What are your territorial rights when buying a franchise?
Everybody knows that when starting a business, whether it be a lemonade stand or a large retail chain, the key to success is location, location, location. Location does not however mean just your physical storefront, but can also mean your territory.
When you buy a franchise, you want to make sure that your location will be profitable for as long as you plan to run the business. In order to do so, you need to take into consideration multiple factors, one of which is your rights in the territory. Franchise territories are based on various factors. Some franchisors in the pet industry base their territories on statistics for how many dogs or cats the average household owns, while other franchise industries base territories on population, mileage, streets, zip codes, school districts and a variety of other methods. When looking at the territory for your franchise, you hope that the franchisor has given thought to your profitability and has given you enough room to grow. On the flip side, the franchisor has worked to give you enough territory to be profitable, but also giving enough room to possibly sell another territory next to you. This is the conflict that goes on in franchising when it comes to territories.
When looking at a franchise territory, you have two options: an exclusive territory or a non-exclusive territory. An exclusive territory is where you have set boundaries based upon the factors listed above. This can be a great thing because you have set parameters that you can operate within and that other franchisees have to stay out of. The drawback to this can be when your exclusive territory is based upon a factor which tends to change such as population or zip codes. Yes, if you have not experienced it, zip codes do change as areas develop. Many franchisees think that exclusive territories create better relationships between franchisees because each franchisee is more open to referring a customer to their neighbor which can benefit the entire franchise system by avoiding aggressive territorial behavior by one franchisee over another. If you are awarded a non-exclusive territory, you can be at risk of competition from your fellow franchisees. This competition may not be malicious, but when franchisees have non-exclusive territories, then many times their customer service areas may overlap. Many franchisees, in the case of non-exclusive territories, request that a franchisor limit the number of franchises sold within a certain area so that over saturation is avoided.
Restricting the franchisor’s right to sell franchises can be just as hurtful to the franchise system as over saturating the area because with too few franchisees in an area, the brand name recognition can sometimes be lacking which will hurt profits for you as well.
So you have the territory that you want. What about your right to grow into other territories? Some franchisors will offer what is called a right of first refusal. If the franchisor grants you a right of first refusal, or if you negotiate for one, then you will be given the opportunity to establish a franchise in the specific territory relating to the right of first refusal before any other franchisee. If a franchisor gives a right of first refusal, many times there are strings attached including that you must be in full compliance with your current franchise agreement or that you must sign a franchise agreement for the new territory within a certain amount of time. Either way, a right of first refusal can be a good way to expand your business without having to do so from the start. In some instances, you may talk with the franchisor about the territory before you have read the Franchise Disclosure Document. When talking with a franchisor about the territory, you should take the time to ask questions about how the franchisor defines the territory and how will the territory be selected. Additional questions should include such topics as what surrounding territories are available, do you have a right of first refusal and if so what are the restrictions on your exercise of it? A word of caution. When you read the franchise agreement, be prepared for the franchisor to reserve the right to sell through what is called alternative channels of distribution within your territory. These rights are rarely, if ever, negotiable and give the franchisor the ability to sell the products or services associated with the business through methods other than franchised stores. These other methods can include selling over the internet, on college campuses, or airports, or even in grocery or drug stores.
Protecting your territorial rights is only possible before you sign the franchise agreement. During your negotiations with the franchisor, if any, you need to address your concerns over the territory offered to you. If you have consulted with any real estate brokers or research companies regarding the franchise territory, the time to bring that research to the franchisor’s attention is now along with the negotiation skills of your experienced franchise attorney. Once you have agreed on a territory with the franchisor, the most important thing to remember is to have it written in to the franchise agreement or into an addendum to the franchise agreement. By doing so you protect yourself in the event the franchisor attempts to change your territory later on.
If you are not sure what territory structure you have or how to analyze or negotiate your territorial rights, you should seek the advice of an experienced franchise attorney who can help.
Jason Power is a senior attorney with Shelton & Power franchise law firm Jason has been helping entrepreneurs review and negotiate franchise purchases since 2009 and is a regular speaker at the International Franchise Expo, West Coast Franchise Expo, Franchise Expo South and various other franchise expos where he gives tips on how to analyze and negotiate a franchise purchase. Jason can be reached toll free at 866-993-7262 or by email at Jason@SheltonPower.com