Purchasing International Multiple-Unit Development Rights

Over the past 20 years or so, the world has witnessed both the incredible growth of global brands, as well as an increase in the sophistication of franchise structures adopted to pursue expansion. Many would comment that with the advent of global brands, gone are the days of the "Mom and Pop" operation.

Many U.S. franchisors would not today even consider expansion into a new country or market unless they were able to lever off of the abilities, local market knowledge and sophistication of larger candidates.

Of course, each master franchising, area-development agreement and area-representative arrangement is different in its own way, but for the sake of this article the common feature is that each permits a franchisor to appoint a local party to assume some or all of the usual responsibilities of a franchisor in the local market together with a plan to open a multiple number of units. So, throughout this article "master franchisee" will be used to refer to any type of person who acquires the rights to multiple-unit franchises in a given market, without referring to each of the three listed arrangements.

With the increased use of multiple-unit growth strategies comes a corresponding increase in the sophistication of master franchisee candidates. This article thus attempts to provide franchisors with guidance on what their potential candidates might be looking for in a franchise system to bring to their market.

The Business of Being Franchised

What will first attract any potential candidate is the uniqueness and quality of the underlying business that is being franchised. If the business does not "wow" the candidate as a matter of first impression, then it is unlikely that the candidate will look past that first casual glance. But deeper than that, most candidates are looking for that combination of factors that provides a product or service that is either entirely new to that market, or being delivered in an entirely unique way, or in connection with an inspiring brand.

Related to that is whether the master-franchisee candidate can understand the system, and believe it can be translated to the local market. Some markets are, of course, very similar to the United States, in terms of language, culture and even the retail marketplace. Others are not similar, but still inviting of American brands and concepts. Every new market will be different in some way, and it is best if both the franchisor and master-franchisee candidate recognize that possibility and address it early on in their considerations and business planning. They will try to identify what makes the business successful in the home market, and whether that similarly applies in the target market. Done right, this often requires extensive market research to determine if the business system, product or service will have a similar or different reception in target markets. In the end, they both should be satisfied that the franchisor's business can be both competitive and sustained in the new market.

The Franchisor and the Brand

Every franchise involves, at the most fundamental level, the license of a system of knowledge or know-how, together with use of a brand, including a trademark.

The master-franchisee candidate will need to consider how well known the brand and trademark are in the target market at the time the opportunity is being considered, as well as the growth potential.

The growth of the brand's recognition will surely be affected by the work to be performed by the master franchisee in the local market. But in addition, the master franchisee will be looking at the franchisor's then current and future commitment to grow the brand outside of the franchisor's home market. If international expansion by the franchisor is an established long-term strategy, the master-franchisee candidate will have one reaction. If this intended international expansion is a first for the franchisor, and an experiment, a different reaction should be expected. It all speaks to the franchisor's level of commitment outside the home market.

Most sophisticated master-franchisee candidates should be making an assessment of both the franchisor, and the franchisor's senior management team. In particular, do they have a commitment to and a track record in international expansion through multi-unit development?

On a technical level, the master franchisee will want to know and see that the franchisor's key intellectual property, usually one or more trademarks, can be protected in the new market by way of registration. Trademarks are, of course, protected generally on a country-by-country basis. Many franchisors have embarked on an international expansion strategy, only to find that their brand name has been taken by a third party in the target market. Sometimes that is a coincidence, especially possible with brand names that are generic or not that unique. But other times it is as a result of the brand's existing popularity arriving in the target market before the franchisor does. Most knowledgeable franchise counsel would advise franchisors to proceed to register their trademarks in the target markets well in advance of any serious thought being given to expanding into a market. Of course, with so many countries in the world, and therefore so many possible expansion targets, the strategy is often affected by the reality of cost. In any event, some obvious growth markets can usually be identified and registration should be pursued.

An important brand-related issue is the marketing of the system, and advertising of products and services. Many local candidates will look to the franchisor on some level for assistance with their marketing and advertising. At one end of the spectrum, some franchisors take responsibility for a global advertising strategy. At the other end, the master franchisee is responsible for preparation of all materials to be used in the market, and for devising on its own the strategy and rollout of an advertising program. Most franchisors provide something in between.

