Franchising: What You're Actually "Buying"
Learn how to invest your IRA or 401k into a franchise penalty-free. ($50k min)
Q: I've been looking at a number of franchises and finally found one I like, but I have an issue with the franchise agreement. This contract only allows franchisees to own the franchise for 20 years. What happens after that?
A: The key comment in your note that's causing the confusion is, "This contract only allows franchisees to own the franchise for 20 years." It might be helpful in answering your question for me to explain the actual legal arrangement underlying a typical franchise license agreement since you won't actually "own" any part of the franchise. All you'll own are whatever tangible assets you purchase for the operation of the business.
There is a common misconception that when you execute a franchise agreement you are "buying" something. This is not the case. It is a license agreement, and you are paying the franchisor consideration (usually expressed in terms of both initial and ongoing fees) in exchange for access to the brand and operating systems of the franchise company for a fixed period of time.
In this regard, the franchise agreement is much like a lease you sign to rent office space for a fixed period of time in exchange for rent and other payments you agree to make. After the lease term (and any renewal options) expires, you lose any continuing right to occupy the property. During the time you occupy the property, you don't actually "own" it-you're just paying to use it. You do, however, "own" the desks, chairs, computers and other stuff that you furnish the office with.
The agreement you are looking at probably contains very specific language stating that the ownership of the brand, trademarks and operating system of the franchise stays totally with the franchise company. This is true in virtually all franchise agreements. Many franchise agreements also contain renewal provisions that extend the original term of the agreement if certain conditions are met by the franchisee.
It is extremely rare to find a franchise agreement that has an indefinite term. Normally you have the original term and perhaps some stipulated renewal options (the majority of these agreements cover a period of about 20 years in total), and then that's the end of it as far as any guarantees are concerned.
This raises the obvious question you brought up of what happens at that point. The logical move for any franchisor (assuming the franchisee is running the business well and paying their bills on time) is to continue renewing the agreement for additional periods beyond what is contained in the contract. This is what happens in most franchise systems. Even though this is logical, it is not required of the franchisor or guaranteed to you.
If the franchise company decides not to continue the relationship with you beyond the term they have committed to, you certainly have the right to dispose of the assets that you actually own in the business, but the franchise agreement is not one of those assets. Beyond that, under the terms of most franchise agreements, you're out of luck.
When you are evaluating a franchise under these terms, it is important that you look at the total investment and the projected return for the period that you know the business will be allowed to operate and make sure that these numbers are acceptable to you. If, for example, you feel that the investment will be about $100,000 and the total return from operating the franchise over 20 years will be $2,000,000, you may very well decide that this is a wonderful deal regardless of what happens in 20 years, so you'll go forward.
If you feel that the agreement must extend beyond the specified term in order to be acceptable to you, you should not pursue that franchise. Keep in mind that if you are a good franchise operator who abides by the established systems and pays bills on time, you'll probably be renewed without issue in most systems.