The marketing function performed by most franchisors can mean the difference between a flat year-over-year sales, and 13% year-over-year decrease in sales.   For Pizza Hut’s largest franchisee, NPC, that difference in sales a massive amount of money.  Hypothetically, if the average Pizza Hut does $1.5 million in sales, then we are talking about a $195,000 difference per store.  With 1,150 stores, we’re talking about $22.4 million.  That’s a large distribution check for the owners to miss out on!

Burger King franchisees are suing their franchisor over being forced to price the double cheeseburger at maximum of $1.  Franchisees’ problem is that it costs more than $1 to make and sell.  I’m sure Burger King corporate response to the loss argument is that the total average sale involving the $1 double cheeseburger turns a profit, because on average people also buy at least a drink and fries.

A former franchisee of Pizza Pizza in Ontario lost his franchise for allegedly falling behind on payments to the franchisor.  This whole relationships seems to have gone mismanaged by both sides.  The franchisee wasn’t keeping good sales records and delivery drivers were impatient with customers, and the franchisor let bad practices continue for too long.

http://news.guelphmercury.com/News/Local/article/524725

source: USA Today

Which donut hole do you prefer, the “A Hole” or “B Hole?”  That is ruffling feather of some franchisees.

Unfortunatley, there is not much the franchisees can do about it legally.  Franchisees can only voice their opinion, sometimes it works:

Burger King recently acquiesced to franchisee pressure to tone down its advertising. In the spring, consumer groups and franchisees said that a kids meal with a SpongeBob SquarePants cartoon character giveaway was too sexy. In the ad, women with square derrieres dance to Baby Got Back. Same-store sales for Burger King are due at the end of the month, but on Monday, its largest franchisee reported a 5.5% sales drop in the quarter.

Franchisors love to sell multi-unit development agreements, but some of the reasons may not be so obvious.

• Multi-unit franchisee typically pre-pay a portion of the franchise fees for each potential location.  Similar to a non-refundable downpayment.  Lately, many franchisee haven’t opened their additional locations or have slowed the opening pace, but the franchisor still keeps their pre-paid franchise fees, which is typically $5,000 – $15,000 per location.  For example, if a franchisee signs an agreement to develop 10 units, then he may pre-pay a franchise fee of $10,000 per unit, or $100,000 for the rights to open 10 units.  He still would pay the remainder of the (oftern discounted) franchise fee as each location is opened.  The Development Agreements typically set a timeline for openings, and if you don’t keep to the schedule which is often opening at least one per year, then you lose your pre-paid franchise fee.
• The parties are negotiating one franchise and development agreement rather than a new agreement upon each new opening.
• Concentration of stores in one small area will help franchise sales in neighboring areas
• Generally multi-unit buyers have more reserve cash, so stores are less likely to fail from lack of short-term capital.
• A multi-unit franchisee is more likely to honor their penalty charges for closing a unit, compared to a single unit franchisee who has less assets.

For those looking to familiarize themselves with franchise agreements, this checklist from the Jacksonville, Florida Chamber of Commerce provides a good start. 

In the United States, resale price maintenance (RPM) is illegal under current U.S. Antitrust laws. In Japan, the Fair Trade Commission’s ordered Seven-Eleven Japan to end its refusal to allow franchise stores to discount bento boxed meals and other food items when the food is close to expiration. This will force all convenience store chains in Japan to review their policy of fixed prices for such products.Hat Tip: Chris Conner @ FranCorp’s Blog 

There has been a lot of talk lately, from Joel Libava’s Franchise King blog to recent MSNBC article, looking at whether 401(k) retirements savings should be used to fund a new franchise.  Many franchisors for obvious reasons like this idea, such as Westshore Pizza & Cheesesteaks who focuses their sales pitch as a great 401(k) investment.Use 401(k) money to buy a franchise?  My legal and financial opinion is almost always a NO!  It is too risky to gamble your needed retirement funds in a franchise.  If you need to tap your 401(k) to buy a franchise, you cannot afford to buy a franchise.  If your entire retirement life is already FULLY funded and you have plenty of cash, then use your excess cash for the franchise opportunity.

Professional investors always take a little cash off the table, and your 401(k) is what you took off the table.   Keep it there, don’t risk it away.  You could easily lose ALL your money in a franchise, but you couldn’t lose all your money in a 401(k) even if you tried.  Additionally, a single unit franchise will almost certainly not make enough money to payout and match a six-figure retirement account in less than a decade.

