Franchise agreement term: match it to the investment

When you turn an existing business into a franchise network, the term of your first agreement is more than a box to fill in. It determines how long the franchisee has to recover their investment and how long you commit to providing support. The right term is therefore not a figure copied from another agreement, but the outcome of a documented assessment of business and legal considerations. The approach below provides a framework for planning your first fixed-term agreement in Hungary.

1. Distinguish legal requirements from ethical expectations

Hungary has no standalone, comprehensive franchise act, but that does not mean franchise agreements are not specifically recognised in law. Sections 6:376–6:381 of Act V of 2013 on the Civil Code regulate franchise agreements. The Civil Code’s general rules on contracts also apply.

The Civil Code’s franchise provisions do not prescribe a uniform minimum agreement term that is compulsory for every franchise system. The parties must therefore agree an appropriate term consistent with the rights and obligations they undertake. It is advisable to have the proposed arrangement reviewed by a lawyer experienced in franchising.

The European Code of Ethics for Franchising, published by the Hungarian Franchise Association, provides a different kind of guidance: the agreement must last long enough to allow the franchisee to recover their initial and subsequent investments relating to the franchised business. This is an ethical requirement, not a statutory guarantee of investment recovery. The code is a form of industry self-regulation, not legislation that automatically binds every business.

The aim of planning is therefore not to promise guaranteed profits, but to establish a timeframe within which the investment can be recovered on realistic assumptions.

2. Map the investment against the agreement term

Rather than starting by inserting a number of years into the draft agreement, list everything the franchisee will need to spend money on. The historical cost of opening your own business is a useful starting point, but it will not necessarily match a new franchisee’s outlay today. The condition of the premises, fit-out costs and opening stock requirements may all differ.

Your investment breakdown should distinguish at least the following:

• One-off start-up costs: the initial franchise fee, fit-out, equipment and costs associated with pre-opening training.
• Initial funding requirements: stock, a security deposit and working capital reserves until revenue builds up.
• Subsequent compulsory expenditure: foreseeable equipment replacement, refurbishment or updates to branding and premises design.
• Recoverable value: a refundable deposit, equipment that can be sold or stock that can be used elsewhere.

Record the expected timing and rationale for each item. Clearly distinguish what you require as the franchisor from expenditure the franchisee would choose to undertake. This will show which requirements you impose directly increase the agreement term needed.

Do not treat depreciation as evidence that an investment has been recovered. An asset’s accounting depreciation period and the actual recovery of the money invested are two different matters. Equally, monthly profitability does not, on its own, prove that the full initial investment has been recouped.

3. Calculate the time available for trading

A substantial period may pass between signing the agreement and earning the first revenue. If the fixed term starts on signing, fitting out the premises and preparing to open will reduce the time available for actual trading.

Specify separately the signing date, the planned opening date and the start of the agreement term, or how each will be determined. The agreement should also address what happens if opening is delayed. A delay caused by the franchisee being unready is not the same as late performance by the franchisor or an obstacle for which neither party is responsible.

Prepare a base-case and a downside scenario for the financial assessment. In the downside scenario, test slower revenue growth, higher operating costs and a delayed opening. The calculations should also include franchise fees, necessary equipment replacement and realistic remuneration for the franchisee’s work.

If you also assess the effect of financing, distinguish between recovery of the total investment in the business and recovery of the franchisee’s own invested capital. Borrowing and repayments can mean these produce different results. Agree the methodology with an accountant or financial adviser.

Do not base your calculations solely on an expected renewal. If the investment can only be recovered during a further agreement term that has not yet been secured, treat this as a risk when structuring the initial agreement.

4. Check all time-related commitments together

Compare the proposed term with how long the premises will be available, when key equipment is likely to need replacing and how long the rights granted by the franchisor will remain available. A long franchise agreement does not, by itself, solve the problem of premises secured for a shorter period.

Pay particular attention to compulsory investments required towards the end of the term. A major refurbishment raises a fresh investment recovery question, even if the initial investment has already been recouped. Consider in advance whether it is reasonable to require it at that point and what contractual arrangements would make the commitment viable.

Finally, prepare a short decision note setting out the costs, opening timetable and operating assumptions behind the proposed term. Discuss these assumptions with the franchisee, not just the final number of years.

Practical takeaway: first map out the investment and the actual trading time available, then use these to determine the agreement term. A franchise network has firmer foundations when both parties understand the business reasoning behind the duration.