress,’ this is an essential element of a franchised business that helps new customers learn about the brand. The more widely the brand is known, the more important it becomes for the franchisor to ensure all of its locations’ look and feel are consistent with its standards.
So, when it is time to build your franchise, the question arises—who will look after construction, the franchisee or the franchisor? You will need to review your franchise agreement carefully to see how this phase is to be handled.
Frequently, franchisors will take the approach of a ‘turnkey’ basis for franchise construction. Under this approach, the franchisee agrees to let the franchisor carry out all of the improvements to the franchise location. These improvements are made on behalf of the franchisee, as generally, the franchisee pays for all of the costs by way of an upfront deposit followed by periodic payments until the project’s completion.
Also, with this approach, the franchisor is solely responsible for hiring a contractor and managing the project and will also often charge a fee for these services. This fee is normally in the range of 10 to 15 per cent of the total cost of construction. Once the location is fully built, developed and ready to open, the franchisee makes a final payment to the franchisor and is handed the keys.
Franchisors often favour the turnkey approach to construction because it helps keep the franchisee focused on more important issues in the early stage—i.e. taking training to learn how to operate the system successfully—rather than being distracted by having to act like a general contractor for the location buildout. In some cases, the franchisor will go so far as to prevent the franchisee from even entering the location until it is complete.
While turnkey operations may simplify the construction phase, they raise questions of their own, e.g. who pays for cost overruns and, in turn, who receives the benefits of any cost savings?
The franchisor will generally require the franchisee to take on the responsibility for any cost overruns, though this may also mean the franchisee will benefit from tenant improvement allowances and other cost savings. In other cases, there is a fixed price, leaving cost overruns as the franchisor’s risk—and cost savings as its benefit.
So, it is important to carefully review such requirements in the franchise agreement. You need to know what your responsibility will be in case construction is not completed on budget.