Experienced franchisees who have had success operating one franchise unit may want to expand. It is also common for a business owner (or entity) to want to develop more than one location at the outset. The next logical step in both scenarios would require area development rights. By becoming a multi-unit operator in a specific territory, the franchisee can become more engaged in the franchise system, build a portfolio and strengthen their local reputation.
What Is An Area Development Agreement?
An area development agreement is a contract between a franchisor and a developer that grants the developer (the franchisee) the right to open multiple franchise units within a defined territory on a negotiated schedule.
The arrangement is codified across three documents:
- the Franchise Disclosure Document (FDD),
- the area development agreement, and
- a separate franchise agreement for each unit.
The initial franchise fees for each location are dictated by the franchise agreement, which is signed for each location. Sometimes, the area development agreement will provide that no additional initial fee will be due; or that the development fee for each location will be credited towards the initial franchisee fee for each location once the development process begins. This dynamic will vary with each franchise system, and a franchise lawyer will ensure fairness and consistency when reviewing the agreements.
Now that we’ve addressed those granular details, let’s focus on the opportunities of area development. Here are five reasons this structure can be the right move for a franchisee.
1. Lock In Favorable Market Conditions
Area developers are typically granted an exclusive territory in which to build their franchises. That means the developer benefits from being the first and only operator in that area during the development period. For franchisors, this structure can help secure committed, well-capitalized operators to drive system growth in a defined region, provided the developer is properly vetted. Buying a franchise already offers many advantages; area development multiplies them.
2. Gain Economies of Scale
Multiple franchise locations allow developers to grow revenue quickly while decreasing per-unit costs. Developers can negotiate better supplier terms, share employees across locations, market all units jointly, and streamline back-office operations. For franchisors, a successful area developer becomes a model operator whose efficiency and profitability strengthen the entire system. Along with the cost savings, this dynamic is a natural extension of the business expansion strategies that make franchising attractive from the outset.
3. Territory Protections During Development
Developing multiple locations takes time, and area development agreements often preclude other franchisees from opening units within the area during the development schedule. While this protection typically lasts only until the last required unit opens, it gives the developer a window to launch without worrying about encroachment.
After the development period ends, territory protection reverts to what is established in each franchise agreement. It is typically a much smaller area, such as a one-mile radius around each location. Franchisors also benefit: a protected development period encourages serious investment and commitment.
4. Build Portfolio Value and Brand Presence
For franchisees, successful multi-unit operations build enterprise value that far exceeds what a single location can generate. A three-unit portfolio is worth more to a buyer, and to a lender, than three standalone units scattered across different systems. For franchisors, area developers create concentrated brand presence in key markets, which can attract additional franchisees and drive system-wide growth. Ultimately, the portfolio becomes greater than the sum of its parts.
5. Negotiate Protections Against One of the Biggest Risks: Cross-Default
The flip side of multi-unit growth is the cross-default clause. This provision allows the franchisor to treat a breach under one franchise agreement as a default under the developer’s other agreements as well. A missed development deadline, operational failure, or fee shortfall at one unit could, under a broadly drafted clause, threaten the entire portfolio. The good news is that these provisions may be negotiable.
An experienced franchise attorney can carve out development-schedule shortfalls from the cross-default trigger, secure graduated remedies such as notice and cure periods, and ensure that a failure to open a future location does not automatically jeopardize already-operating units. That negotiated protection is what helps make area development a calculated growth strategy rather than a gamble.
The Case for Area Development
Area development offers franchisees a faster path to portfolio value and franchisors a vehicle for concentrated system expansion. As previously discussed, hiring a franchise lawyer is key to successful area development. The lawyer can review existing agreements, standardize the new agreements and liaise between parties.
Contact Lusthaus Law
Lusthaus Law’s website is a resource for New York franchisors and franchisees. We have published two downloadable and complimentary e-books and our Insights blog is regularly updated to reflect industry trends, legislative updates and recent achievements in client representation.
Contact us today to learn more about how Lusthaus Law P.C. can help you navigate a clear path for your franchise’s successful future.
