Under a development agreement, a franchisor offers a franchisee the opportunity to buy the right to develop franchises in a broad geographical territory. Typically, development agreements are separate from franchise agreements, and they require the developer to open a particular number of franchised stores within a number of years.In some cases, the franchisor gives the developer the right to sub-franchise, so the developer sells franchises within the territory.
Development agreements without sub-franchising
Under straight development agreement with no sub-franchising, developers must have the capital and resources to develop the market over the specified period of time. If a developer fails to do so, they lose the exclusivity to build franchises in that territory.
Development agreements with sub-franchising
If the developer is also a sub-franchisor, the arrangement is more complicated. The developer/sub-franchisor must prepare a franchise disclosure document in order to sell franchises. Usually, developers must also help franchisees build and operate stores.
The upside is that the sub-franchisor gets a share of the franchisee's royalties and up-front fees. However, if a sub-franchisor fails to develop at the required rate or does not fulfill the obligations, the agreement may be terminated and, in some instances, the arrangement will revert to the franchisor. In addition, the sub-franchisor will have no right to continue collecting royalties from the franchisees.
Is a development agreement right for you?
Only franchisees with substantial capital resources and experience operating the type of units at issue should purchase development agreements and sub-franchising agreements. While development agreements can lead to substantial wealth, they contain risks that franchisees must understand, evaluate, and factor into their plans.
A good franchise lawyer can guide a prospective developer through the development agreement and explain its risks and opportunities.