Every franchise agreement should discuss the issue of the source of customers. This is known as the geographical territory, protected territory or exclusive territory. Many agreements spell out the zone or area of your customer source. It is important to understand the Geographical, Protected or Exclusive Territory Clause in the Franchise Agreement. In some situations this may break the deal due to the nature of the territory and the demographics involved. This article teaches you how to evaluate the Geographical Territory Clause in the Franchise Agreement and how to negotiate a fair and equitable clause.
I am reminding you that I am not an attorney. The laws vary from state to state. THERE IS NO SUBSTITUTE FOR GOOD LEGAL ADVICE. When you are done reading this article, please seek out legal help as it pertains to your franchise agreement. This article’s intention is financial and business in nature.
As the franchisee, your primary concern is protecting a customer base. Often this is defined as a geographical territory. Ideally, you will want the wording to provide you with absolute control over an area. Most franchise agreements grant rights to an area within a radius of your location. The key is to understand that often these rights are limited. Examples of limiting your rights include:
- The Franchiser reserves the right to operate licensed franchisees or franchiser owned operations in malls, institutions (like a college campus, hospital facility/campus, government facilities) or sports arenas. The term that should catch your attention is the ‘NOTWITHSTANDING’. You should look at this term as meaning bad news for the franchisee.
- A second method the Franchiser invades the territory is they will reserve the right to sell the branded product in a facility such as a grocery store or convenience mart provided there is no Franchise name as a part of the store. This is how Starbucks and Dunkin sell their coffee in grocery stores. This should concern you for two reasons. First, if one of your customers finds it more convenient to purchase your product through these types of stores, you will lose sales. Secondly, you should be the one to have the right to package and place the Franchiser’s product on those shelves. Remember you are buying the rights to a territory.
- Many of these territory clauses limit the range to within a radius of your store location. However, a competitor could build a store exactly 100 feet outside the radius and still compete for the customers within your zone. Your goal should be to limit the ability of another franchise to acquire your customers. So it is OK to state that your customer zone is within 2 radial miles of your store, but a new or competing franchise cannot build another store within 3 radial miles. This allows for retention of those customers in the one to two mile radius to go to your store because it should be mathematically closer.
- Another tool the Franchiser uses is the right to ‘take back’ a portion of the territory because they may state that you are not maximizing sales or the potential of the Franchise name. You need to understand they may create a reason to take a part of your zone from you to sell another franchise. Turn the wheels back on them and make the clause read that if in the Franchiser’s mind a certain area isn’t maximized, then you have the right to portion off the territory and sell a franchise as a co-owner with the Franchiser. What this means is that the Franchiser still gets their royalty and you can collect a smaller royalty. Let’s say the Franchiser’s royalty is 6% so you have the right to sell the carved out zone for a 7.5% royalty. You collect 1.5% while the Franchiser collects their 6%. Again, remind them that if they honestly feel the zone is under performing, then there should be no reason a new franchisee would not be willing to pay a premium for this site. Protect your customer base.
As a franchisee, you are probably more aware of the customers in your area than the franchiser. You are probably more aware of future growth plans, transportation changes, government changes etc. Use this to your advantage and carve out a territory to match the future and not today. If a new bridge is going to be built over the railroad tracks connecting two wealthy areas, then think about how to protect this new customer base in the future. Discuss this with your attorney. Don’t allow the Franchiser to use blanket or absolute terms that truly limit the scope of your territory. If physical geography barriers exist, get more territory added to your zone. As an example, let’s say that your store in located in a section of town backing up to a federal reserve of some sort. So a certain mile radius means nothing as it relates to the Federal Reserve. Use this as a bargaining chip in negotiations. Expand on the zone by having a map drawn zone. This should be your exclusive customer zone and then another outer zone area as a no build zone. This means the Franchiser cannot build a new franchise within the no build area.
Methods to Protect Your Territory
The key to all of this is to protect the customers within your territory. You really don’t need to protect the physical zone, the land doesn’t buy product from you. Protect the customers.
- If the clause provides for a radial zone of a certain distance, then make sure this clause indicates it is for the customer base and not the physical land zone. If another franchise desires to open, then this franchise must be physically located at least ½ of the distance away from the outside point of the radius as your store is located to the outside point of the radius. This protects the customers within your radius from choosing between the new franchise and you. They will continue to go to you. It also protects the new franchisee by preventing customers within his radius from going to you. It’s a win-win. You need to sell it like that to the Franchiser via your attorney.
- If the Franchiser wants to protect the right to open a new franchise in a mall or some large working facility, then they will try to carve this out from the agreement with you. Don’t let them do this. You force it to stay with you by restating that element of the clause to declare that you have a five year right of first refusal to place a new store within these types of facilities. This gives you five years to raise the money and get it done. Furthermore, you should reserve the right to have a limited store front or exposure via a kiosk or a small independent stand with the Franchise Name on the store. You do not want to be forced to open a full scale store when one may not be necessary. Again protect yourself from them infringing upon your customer base.
- Another carve out they will try is the branding ability. This means they will want the right to sell some of their product in non-traditional franchise locations e.g. grocery stores or convenience marts. You can protect yourself by having this sentence or section rewritten to state that you have the right to place the product in these locations if the Franchiser identifies the locations where they desire to place product. You can even state that you control the right of first refusal to place product on these shelves.
Remember, the goal is to protect the customer base.
Non Territorial Clauses
Some franchise systems have a no territory clause. Sometimes it is not needed due to the nature of the business operation. Examples include mortgage companies, service related operations such as carpet cleaning, plumbing, HVAC etc. Most of the territory clauses exist with product or restaurant functions.
In these types of franchise agreements look for how conflicts between franchisees are resolved. A customer doesn’t care whether this tax service franchise did the work or that tax service franchise did the return. He may be addressing his concern with you. What are the tools and procedures franchise organizations use to arbitrate conflicts?
The geographical, protected or exclusive territory clause is your chance to protect future income. You do this by focusing on the customer base. Think about where they will come from and how to protect yourself from the Franchiser carving out opportunities for them to take away sales from you. Use the methods I identified above to protect your customer base. Knowledge is Power.
If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org. I would love to hear from you. If interested in my help as an accountant or consultant, contact me through the ‘My Services’ page in the footer.