The risks of master franchise agreements

What is a Master Franchise

A master franchise model helps franchisors more rapidly establish their brand and system in a new market (e.g., a new country, region, or continent) with lower capital risk. Usually, the master franchisee agrees to launch a certain number of new unit franchises in a set timeframe. The master franchisee pays an initial fee and agrees to share a portion of the ongoing royalties that it collects from its sub-franchisees with the master franchisor.

The master franchisee takes on some or all of the master franchisor’s responsibilities in the defined territory. This can include recruiting sub-franchisees (unit franchisees), training and supporting them, providing local marketing, managing local operations, reselling unit franchisees and other typical franchisor’s responsibilities. This division of responsibilities between the master franchisor and master franchisee can vary in different circumstances (e.g., the franchisor may take over certain responsibilities if the master franchisee is performing poorly).

The Difference Between a Unit Franchise Agreement and Master Franchise Agreement

Master franchise agreements differ from “regular” or unit franchise agreements in very fundamental ways. A master franchise agreement is typically highly customized and thoroughly negotiated by the master franchisor and master franchisees. A master franchise agreement makes the master franchisee a “sub-franchisor” in the territory. It captures the master franchisee’s management and support responsibilities in relation to its own sub-franchisees and the split in the royalties that the master franchisee will share with the master franchisor. The master franchise agreement provides for broad rights and obligations in the establishment and growth of the franchise system in the territory and normally requires the master franchisee to meet minimum expansion targets. The term of a master franchise agreement can be long, potentially ten to twenty years.

By contrast, a unit (or sub) franchise agreement is typically a standard form franchise agreement that a unit franchisee is required to sign with normally little to no negotiation. It sets out in great detail the rights and obligations of the sub-franchisor (master franchisee) and the unit franchisee in the operation of the unit or location. The term of a unit franchise agreements tends to be between five to ten years.

Both master franchise agreement and unit franchise agreement involve the payment of an initial franchise fee and ongoing royalties, among other fees.

It is common for master franchisees to operate their own locations, as well as to sell rights to franchised locations to sub-franchisees.

The Requirement to Deliver a Franchise Disclosure Document

If the franchise rights are in a franchise regulated province in Canada (such as Ontario or British Columbia), a franchise disclosure documents (FDD) is required with both agreements. In both master franchise agreement and the unit franchise agreement – the franchisor (master franchisor or sub-franchisor in these scenarios) is required to give the franchisee (master franchisee or unit franchisee) an FDD which must disclose all information that is prescribed by legislation and all information that constitutes material facts. In the case of an FDD that the master franchisee is required to give to unit franchisees, the master franchisee takes on legal liability as franchisor to deliver a fully compliant FDD to the unit franchisees.

The Advantages and Disadvantages for Stakeholders of the Master Franchise Agreement

• The Master Franchisor

For master franchisors, master franchise agreements facilitate the rapid expansion of a system in a new territory by assigning responsibilities to a local investor with significant resources and operational expertise to build the system from the ground up in that territory.

Having said that, the loss of direct control over unit franchisees in the territory, and the potential risks associated with selecting the wrong master franchisee, are important considerations that a master franchisor should consider. Granting master franchise rights to the wrong master franchisee can potentially lead to future legal disputes, hurt the brand, or result in inconsistent service standards and unhappy sub-franchisees, as well as delay the expansion of the system in that territory.

• The Master Franchisee

Master franchisees can enjoy the benefits of a franchisor without having to conceive a new concept or business model from scratch. They gain access to an established brand, business model, and operational procedures from the master franchisor’s home territory. Master franchisees can also benefit from their corporate-owned locations, as well as from the fees and royalties collected from their sub-franchisees.

Potential master franchises should conduct extensive due diligence investigations about the master franchisor’s growth and market potential, about how well the product or service will be received in their market and if the product, service or business model needs to be adjusted or customized for the local market.

Close attention should also be paid to the requirements of the development schedule. The master franchisee should evaluate the following:

• Is the development schedule reasonable and fair?
• Is immediate termination a risk if they fall behind schedule?
• Is there a cure period that will allow them to get back on track?

These are preliminary questions to bear in mind when starting to negotiate the terms of the master franchise agreement.

• The Sub-Franchisees

For sub- (or unit-) franchisees, the master franchisee is typically their initial point of contact with the franchise system. Prospective unit franchisees should assess the master franchisee’s qualifications and experience. They should also be conscious of the fact that the master franchise agreement could be terminated at some point during the term of their unit franchise agreement and they may report to a new master franchisee or experience increased involvement of the master franchisor. This happens more often than what unit franchisees think.

It is essential to understand which support obligations are provided by the master franchisor versus the master franchisee, as these responsibilities may shift over time. Unit franchisees may perhaps consider trying to negotiate some protections and limitations in their unit franchise agreement to address scenarios such as termination of the master franchisee’s rights.

Conclusion

Understanding the dynamics and considerations of master franchise agreements is vital for all stakeholders involved. With careful evaluation and effective negotiation, this business model can provide a win-win situation for master franchisors, master franchisees, and sub-franchisees alike, facilitating successful business expansion in a territory.

This article is provided for general information purposes only and is not intended to provide legal advice. Parties in a business dispute should obtain legal advice from a knowledgeable commercial lawyer.

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