2.12 Territory | Item 12

Best Practice

If your franchisee must first secure a physical location for the franchised outlet, we recommend you designate a non-exclusive “Site Search Area” that is broader than the ultimate protected territory. We also recommend that you describe the Site Search Area in general geographic terms, such as a town, city, or county, and avoid using a map, as franchisees will assume that this map is their “exclusive” territory.

We usually call the franchisee’s territory a limited protected territory. Many disputes over Item 12 occur concerning exclusive and non-exclusive territories. For most franchisees, they expect that they’re getting some type of exclusive, protected territory. However, in the franchise agreement, franchisors are almost always going to reserve certain rights to themselves to sell products and services in that territory, even though they have a franchisee there. For example, a food service concept franchisor may want to provide sauces or frozen meals to grocery stores in the territory. If it’s a specialty retail store, maybe they sell products over the internet. More importantly, by making this distinction, you can have an option to add products in a department store or sell in airports, stadiums, or at special events. Ultimately the franchise may be acquired or sold to a competitor. In this case, the franchisor may be operating and competing in this same territory, and if you don’t have broad enough language in your franchise agreements, you could be limiting the pool of future potential suitors.

When you’re talking about long-term value, a new franchisor should be very careful not to ever use the words “exclusive territory” because you’re always going to have various exclusions to the territory. When preparing your FDD, we’re going to use broad enough language that protects not only the integrity of the system but also your exit strategy options. So, when talking about territories with your franchisees, you should never use the word “exclusive”. Always remember, the language you use when talking to prospects and your franchisees is just as important as the language in the contracts and sometimes even more important.

If you follow our best practice, you will see the following in your FDD:

You will not receive an exclusive territory. You may face competition from other franchisees, from outlets that we own, or from other channels of distribution or competitive brands that we control.

Whenever you reserve rights to sell products or services in the franchisee’s territory through your own or other franchised outlets, the regulations require the above language. We cannot alter this language in any way. This language will be required, for example, if you reserve rights to open “non-traditional” outlets (such as at airports, arenas, hospitals, or universities), if you control Commercial or National Accounts that may generate business in the territory, or if you allow franchisees to service pre-existing clients who may be located in another franchisee’s territory. This clause is quite common, and we can help coach you on how to have those conversations with potential franchisees that push back on the definition.

One of the biggest mistakes emerging franchisors make early on is they give away territories that are way too large. Another common mistake made by new franchisors is agreeing to rights of first refusal. This is a big problem that makes it harder to sell new territories because of your earlier commitments. It’s also not uncommon if you start doing many deals that you lose track of what first refusal rights you have given in earlier deals and then sell a new deal in violation of the old deal with overlapping franchisee commitments. That’s a big headache, and unfortunately, one that happens too often.

Granted, you may have to give away a huge territory to your first franchisees to get the system started, but you should know it is not a cost-free transaction. You will regret it. You have to make a judgment balancing the cost of the deal against the cost of your future regret. If you look at any mature franchisor and see where they were founded, often you will see huge territories around their home office. It can even impact the franchisee’s local sales because the brand doesn’t have proper market penetration if those first franchisees with a giant territory act as squatters without maximizing the territory. It’s just human nature for the franchisees to want more, and it happens in every franchise system. It’s your job as the leader of the system to be aware of the issue, to explain it to your franchisees, and to strike the right balance.

See Tom Spadea’s article in the Franchise Dictionary Magazine “Territory May Be Your Scarcest Resource: Treat it Accordingly.”