Management Contract – Definition, Pros and Cons, and More
Are you running a business and you’ve been exposed to the term management contract? Perhaps you’ve been offered the option of having a management company look after your business or a part of it. But before you make the decision to transfer a part of your business to another company, you should read more about management contracts.
In this guide, we’ll explain what these agreements are all about and the functions they entail. You can read a bit about the different types of management contracts in use, as well as download a template to use as part of your deal. We’ll also look at the benefits and possible downsides to signing a management contract.
THE DEFINITION OF MANAGEMENT CONTRACT
Let’s first look at the definition of management contract and the elements needed to create, enter, and enforce it. The Business Dictionary defines a management contract as an
“agreement between investors or owners of a project, and a management company hired for coordinating and overseeing a contract”.
A business or an organization will hire a management company to perform specific tasks. The management company will receive a compensation for the work. Your organization might hire a management company to look after its marketing and under the contract, the management company would perform marketing on your company’s behalf and receive a fee for doing so.
Under the management contract, the operational control of the enterprise or the specific department would be in the hands of the management company. Therefore, the management company you would choose, would be able to make all the operational decisions regarding the function you specified, i.e. marketing.
Your contract might limit the excess of the control, but in most instances, the contract includes all operational functions of that specific enterprise or department. The compensation for the management might be decided based on performance or it can be a set sum decided between you are the management company. You might provide the company a fixed monthly remuneration or a fixed percentage of the profit. On the other hand, your company might pay a specified sum based on certain performance metrics the management company is able to meet.
A management contract will always consist of three core components. The three parts are the first things you will need to specify when seeking out a management contract. The parts are:
- The conditions of the contract – The lengthiest and most detailed part of the management contract is naturally the conditions of it. The contract must clearly identify the parties involved and the functions that are being transferred to the management company. This includes the outline of the rules and responsibilities both parties have and the extent which either party can influence the operational functions once the contract starts. To avoid confusion and conflict later on, the conditions must be clarified and the functions and operational responsibilities outlined in detail.
- The duration of the agreement – The section specifies the duration for how long the management company will be in charge of the enterprise or department. The duration could range from a few months to years, and you might have set specific conditions for the duration. For example, if certain performance metrics are not met, the contract can be terminated sooner and so on.
- The method of computing the management fees – The management contract should also discuss the compensation method. As mentioned above, the method for computing the management fee can range from a set percentage, a set sum or a specified sum related to performance. An example fee could be a % of total revenue and/or a % of gross profit.
The video below is worth watching to understand the basics of a contract, which are directly applicable in the case of management contract as well.
THE FUNCTIONS OF MANAGEMENT CONTRACT
The definition says how under the management contract the operational functions are handed over by a company to the management company. But what are the functions an organization or a company can hand over to the management company? The range of functions is wide and varied. The typical functions entail the following:
- Technical operations such as production of products
- Management of human resources, including training of personnel
- Financial management of the organization such as accounting
- Marketing services, including promotions
A company can essentially identify the functions it hands over to the management company depending on its needs. Your business might require an outsider to look after your accounting, including a range of financial functions that fall under this operational department. On the other hand, larger enterprises might make management contracts on much wider operations, such as looking after a specific store or business entity.
Are management contracts franchising deals?
Since management contracts entrust the operational control of the entity or function to the management company, the contract is sometimes confused with a franchising agreement. But the two are separate from each other. Both management contracts and franchising deals are both opportunities to earn by selling intangibles and the agreements create an affiliation with another business entity.
But under a management contract, a company is provided with structure and framework in the form of the deal, whereas a franchisee is an independent business. A franchising deal creates a contract between a franchiser – someone who owns a company – with the franchisee – the person or organization buying the right to the company name and other trademarks.
Let’s look at the difference in the form of an example. If you own a hotel chain A, you might seek out to make a management contract with a company B over the operational control of a specific hotel. Under the management contract, B would gain the operational control of looking after the hotel and in turn, you would pay a specified fee to company B. Company B would be allowed to run the hotel in any way specified in the management contract. On the other hand, you might make a franchise deal with company C, which would allow the C to use the trademark of A and perhaps use some of the business models and tools of A. C would pay a specific fee to you, company A, for the rights.
