Currently, franchises are an increasingly fast-growing segment of the retail industry, especially in the case of fast casual and quick service restaurants. But before jumping feet first into one, there are some pitfalls prospective franchisees need to navigate before taking advantage of a potential opportunity, says Ian R.D. Labitue, an associate with Kegler, Brown, Hill + Ritter.
“Franchisees are driving the growth of retail right now because the backing of a strong franchisor can provide leverage when it comes to negotiations with a landlord,” says Labitue. “But you have to ensure that the lease terms are in your best interest because ultimately the franchisor will not be operating in the leased space — you will.”
Smart Business spoke with Labitue about what franchisees need to consider regarding franchise and lease agreements.
Is negotiating a lease normally the responsibility of a franchisee?
Many franchisors will place the burden on the franchisee to find a suitable space and negotiate lease terms, however, a franchisor may want to be active in the process as well. Oftentimes, they connect a franchisee with a local broker to assist, but that may create a conflict of interest because the franchisor is paying the broker’s commission. A franchisee should always be actively engaged in the process and never on autopilot, even with the help of a franchisor or broker.
Will the franchisor dictate aspects of the lease space?
A franchise agreement will spell out the use of the leased space, but a landlord may want the franchisee’s permitted use to be as restricted as possible so that they don’t violate exclusives with other tenants. As a franchisee, you want latitude so that you are able to offer any product or service the franchisor offers. They may sell supplemental items to their primary offerings, like T-shirts or other branded paraphernalia, and you want the ability to stock those things to take advantage of the additional revenue.
Can you provide any examples of franchisees overlooking something that became a problem?
The franchise agreement not only governs the relationship between the franchisor and franchisee, but also impacts the relationship a franchisee has with its landlord. The franchisor’s leasing standards will be spelled out in the franchise agreement and are often included on a ‘lease rider,’ which can be incorporated into the franchise agreement. When a lease rider is present, the franchisee is bound by the terms of the franchise agreement to incorporate the terms in the rider in any lease it may enter into. This can be very problematic and restrictive when the time comes for the franchisee to negotiate a lease agreement. In essence, the franchisee is already starting off in a less powerful position because the terms of the lease rider must be included in the negotiation. It may make securing a space more difficult if the landlord is unwilling to agree to the predetermined franchisor lease terms.
What are some other items a franchisee should negotiate to include in its lease agreement?
Opening and/or continuing co-tenancy provision. Ask the landlord for the right to abate rent or even terminate your lease if an anchor tenant in the shopping center closes. If you’re in a development with a strong anchor, you want the ability to lower your rent or terminate the lease if they leave because their absence will almost certainly affect your sales in a negative way.
Exclusive use provision. Try to negotiate for an exclusive as well. If you’re a quick service burger franchise, restrict the landlord from signing leases with other restaurants with the primary business of selling burgers to ensure you’re the only establishment of that type in the development.
Tenant allowance provision. Ask for a tenant allowance for any improvements to the leased space; landlords are generally more willing to provide a one-time allowance than to keep a space vacant for an extended period of time.
Lease negotiations as a franchisee are a balancing act because you have to comply with the franchise agreement, but you also have to protect your interests and reach an agreement with a landlord that’s beneficial to you as a tenant. ●
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