Supply

Some franchise systems are built around the delivery of a product or service that involves the use of unique and proprietary products, services and equipment. A master-franchisee candidate should investigate whether anything of a proprietary nature is part of the system, and then if it can be made readily obtained in the new market. In certain instances, for example, the importation of certain types of ingredients is regulated or even prohibited. Both the franchisor and master franchisee should not assume that any such items can freely cross borders, even in this era of ever-growing free trade.

Even in regard to items that are not proprietary to the franchisor, the master franchisee needs to consider whether the necessary inventory, ingredients or equipment will be readily available, either from the franchisor or local sources, on a regular, timely and cost effective basis.

If certain items are best obtained from local sources, whose job will it be to find these local sources and arrange for supply? Will the master franchisee need to set up its own manufacturing facility, arrange for transportation, and even modify recipes or other unique system features for the local market?

Lastly, it is no secret that many franchisors receive a substantial benefit from volume rebates, payments or discounts from suppliers. Who will obtain the benefit of these when the master franchisee takes over the supply responsibilities of a franchisor in the local market?

The System

As stated earlier, a franchise is the license of a brand and a system, which involves the use of know-how and certain methodologies in operating a business.

The sophisticated master-franchisee candidate is usually expected to pay significant up-front and ongoing tees for multiple unit rights. In return, the candidate is often looking to only acquire rights to, and to invest substantial sums in, a system that is sufficiently established and documented. This increases the likelihood of success, and usually means that the master franchisee needs to do less to establish the system in the new market. Many start-up franchise systems would have trouble meeting what the local candidates should be looking for as their system may be a work in progress. This can affect the price to be paid, but also the entire viability of the system in the market.

To investigate this area, the master franchisee should be looking at the quality of the franchisor's training systems and materials, operations and other manuals, information technology (by which system knowledge is transferred), and other system features. In countries where English is not the first language, issues and costs surrounding initial and ongoing translation of materials will need to be considered.

Very often a franchise system needs to be customized to the needs of the local market, such as the changes to food recipes brought about to suit local tastes. An example of this is when the Popeye's Chicken and Biscuits chain needed to provide spicier food products to meet the demands of certain Asian markets. Thus, the local master franchisee will want to see how receptive the franchisor is to understanding and accepting the need for permitting changes. Occasionally a franchisor will not readily accept the idea of any changes to its system, on the basis that it does not want to tinker with a system that works well in the home market. But often this reflects on the fact that the franchisor simply does not want to understand that a system can and sometimes must be changed to reflect local needs without being ruined.

The Financial Model

Of course, none of the first four areas covered will matter unless the master franchisee sees and believes that there is a financial model to the venture that works. Every multiple-unit franchisee candidate should investigate thoroughly the expected costs in establishing and operating the business, the infrastructure that will be required in the new market (including corporate units), expected sales, costs and margins, the potential and expected return on investment, the economics of unit operation and an exit strategy.

A franchisor that is used to offering single-unit franchises in its home market may also be new to the analysis where a multiple-unit growth model is to be adopted. In a true master franchise arrangement, for instance, there will be a sharing of sub-franchisee generated fees and royalties, and this can be the subject of significant negotiation based on the obligations that the franchisor and master franchisee will assume in the relationship. Then, in the international context, there are issues that are wholly unique, such as currency and exchange issues, as well as withholding tax obligations.

Almost every multiple-unit agreement is different, and very often this is based on the market potential for the target market. Both sides will need to have a common vision of the market potential. In addition, they will, of course, need to come to terms on a form of agreement. The legal terms, and in particular those of a business nature, will have a significant impact on the master franchisee's analysis. For instance, length of term, ability to renew, the proposed development schedule, and the application of local franchise laws are all issues that are important. They also are significant business terms that affect the overall analysis of the planned venture.

Larry Weinberg heads the franchise law practice group at the Toronto law firm of Cassels Brock & Blackwell LLP. He can be reached at 416-860-2987 or lweinberg@casselsbrock.com.