May 23, 2017
Converting your thriving business into a profitable franchise will bring about a seemingly endless laundry list of decision-making. One you will need to face is setting the best term for franchisees. Franchise terms, the length of time you are allowed to operate the business, typically come in three different flavors: 5 years, 7 years, or 10 years. While I have seen some deviate, such as a 20-year term, most businesses abide with these timeframe standards.
By and large, I recommend the 10-year term. But that’s not a blank slate for all business models. Let’s dive into some of the nuances that make a specific term better for some businesses.
The franchise term is designed to protect both the franchisee and the franchisor. For the franchisee, if they invest a few $100,000 into purchasing a business model, they want to feel comfortable they will own the franchise unit long enough to make a good return on their investment. Anything too short may raise red flags. Remember, renewal fees mean incurred costs to the franchisee.
Oftentimes, franchises with a smaller startup fee will explore shorter franchise terms. These are typically Internet-based business models, such as a tutoring company. Again, with that smaller initial investment, a franchisee feels more comfortable they will be able to recoup their money in the shorter term.
For example, an online background screening service with a $20,000 initial investment may deem a five-year term appropriate, whereas a brick and mortar sandwich shop with an initial investment over $250,000 will want to look at a longer term.
A proper franchise term isn’t just for the benefit of the franchisee. It also benefits the franchisor. Signing a franchisee to a ten-year lease locks them into royalty payments and your other revenue streams for that time period. In short, you’re extending the lifetime value of a franchisee.
For brick-and-mortar businesses, franchisees typically get better breaks on longer leases. A landlord will be more willing to help out on tenant improvements and free rent if they are committed long term. They are also more attractive tenants. In commercial real estate, a ten-year lease is the type of long-term lease that many landlords strive for. In a competitive market, that longer lease can be what gets them the space.
What might seem as a footnote can dictate the long-term success for a franchisee. Locking in a favorable lease with options to renew is a crucial component both for a favorable franchisee exit strategy as well as the longevity for that unit. Additionally, I strongly discourage franchisees to pursue a lease for a different term length than their franchise term. That just spells trouble.
Once you establish the initial franchise term, then you need to assess the right term and costs, for your renewal terms. I commonly see brick-and-mortar businesses have an initial 10-year term with either 10-year or 5-year renewal options.
These renewals incur costs for the franchisee. From renewal fees to updating the trade dress to renovations to new trainings to adjusted royalty fees, a franchisee is staring down a costly bill to sign on again. While it’s not as much as their initial investment, it will be enough that they will want to space them far enough apart that they can amortize the fees.
Your franchise term needs to make sense for the long-term success of the franchisee. It brings to mind the old adage, “What’s good for the goose is good for the gander.” Your franchise’s long-term success is inherently linked to the success of your individual operators. The better they do, the more longevity the franchise as a whole has. And that includes profitability.
That’s why it’s important to go into these decisions, such as setting the franchise term, with the mindset of creating a system that sets individual franchisees up for success. The goal is to not nickel and dime a franchisee every few years over renewals. That only hurts the overall goals, such as generating monthly revenue.
When going through the process of converting your thriving business into a franchise, you need to partner with an experienced franchise lawyer you can trust. As both an experienced franchise lawyer and a part owner in a franchise, I can help you avoid common pitfalls and build a solid legal foundation toward long-term success in your debut into the franchising world.