Why is the term of franchise agreements usually five years?

Five years is by far the most common duration for a franchise agreement. However, this does not mean that franchise agreements must always have a five-year term by definition.

Why five years as term for the Franchise Agreement

Franchise is a sustainable form of cooperation between the franchisor and the franchisee. The duration must be such that both parties are willing to invest in the franchise formula. The level of these investments differs for both parties. For instance, a franchisor will mainly invest in the further development of the formula. The investment of the franchisee is highly dependent on several factors, such as in the retail and hospitality sectors; whether there is a rental or purchased property, the necessary adjustments to the property, working capital, stock, etc.

Therefore, it is of great importance to the franchisee that the term of the franchise agreement is such that he can recoup his investment. Assets are normally amortized over five years for accounting purposes, and goodwill (including the entrance fee) can even be amortized over ten years. With a term of (at least) five years, the franchisee thus has the opportunity to earn back his investment.

“At McDonald's, it is customary for the term of the franchise agreement to be as long as twenty years, because very high investments are made by the franchisee.”

The different interests for the franchisee, franchisor, and the consumer for a term of five years in franchise agreements:

1. In the interest of the franchisee

• From a practical standpoint, the duration of the franchise agreement is (often) equated to the term of the rental agreement.
• Once the investments have been amortized, it is often necessary to reinvest to keep the business up-to-date. Entering into a new five-year franchise agreement offers the same security.
• A franchisee wants the option not to be bound by the agreement, the establishment, or his activities for too long if it turns out that the results are not what was initially expected.
• A franchisee may reach an age where entrepreneurial activities no longer align with that life phase. For example, a business owner who no longer feels connected to developments in a certain market because he no longer belongs to that target group.

In short, a five-year term creates a concrete moment for the franchisee and franchisor to determine, in good consultation, whether it is beneficial for both parties to enter into a new five-year agreement.

2. In the interest of the franchisor:

• It allows the franchisor to renew agreements related to the formula based on (market) developments or, for example, new legal requirements.
• It offers the franchisor the possibility to part ways with the franchisee under certain circumstances (provided it is reasonable and fair) after five years. The formula and, consequently, the requirements that franchisees must meet often evolve over the years. The question then is whether a franchisee fits the formula for the next five years as well.

3. In the interest of the consumer:

• Five years is generally the maximum term according to the Competition Law in which certain competition-restricting agreements can be made if it concerns a chain with market dominance. Think of a supply obligation of products from the franchisor and a prohibition on selling competing products.

Why less than five years as the duration of the Franchise Agreement

There are also circumstances where a shorter duration than five years may be more appropriate. For example:

• When a franchisee takes over an existing franchise establishment, including a rental agreement, the franchisee and franchisor typically want to align the franchise agreement with the remaining duration of the rental contract. In many cases, this results in a term less than five years.
• The same consideration applies if a franchisee rents a location for a period shorter than the usual five-year term.
• If it is a low-threshold formula without major investments, such as a service formula without a physical establishment and with an investment of only a few thousand euros. In this situation, it may be desirable for the franchisee and/or franchisor to first see if the cooperation actually yields the desired results without long-term commitments to each other.

In conclusion

The length of a franchise agreement is sometimes negotiable. It should be realized, however, that both franchisor and franchisee take a risk if the term is so short that they can part ways before the cooperation has actually borne fruit.

Moreover, it is always advisable to build in annual discussion moments during the term of the franchise agreement to discuss future plans. It is also recommended that the franchisee prepares his personal (financial) plan. Additionally, it is strongly advised to discuss the possible extension of the agreement well over a year before it expires. This way, there is sufficient time to explore alternatives, such as finding another location or a successor to take over the franchise establishment.