EXAMPLES OF MANAGEMENT CONTRACTS
Management contracts are a popular choice for organizations, especially those with large-scaling functions. The contracts are also used in a number of industries for a variety of functions. Below are some examples of the most common management contract types and brief description of what each contract means.
The hotel industry is one of the most popular industries when it comes to management contracts. The industry has a number of examples where a larger enterprise entrusts the operational management of a specific hotel to a management company. The management contract is made between the owner of a hotel and a management company, which will take operational control, often on the entirety of the hotel.
It is common for the contract to provide the management company the control to service guests, maintain the premises, and conduct marketing and other promotional services. The management company will also set operational policies, as well as control the human resources of the specific hotel. The hotel management contracts tend to be long-term agreements due to the nature of the industry.
Furthermore, the operator often has the upper hand in terms of the terms of the management contract.
The below image clearly highlights the process of a management contract in the hotel industry and outlines the basic principles of the process.
Source: Green Hospitality Management website
Another popular management contract example comes from the property industry. Property development companies tend to hire management companies to look after specific properties, either in business or residential properties. The management contract in the industry is rather similar to the example above of the hotel management contract.
The property management generally is in charge of operations such as maintenance, tenant management and financial collection of rents and other arrays. Property management contracts typically include the whole property, as conflict of interest issues could arise if different management companies are used within a single property.
Property management contracts are not only used by large businesses, but individuals can also hire a property management company to look after a second-home or another such real estate. The contract type can be beneficial to both parties.
Management contracts are not just about handing a number of functions away at once and it doesn’t necessarily need to involve two enterprises. An example of a different type of transfer of functions is contracts of association managers. These management contracts often involve non-profits and other similar organizations, such as trade associations.
These entities often don’t have the resources to have the board of directors to be in charge of the day-to-day activities. This might be due to budget constraints, as hiring full time staff can cost much more than handing out operational control to a management company. When such contract is made, the management company tends to take operational control of things like meeting planning, communication management, accounting, and so on. Depending on the organization, the management contract might also include things like website management or the running of different sponsorship programs.
Similar to association managers, industries like entertainment and sports often use management contracts. Artists and athletes tend to hire management companies to look after the mundane parts of their careers – including booking sponsors, dealing with endorsements, enhancing public relations, and looking after their finances – while they focus on creating art or performing as a top athlete.
Under these management contracts, the fee is often directly linked to the person’s annual earnings, which can of course be enhanced by the management company (getting better sponsorship deals and so on).
Food service managers
Management contracts are also used by the public sector. Food service management contracts are a good example of the management contracts in the sector. Under these agreements, schools sports facilities, nursing homes, and public office buildings have their food facilities and services provided and managed by a management company.
The management company often pays a specific lease and a percentage of the food sales to the building’s owner, while taking on the operational control of preparing, serving and marketing the food. These sorts of management contracts can sometimes be used in the private sector as well, with large corporations often having a management company take charge of feeding the employees, so to speak.
The idea of the management contract is to provide smooth delivery of a core function of running a business (creating a place for the staff to enjoy a meal), but which is not the core part of the business or entity (school’s main function isn’t to cater students dietary needs).
Management contract template
If you are considering a management contract, you could contact a third-party to help with the creation of the contract. It’s especially important to seek out legal advice before signing a contract to ensure your business is not walking into a bad deal. You can also find out templates to guide you in the process for example here.
THE ADVANTAGES AND DISADVANTAGES
So, why are companies, individuals or organizations willing to transfer the control of certain operations to a management company? Should you consider creating a management contract as well or are any dangers lurking around the corner? Let’s look at the advantages and disadvantages of management contracts.
The advantages of management contract
The benefits of creating a management contract deal with timesaving, operational continuity and knowledge. Handing out operational control of a specific function ticks out the specific operation from the business’ ‘To Do’-list. The company doesn’t have to worry about this aspect, but instead focus more on important areas or areas the business is better at.
