Franchise agreement terms: aligning investment with the right to operate

When turning your existing business into a franchise network, you need to choose an agreement term that works for both parties. The franchisee may need to invest in equipment and fit-out work that will be used for several years, while the right to use the business concept lasts for a limited period. You should therefore assess the agreement term against the required investment before offering your first agreement, rather than simply following established practice.

Map out where the franchisee will tie up capital

Start by listing the investments needed to operate your particular concept. Draw on experience from your own business, but distinguish between assets you already have and items a new franchisee will actually have to pay for.

For each major item, your assessment should show:

• who owns the asset and pays for the investment,
• when payment is due,
• how long the asset is expected to remain usable,
• whether it can be sold or used outside the franchise concept,
• what costs arise if it can no longer be used.

A standard machine may retain value without your brand. Bespoke fixtures and fittings, on the other hand, may be expensive to install and difficult to sell. This makes the usefulness of the assets at least as important as the total investment.

Also distinguish between accounting depreciation, technical lifespan and financial payback. Depreciating an asset over a particular period does not mean the business has earned back its cost within that time. Nor does a monthly profit, on its own, show that the initial investment has been recovered.

Test the agreement term without assuming renewal

First, prepare a financial forecast that assumes the business can only use the concept for the agreed term. A possible renewal should not be treated as a guaranteed right unless the agreement provides one.

Test how the investment is affected if opening is delayed, sales grow more slowly or equipment needs replacing earlier than planned. The aim is not to promise a particular payback period, but to identify an arrangement that depends on everything going to plan.

Also decide when the agreement term starts. If it runs from signing but the outlet opens much later, the franchisee has less time to operate in practice. Explain how the start date and any delays will be handled, and who has control over the timetable.

For the franchisor, a longer agreement term also means a longer commitment. You must be able to provide the promised rights and support throughout that period. A longer commitment is therefore not automatically better than a shorter one. It must accommodate both parties’ obligations.

If the figures only work on the assumption of an uncertain renewal, reconsider the arrangement. Alternatives might include a lower initial investment, equipment that can more easily be used in another business, or a different agreement term.

Make the financial implications of renewal clear

Distinguish clearly between a right to renew, an opportunity to apply for renewal and a fresh negotiation requiring both parties’ consent. These options create different conditions for a business owner considering an investment.

Explain how far before the agreement expires the issue must be raised, and when a decision must be communicated. The franchisee needs time to assess whether to continue operating before taking on new financial commitments.

In particular, clarify whether renewal may involve:

• a new fee,
• requirements for refurbishment or new equipment,
• different financial terms,
• a requirement to enter into a new franchise agreement.

Consider, for example, an outlet that needs to replace a key machine when only a short time remains on its agreement. If the continuing right to use the concept is uncertain, the decision becomes difficult, even if the machine is essential to operations. Plan how major reinvestment will be discussed as the agreement approaches its end. Avoid verbal assurances that renewal ‘usually works itself out’.

If compensation for investment not yet recovered, or an equipment buy-back, forms part of the offer, the terms must be explicit. Do not base the financial forecast on an assumed buy-back that no one has committed to.

Ground the arrangement in Swedish law and disclosure requirements

Sweden has no comprehensive franchise-specific legislation, but the Act (2006:484) on Franchisors’ Duty to Provide Information regulates the information a franchisor must disclose before an agreement is entered into. This information must be provided in writing, be clear and understandable, and be supplied well in advance of signing.

The disclosure obligation covers, among other things, the agreement term, conditions for amendment, renewal and termination, and the financial consequences of termination. Fees and other financial terms must also be described. However, the Act does not determine which agreement term will make your investment model financially viable.

General contract law, including the Swedish Contracts Act, also applies. Have a lawyer with franchise expertise review how the provisions governing the agreement term and the investment requirements work together. A financial forecast is no substitute for contractual terms, and clear disclosure does not, in itself, make an unbalanced arrangement appropriate.

Practical takeaway: Plot the investments and the agreement term on the same timeline. If a mandatory investment depends on a renewal that is not guaranteed, adjust the arrangement before inviting anyone to join the franchise network.