Franchise agreement duration: align the term with the investment

When turning an existing business into a franchise, the agreement’s duration is not an administrative detail. It determines how long the franchisee may use the business model and the period over which they can plan to recover their investment. For a sustainable franchise network, the term should reflect the outlet’s economics, rights to occupy the premises and renewal rules, rather than simply being copied from someone else’s agreement.

Start with the investment, not a round number of years

Before suggesting an agreement term to your lawyer, draw up an overview of a typical franchisee’s initial investment. Include the fit-out, equipment, initial franchise fee, set-up costs and working capital. Identify separately any refundable deposit, equipment that could be sold and investment in the premises that would be difficult to put to use elsewhere.

Then estimate how much cash the outlet can realistically generate to recover that investment. Revenue is not a return of capital, and accounting profit is not necessarily available cash. Include ongoing costs, franchise fees, tax liabilities, necessary equipment replacements and remuneration at market rates for the person managing the outlet. Show loan repayments separately so that you can distinguish the viability of the business from the affordability of the chosen borrowing arrangements.

Prepare a base-case and a downside scenario. In the latter, test the effects of slower sales growth, higher costs or a longer start-up period. If recovering the investment depends on a future extension that the franchisor is free to refuse, the initial term and the investment are not properly aligned.

Practical rule: assess investment recovery within the initial agreement term, and do not present renewal as certain unless the agreement provides an exercisable right to it. Even a well-chosen term does not guarantee business success.

In Croatia, the term must be clearly agreed

Croatia has no specific franchise law prescribing a uniform duration for all franchise agreements. Nor is there a general statutory minimum term that guarantees franchisees will recover their investment. The duration therefore needs to be set out in the agreement, subject to the applicable general legislation.

The Croatian Civil Obligations Act governs the general rules of contractual relationships, including the principles of good faith and fair dealing and the performance of obligations. The Companies Act is relevant to companies’ legal status and representation. The Competition Act and applicable European Union rules are important when considering restrictions within a franchise relationship. A long agreement term does not mean that every restriction or exclusivity obligation may last just as long.

Do not assume that a franchisee has an automatic right to renewal simply because they have operated in compliance with the agreement. If you want to provide a predictable opportunity to continue the relationship, define it. Equally, a franchise industry code of ethics is not a substitute for legislation; it may apply through membership or contractual acceptance.

The agreement must state unambiguously when the term begins: on signing, on authorisation to start trading or on another clearly defined event. The preparation period should not quietly eat into the operating period on which the financial calculations are based.

Align the agreement with the premises and equipment lifespan

Franchise rights do not, in themselves, secure the right to occupy business premises. If the lease expires before the franchise agreement, the franchisee may be left with contractual obligations but nowhere to operate. Conversely, a long lease may continue to generate costs after the right to operate the franchise has ended.

Before finalising the term, compare:

• the duration of the franchise agreement and the date from which it runs;
• the lease term and the conditions for any extension;
• the equipment repayment schedule and expected useful life;
• planned major refurbishments or equipment replacements;
• the expiry dates of other permits and rights required for the particular business activity.

The aim is not for every document to have the same expiry date, but for any differences to be understood and manageable. For example, an option to extend the lease is useful only if the conditions for exercising it are sufficiently clear and achievable.

Give particular consideration to any mandatory refurbishment towards the end of the agreement. Before incorporating it into the model, establish how you will assess whether the investment is justified in relation to the remaining operating period. Do not leave that discussion until a contractor has already been engaged.

Make renewal a predictable process

Distinguish between a right to renew subject to meeting specified conditions and an opportunity to negotiate a new agreement. These are not equivalent promises. Prospective franchisees must be able to understand what is actually being offered.

Specify when the franchisee must apply, when the franchisor must respond and which criteria will guide the decision. These may include having met all payment obligations, complying with standards and securing the right to occupy the premises. Where shortcomings can be remedied, provide a process for checking them and a reasonable period for putting them right.

Also clarify in advance whether renewal will require a new fee, further investment or acceptance of the standard agreement in force at that time. Do not give the impression that the relationship will continue on the same terms if that is not the intention. Schedule the decision early enough for both parties to make reasonable business arrangements.

Practical takeaway: before offering a franchise, draw up a single timeline covering investment, payback, the lease and renewal. If the timings do not fit together, adjust the model first and only then finalise the agreement.