International expansions of franchise systems have been increasing at a rapid pace for years. For some franchisors, such expansions have proved to be very successful, but for others, the experience has been costly and frustrating. Often, one of the greatest areas of frustration is getting the master franchise agreement settled and signed, even when the candidate and the fundamentals of the deal are right.
Dividing up the Spoils and Job Allocations
Without a doubt, the most poorly handled issue in master franchising is the division of the front-end franchisee fees and continuing royalty fees for the unit franchises in the territory between the franchisor and the master franchisee. It is not unusual for the franchisor to base the decision on the allocation of these fees on the anticipated or desired return from the development of the system in the territory without serious or careful regard for how the master franchisee will finance the necessary development and support services for the unit franchisees. Mistakes with this issue will either ensure the demise of the master franchisee or reduce the quality and performance of the system in the territory. Additionally, presenting unrealistic numbers to a sophisticated prospective master franchisee can wreck the deal.
The responsibilities for the development and administration of the system should be decided first as between the franchisor and master franchisee. Then the division of the various fees should be based upon the costs of discharging those responsibilities and only after that should the parties divide up the remaining “profits.” Being able to provide proof of a careful analysis of these matters will go a long way to getting the deal done with the best candidate.
Selection of Unit Franchisees and Locations
Often, master franchisees want the right to select unit franchisees and locations within their territory, but franchisors do not want to abdicate the responsibility for final approval of franchisees and locations before the master franchisee has proven to be capable in these crucial areas.
By proposing an initial fixed number of franchisor approvals, subject to specific achievements of the master franchisee, with a resumption of the requirement of franchisor approvals in the future if other criteria are not met, the franchisor can overcome a common challenge to concluding negotiations.
Both parties are understandably more familiar and, therefore, more comfortable with the legal regime in their respective home jurisdictions. To avoid another obstacle to getting the deal done, the franchisor should consider having the governing law of the agreement be the most appropriate law depending upon the issue, with some issues being determined by the law of a third jurisdiction acceptable to all.
While the governing law provision of the agreement will be more complex than usual, the extra comfort level of the parties will make it easier to finalize the agreement.
Franchising is one of the best and most efficient ways of expanding a business. Once a solid foundation is built for the success of the system in the home jurisdiction, international expansion is a sensible and potentially profitable strategic choice. A poorly executed international expansion can drain the resources of the franchisor to the point of destroying the entire system. The moral being that it is less important what you do than how you do it.
Getting to yes, with the best candidates, for the right master franchise agreements can go a long way in ensuring that international expansions are profitable and satisfying for the franchisor. The foregoing has only touched the surface of a complex and challenging area of negotiations. It is not “rocket science,” but it does demand careful thought and patience.
By Edward (Ned) Levitt, CFE