Tax and Match Advantages – Big DifferenceIs 401(k) a good investment in the first place?  YES!  Since your 401(k) investments are done with pre-tax income, you are saving about 30% more than you would have with after-tax income.  Plus, an employer match will nearly double the money that goies into your 401(k) than if you just invested the income from your final paycheck.  Upon retirement, you can control the 401(k) withdrawals to minize income taxes.  Even if the employer is not matching, the certainty of pre-tax investing is powerful because it is taken out automatically, but once the paycheck hits your bank it is much more likely to be spent rather than invested.

Quiznos is helping franchisees renegotiate leases at no cost to the franchisee. Good move.

Since the teams have been in operation, Quiznos has negotiated more than 40 leases thus far, with an average reduction of 15-20 percent in lease payments

Here is one franchisee’s experience in the press release

Thomas Mihailovich, a franchise owner in Rochester Hills, MI, participated in the lease renegotiation program in late February. Quiznos and a third-party team worked with Mihailovich and his lessor to arrange a reduction in rent of more than 20 percent, a cost savings of $50,000 over the term of the lease.

“I began the process and within one week I was saving nearly $500 per month on my rent,” said Mihailovich.

How do you renegotiate a lease?


If you are currently leasing a space for your franchise and want to renegotiate the lease, you do have a few leverage points. First, the landlord doesn’t want to lose a tenant because it will usually mean unrecoverable expenses and vacant space for a period of time. Second, along the same lines, a long-term stable lease makes landlords smile, so offering to extend or renew a lease for a longer number of years is very attractive, even at a reduce price per square foot.

Here is a sample approach. Find another space nearby that fits your needs equally well and is less expensive. Then approach your landlord and ask him to match the rent or you intend to move. See what the response is. From that point, ask permission to sublet. Depending on how long you have on your lease, ask also offer to sign a longer lease in exchange for reduced lease payments.

Getting the assistance of a real estate broker or better yet an attorney is usually well worth the money in renegotiating a lease.

Here is an insightful article with examples on the subject.

Australian franchisees have similar gripes to U.S.A. franchisees – disclosure issues and the renewal rights in agreements for franchisees.

It has not always been so crystal clear when a franchise chain collapses and there is an urgent need to clarify the legal rights, obligations and ranking of franchisees in a liquidation or sale of the business by receivers.           

The article brings up an interesting ethical question:  Is it legal or ethical for Franchisors that are at the brink of collapse to recruit new franchisees to their stricken businesses even as they face the very real prospect of bankruptcy?   

In my opinion, the legal and ethical answers are similar.  The franchisor must not lie or mislead in the sales process and it must disclose risks accurately, but within those boundaries it should do what is necessary to survive. 

Does a cash starved franchisor have tell a prospective franchisee – “We need to sell 10 more franchises this year or we will go bankrupt and you will lose your license” ? No, I do not believe that is or should be a requirement because many businesses live on the edge of financial survival.  But, if the franchisor knows that bankruptcy or winding down the business is a 100% certainty, I do believe the franchisor should ethically stop selling franchises, inform the franchisees of the situation, and work out a sale of the assets in the best interests of all stakeholders.  Franchisors who sell a few more franchises just to pay off some bills or salaries as they wind down the business are indeed unethical.

Being a franchisee in a larger system does have advantages if the franchisor goes bankrupt.  The likelihood is very high that some group will acquire the assets and enable the franchisees to continue operating.  Or, worst case, the franchisees themselves could come together and buy the franchisor’s assets out of bankruptcy.   Small bankrupt franchisors have such little book and IP value that there typically scant interest from investors.

How is a franchisee to know if the franchisor is near its end? The only sure way to know is to analyze at the franchisor’s financial statements such as it’s cash flow and balance sheet. If you don’t know how to do that, HIRE AN ATTORNEY OR ACCOUNTANT/FINANCIAL ANALYST TO GUIDE YOU!

Ontario attorney Michael Webster blogged on this franchisor bankruptcy issue last year. 

Rick Romell from the Sentinel Journal in Milwaukee called me to discuss the Meal Prep industry a few weeks ago.  He produced an informative article which can be read here.

Burger King complained to the National Advertising Division (NAD) of the Council of the Better Business Bureau regarding “Wendy’s, Always Fresh, Never Frozen” burger claim. Long story short, Wendy’s substantiated their assertion. Fresh is possible, Burger King.

Former Petland Inc. franchisees are suing the Chillicothe chain for fraud, alleging the stores are doomed from the start – and the company knows it….Melick estimates the average investment per franchisee totals up to $250,000, and the firms have been in contact with more than 40 franchisees.