Consider you are running a start-up and you are trying to establish your business in the sector. Having to do your own bookkeeping might take too much of your time away from things like marketing or product development. By hiring a management company to look after the accounting part of the business, you are able to save time and your resources.
Furthermore, that aspect of your business might not require enough attention to justify hiring an accountant as part of your team. The cost of a management contract could be less than hiring a full-time accountant for the business. Therefore, you will be better able to direct your resources in terms of money and time by entrusting the specific function of the business into the hands of a management company.
Overall, the management contract can help distribute responsibility better. You won’t be in a situation where the human resource department also needs to manage the bookkeeping, but your resources are directed to deal with the right responsibilities.
You also create a situation where the organization receives expertise and experience. Consider the example of a start-up. You might not be efficient in business finances, but instead know everything about marketing and product development. When you are hiring a management company to take control of your accounting, you are seeking out services from a professional. Instead of relying on partial information, you will have an experienced person focusing on the operations they are most capable to perform. You therefore guarantee your business’ finances are in the hand of professionals, which can boost your profitability and operational efficiency.
Management contract can also provide more continuity to an organization. The contract company might have individual managers change during the contract, but the standards set at the start of the deal will continue to remain in place. What this means is that you don’t need to worry about change in performance or style, as you have spelled out the conditions in the agreement. For example, you would have identified the expectations and the different processes you might want the management company to use or not use as part of the operational control. Therefore, you can continue to enjoy the same level of function and efficiency, without the need to worry how personnel changes might influence your business.
The disadvantages of management contract
Despite the obvious advantages outlined above, you shouldn’t jump into a management contract. The contract can pose a few questions, which you need to consider before venturing into an agreement with a management company. The most obvious disadvantage of a management contract revolves around privacy.
The organization is essentially surrendering information about its products, finances and other such matters to another entity. While the contract naturally deals with these issues and requires full confidentiality, the information is still not only confined to your organization. If your organization is in charge of every operational aspect, you can confine the information to in-house staff and premises.
But with a management company, you entrust the information in the hands of people you haven’t vetted yourself and place your trust on handing over information outside of the physical premises of your company. Although this risk can and should be managed by the management contract, it nonetheless exists.
Furthermore, privacy issues are not just about your information and relationship with the management company. If your business uses third party suppliers, you need to ensure the contract with them doesn’t deny your business from making a management contract. Third parties might have specific objections towards their information being handled by another entity or have issues with dealing with a third party instead of directly with your business. It’s crucial to consider these issues before you venture into a management contract.
Finally, you need to keep in mind overall issues regarding conflict of interest. If you are using a large management company, you need to be aware of the possibility the company also deals with your competitors. You want to ensure the management company resolves such possible conflicts of interest with your business’ interests in mind. Management contracts shouldn’t hinder your company’s success. When drafting the contract, clearly identify the people who are in charge of your business and discuss how you want possible conflict of interests to arise.
While it should be obvious from the definition of a management contract, it is worth reminding how the agreement transfers the operational control of your business to the management company. Therefore, depending on the clauses in your contract, you won’t have a say in many of the things the function will do. It’s important to be aware of this because you might find yourself looking to influence decisions when things are not going well, for instance. Yet, the operational control is not in your hands and you just need to trust you’ve made the right decision.
THE BOTTOM LINE
Management contracts are a clever mechanism for sharing the burden of running an organization. The process entrusts certain operational responsibilities into the hands of a management company – an organization that is an expert in the specific field. The management company will receive a specific fee, while ensuring, the function is performed to the highest of standards.
Due to the nature of these arrangements, they tend to be popular in industries such as hospitality, property management and even airline and the hauling industry. Under the management contract, the operations handed over can range from single functions, such as finances, to large-scale business management, such as looking after a specific hotel. Management contracts have the benefit of boosting a company’s performance by enhancing knowledge and dividing responsibilities.
On the other hand, getting another entity involved will always create the possibility of privacy issues and conflict of interest clashes. Nonetheless, the system can help large-scale organizations look after their businesses better or provide more resources for smaller companies. The contract is definitely worth exploring if certain functions of your business seem time-consuming or difficult to deal with.