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Chapter 3. The Wealth-Creating Power of ... > License Agreement: How the Franchise...

License Agreement: How the Franchise Shares Responsibilities and Wealth

One of the key operating features of the franchise partnership is the license agreement, a document that codifies the relationship between franchisor and franchisee. Six sections of this document are relatively consistent throughout franchising and represent the core of the operating arrangement. Table 3-2 is a chart that describes the license agreement item, its overall impact, and the effect of that impact on your perception of the return potential as a franchisee (called a marketplace signal).

Table 3-2. License Agreement Key Provision Impact Analysis
License Agreement ItemImpactMarketplace Signal
TERM: Details the length of the contract between the franchisor and franchisee in years.This defines the number of years used in the calculation of the PDV of the income stream.Longer = positive
RENEWAL: This defines the ability of the franchisee to add additional years to the license agreement.This increases the number of years of potential income stream.Renewal = positive
FRANCHISE FEE: The one-time, upfront fee the franchisee pays the franchisor when the license agreement is signed.Impacts the initial investment and signals relative quality of the franchise.Higher = positive
ROYALTY: This is a percentage of the outlet revenue that is paid to the franchisor throughout the term of the license agreement.Establishes the linkage between the success of the franchisee and the franchisor.Higher = positive
MARKETING FEE: This is usually a percentage of revenue (sometimes a flat fee) that the franchisee must commit to marketing expenditures.Signals the firm’s commitment to building the brand and driving economies of scale in marketing.Higher = positive
SUPPLY REQUIREMENTS: Outlines the rights and responsibilities of the franchisee in purchasing.Some franchisors attempt to make money by selling goods to their franchisees. Others act as a negotiating agent for the franchisee to obtain national contracts. This section of the license agreement is key to understanding the potential for economies of scale in supply.National contracts with third-party vendors = positive

These license agreement features offer a realistic context in which to consider the specifics of the concept. They codify the economic relationship between the franchisor and franchisee and therefore affect the income stream that is used in the PDV calculation. They are also tools to differentiate a given franchise from another. For example, when the average advertising fee is $20,000 and yours is $100,000, the difference screams, “Why?” Your higher fee should correspond to higher quality, and you should be ready to communicate that advantage to franchisees.

Franchising Benchmarks

Remember our discussion regarding the franchise fee and royalty rate that the franchisor can charge? Although we focused on the Present Discounted Value calculation, we were careful to discuss the adjustments to the calculated amount brought on by market forces. What are the other 4,199 franchisors charging for their franchises? Table 3-3 reflects some of the essential variables that define market conditions. Remember, not only are you making a decision to buy a franchise or start a stand alone business, you are also making a decision among franchises. When you assess a particular franchise this data provides a benchmark to make a comparison.

Table 3-3. Key Factors in the Franchise Relationship[a]
Percent outlets owned26.4 percent0–88.1 percent
Percent outlets franchised74.25 percent12.1–100 percent
Franchise fee$28,559$5,000–$122,500
Royalty rate5.58 percent2–12 percent
Advertising fee3.84 percent0–15 percent
Term of the contract13.79 years5–20 years
Total number of outlets2,652104–13,604

[a] Spinelli, Stephen, Benoit Leleux, and Sue Birley, (2003). “An Analysis of Shareholder Return in Public Franchisor Companies,” Journal of Private Equity, Summer 2003.

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