The lead plaintiffs claim Petland fraudulently induced them to start a pet store when it knew, or should have known, the shops couldn’t succeed. A major allegation from franchisees, Melick said, is that pets supplied to the stores through Petland’s vendors were sick or dying.

Melick compared the franchisees’ problem to a restaurateur opening a new business and sending dozens of people to the hospital for food poisoning in its first weekend.

“For a large group of these franchisees, sick puppies is a problem when they open,” he said. “You just can never recover.”

source

You’ve probably heard that a couple of teenage female KFC employees took a bath in the big kitchen sink and took pictures.  I’m sure the franchisee was outraged to wake up and deal with this PR disaster (not to mention the parents of the kids).  A news crew was outside showing the pictures to customers who unanimously said “GROSS!”  Ditto…see image to the right.   The article mentioned that zee fired the employees. 

A group of Geeks on Call franchisees are suing their franchisor for essential competing against with an telephone/online service.   I’m sure the FDD permits this.source

All of the suits were filed by the counsel for a recently formed franchise association. The suits, all substantially identical, claim that Geeks on Call is responsible for a financial downturn allegedly experienced by the Plaintiffs. The suits point to the recent introduction of CalltheGeeks.com as a cause of diminished revenue.

CalltheGeeks.com, remote technical support, is not offered in areas currently served by franchises. Company records show that many of the franchisees who filed suit are, in fact, showing year to date revenue exceeding prior year revenue.  Current economic data indicates that the small business community is choosing to repair rather than replace computers, a trend that bodes well for our franchisees within the IT sector. Unfortunately, rather than working with the Company to seek out and capitalize on this opportunity, these franchisees chose to file suit.

Mark Baumgartner, General Counsel for Geeks On Call Holdings, Inc. stated “the allegations in the Complaint are without merit. Numerous Plaintiffs had previously been notified that they were in breach of their franchise agreements. We know that many of these Plaintiffs have been more focused on disparaging the Company than on building their business. Unfortunately, their disparagement harms the Company and the Geeks on Call franchise community as a whole.”

It’s always hard franchisees to imagine the nice salesman’s boss would ever dilute your sales by competing against you, but it happens all the time. If you see a clause permitting the franchisor to compete with you even though they won’t open a location within your territory, negotiate that point before signing!!   Insist on restrictions on how they sell in your territory, even when the zor claims their lawyers require that language.  Ask for a percentage of sales generated within your territory at the very least.I’m not surprised the franchisor chose to not own a single store. For a different perspective, here is an apparently happy franchisee. 

The franchisee that owns all 90 Waffle House restaurants in Central Florida has filed Chapter 11 bankruptcy largely to stop the parent company from kicking it out of the 1,600-store system. Northlake Foods Inc., which is controlled by W.B. Johnson, an Atlanta entrepreneur, filed for the bankruptcy court protection in September.  By then, Johnson and his partners in the franchisee group had been fighting one another in court for more than a year.

Waffle House Inc., the Norcross, Ga., company that owns the chain and the rest of the Florida Waffle Houses from Tallahassee across the Panhandle, argues that Northlake’s franchised stores would be profitable had it not been for the way Johnson and his partners split up their personal ownership of assets to settle their own differences.

source

A partner in the law firm DLA Phillips Fox in Australia cites Iowa as an example of what happens when a government over-regulates franchisors.

“We have seen the effects of over-regulation in various countries and notably also the US State of Iowa where the franchising sector shrunk substantially and franchisors deliberately avoid franchising into Iowa, resulting in lost contribution to GDP and job creation. Various attempts were even made to have the 1992 Iowa Franchise Act declared unconstitutional as it is considered to unlawfully interfere in contractual relationships,” Conaghan said.

Is Iowa overreaching?  You be the judge.  You can read more about the drama in Iowa franchise law over the past 15 years here.

Iowa (link to current regulations) has gone to great lengths to protect the franchisee.  Below are examples of the protections:

• restrictions on the franchisors ability to refuse a transfer,
• imposes financial liability on franchisors who permits encroachment that adversely impact a franchisee’s sales,
• restrictions on “good cause” for terminating or not renewing the franchise agreement,
• franchisors cannot require franchisees to sue in another state,
• good faith required in honoring the franchise agreement,
• independent sourcing must be permitted,
• very limited non-competes  after the franchise agreement is terminated, and
• franchise agreement must apply Iowa law

Some of the current political debate in the United States revolves around regulations, which really means imposing rules on private contracts.  Governments must balance regulations with encouraging businesses to operate in your region.  In Iowa, many franchisors simply choosing not to do business there.

