This article was featured in the March issue of Franchise Dictionary Magazine.
Franchise Term Lengths: Does it Matter? Who Benefits?
At the risk of really getting into the weeds on a very narrow issue, when was the last time you gave any serious thought to the term length in your franchise agreement? As we immerse ourselves in this renewal season, franchisors have an opportunity to rethink and rework sections that may be holding them back in the short term and costing them in the long term.
Many franchisors, especially when they start out, are concerned about locking in someone for 10 years or longer because they are really just putting a toe in the water, testing out whether or not their brand and system can grow as a franchise. Especially service brands, without a lease or big SBA loan driving the term higher, you see many brands with five-year terms. Some think a five-year term is advantageous to the franchisee and will be perceived by them as better than a longer-term commitment; however I would argue the exact opposite is true. A franchisee is making a commitment to build a business and a bedrock factor of any business is certainty. If the franchise agreement can terminate or dramatically change in five years, then how can franchises be certain they have a sufficient runway to be successful?
Banks, landlords, and hopefully franchisee attorneys, all recognize that a longer term is better for the franchisee. Franchise Grade – my favorite rating, research and education company – will lower a franchisor’s grade if they have a shorter term based on the very real fact that a shorter term is worse for the franchisee.
However, a shorter term doesn’t just hurt the franchisee. Those of you who have read my columns before know that I always preach starting and building your system with the end in mind. When it comes time to harvest your brand and find a private equity buyer, longer terms are enormously important. PE firms are looking for future predictable cash flow and will directly calculate expected future royalties by relying on the remaining terms in your franchise agreements. The franchisees may have certain automatic rights to renew, but you as the franchisor can’t force it.
Bottom line – think long term by having a long term!
To see all of Tom’s featured articles on The Franchise Dictionary Magazine, visit this page.