Franchisees in Australia beware! A franchisor may withhold consent to transfer a franchise to a 3rd party if it goes against the interest of the franchisor’s known policies and future development plans. Read the case summary here.

When considering whether withholding consent to a transfer is reasonable, a court will assess the reasons advanced by the franchisor against the special nature of the relationship between the franchisor and its franchisees or potential franchisees.

A court will accept reliance on the franchisor’s policies and future franchise development plans. It is necessary to caution that in this instance the franchisor’s policies and plans were well documented and known. Accordingly, a franchisor attempting to rely on an overall system of policies and future development plans will have to ensure that those are documented and known to franchisees.

The ability of a potential buyer to comply with its obligations under the franchise agreement is only one of the factors a court will consider.

In this case, it was common ground that Zupps is a highly respected franchisee but this was outweighed by the franchisor’s broader policy considerations.

Franchisees intending to sell their franchises will be well advised to familiarise themselves with the franchisor’s policies and selection criteria.

Franchisors will also be well advised to document their policies, future plans and selection criteria and apply those objectively and in good faith when considering a franchisee request for consent to transfer of a franchise.

Whilst Justice Douglas clearly followed the likely approach to be adopted by Australian courts, it remains important to appreciate that the outcome will invariably depend upon the facts of each case.

Three Burger King franchisees in Florida found that every word counts in the franchise agreement.Burger King’s franchise agreements mandate operating hours “at a minimum of 7 a.m. to 11 p.m, seven days a week, 52 weeks a year, unless otherwise authorized or directed by BKC or unless prohibited by applicable law.”The franchisees argued that the language only gave Burger King the authority to exempt franchisees from those minimum hours, but not to mandate extended hours.  The franchisor argued the language clearly gives them the right to require additional hours.I agree with the franchisor that the language “unless otherwise…directred by BKC” clearly gives BKC the authority to change the hours of operations.

In the forum, a visitor proposed a question whether a buyer of an existing franchise can renegotiate the lease.  Paul Steinberg as always provides great guidance:

As previously noted, most landlords will not agree to a novation but most leases contain provisions relating to assumption.

Viz the personal guaranty, I have had leases which provide that upon assumption, the incoming tenant signs a personal guaranty whereupon the outgoing personal guarantor is released. Of course, this works only if the outgoing (selling) entity will be a shell after the sale, but if that is not the case then you can tweak the language to achieve the desired result.

If you are the seller and are unable to get a release from the guaranty, you should make sure to have appropriate language in your contract (or addenda thereto) to enable you to go after the purchaser and the natural person/guarantor which stands behind the purchaser. This will avoid the purchaser defaulting and leaving the original guarantor stuck. Of course, this will only work if the defaulter’s guarantor has assets…but judgments are good for many years (depends on state law). At very least, the new (purchaser) tenant will think twice about defaulting.

Inc. magazine tackled this question.

….If the landlord is reasonable,

Go to the landlord and say, ‘We really want to stay here, but we just can’t make it at the rent we’re paying. Here’s what we can afford as a base rent right now.’ And explain how you came up with the figure. Take him through the numbers, and show him why you’ll be able to survive with the lower base rent but you’ll go out of business if the rent remains at the current level. “At the same time, I would make it very clear that you have no problem paying more as your sales come back. One way to do that is by offering to give the landlord a percentage of your gross sales over a base amount that you agree upon.

….If the landlord is NOT reasonable,

Basically, you need to do a hardball negotiation. I’d go to him and say, ‘We can’t make it at the rent you’re charging us, and we’re going to be forced to close the store unless you give us some help.’ Then see what he says. It’s important to understand that you have a fair amount of leverage in this situation. Even if the landlord weren’t facing tenant problems already, it costs him money whenever somebody leaves, in terms of lost rent, broker’s fees to find another tenant, probably some demolition, and so on. My advice would be to hold out for a rent abatement of some sort. I think you have a good chance of getting one. For example, you can probably get the landlord to let you have a rent vacation, which would be preferable to rewriting — and extending — the lease. If you have problems with the landlord, you don’t want to lock yourself into a lease agreement for a period that’s any longer than necessary. You’re better off keeping your options open.

What metrics should you use to determine whether your rent is too high? Some experts recommend targeting any store with negative cash flow, or with occupancy costs higher than 10 percent of sales.