Are you considering transitioning your franchise network to a company owned structure? If so, you may be about to embark on a complicated and lengthy process. It is essential to understand your legal obligations and rights throughout the process to ensure that the transition is as smooth as possible. In this article, we will first explain why moving to a company owned model may be a good idea for your business before outlining the transition process.

Why Is a Company Owned Model A Good Idea?

Profit

If your business is highly profitable, one reason to revert to a company owned model is that you get to keep all of this profit.

In a franchise model, you typically take 6% of each franchisee’s gross revenue as franchisee fees, and 1-2% as contributions to the marketing fund. This means that you may not make much money until you grow to a franchise of more than about ten stores. Running a franchise network with fewer stores than this can be a lot of work without much reward.

If you own all aspects of the business, all the profit is yours. This also means that all the losses will be as well.

Staffing Capability

Changing your business model may be a good idea if you trust your staff and their ability to run more outlets. Many businesses form franchises because they are unable to expand outside a small geographic region. However, if you can grow your staff without sacrificing the quality of your workers or management, you may be able to move to a company owned model.

Better Control of The Business

The franchise model can make it hard to have direct control of your business. Regaining company ownership of your business and assets can give you that control. As long as you meet your other financial and legal obligations, important business decisions are yours to make under the company owned model. These decisions might include:

  • selling sites or expanding your business;
  • taking the business in a different direction;
  • merging with another business; or
  • streamlining your product and services.

If you expect your business to face significant future changes, changing your business model might prepare you to meet those changes. A company owned model might mean that you face fewer obstacles from individual franchise agreements.

More Flexible Corporate Strategy and Processes

A company owned business model also gives you greater flexibility in day-to-day management. Maintaining a franchise network means that you must spend time and money training new franchisees and updating your operations manual.

As individual franchisees run their franchises separately, small but necessary business changes can be challenging and time-consuming to make. Making these changes may cause tension in your relationships with your franchisees. Some changes may even require approval by a majority of the franchisees, and disagreements between your franchisees can prevent these changes from happening.

In a company owned structure, management staff all work under your direction. Your decisions should flow through the business better and faster.

Clearer Consequences of Failing Businesses

You may think that if a franchisee fails, only the franchisee’s business suffers. To an extent, this is true. On the other hand, the failure of a company owned site can have a significant impact on the entire business.

However, as the franchisor, you can still be held responsible for the failure of a franchise in your franchise network. Franchisees sometimes sue their franchisor for misleading and deceptive conduct. Individuals, such as company directors or your employees, might be personally liable as well as the company.

This means that the franchise model does not give you complete protection from franchisees’ losses. Under a company structure, however, the consequences of business success and failure are very clear.

Easier to Sell

Generally, it is easier to sell a company owned business than a franchised business. Investors often see franchise model businesses as a more complicated purchase than company owned businesses. However, this is not always the case.

Better Compliance With Laws

Generally, individual franchisees are responsible for their franchise businesses. This responsibility includes acting as an employer towards their workers, as you do not directly employ the staff as the franchisor.

When franchisees do not pay their staff correct wages, however, the law can punish both the franchisee and franchisor. There have been many cases of individual franchisees facing legal proceedings and fines due to this issue. In some cases, franchisors have also paid hundreds of millions of dollars in compensation to franchisee employees where there have been major breaches of employment obligations.

As the franchisor, you may face punishment for things that your franchisees do wrong. Identifying and correcting wrongdoing early is much easier in a company owned structure.

An increase to the penalty for breaching the Franchising Code of Conduct was recently recommended to parliament. This means that this risk is now even more important to consider.

How Do I Transition My Franchise to a Company Owned Structure?

Assemble Your Team

You will require senior members of the business to handle the commercial negotiations and legal specialists to advise you on the legal aspects of the transition.

You might also want to consult with experts such as:

  • communication specialists;
  • local franchisee support bodies;
  • in-house legal counsel;
  • external financial analysts; and
  • strategy or technology consultants.

Building a dedicated team will make your business more responsive and flexible during the transition process. You might have to be very patient when transitioning to a company owned structure. Waiting for each franchise agreement to expire before taking over and negotiating buy backs can take years, rather than months, to fully implement.

Build Your Resources

You may need to compensate franchisees for the buy back of their franchises. At the very least, if you plan to take over franchises at the end of each term, you will need to budget for buying back their equipment and fit outs.

This process will require money and patience. If you do not wish to wait, you will need more money to speed up the process.

Plan Your Approach and Ideal Outcome

The size of your franchise will determine how complex the transition process is. Generally, the transition to a company owned model is only possible in smaller networks where negotiations to take over each franchise can still practically take place. A transition may be achievable in a network of five or six franchisees, but a franchise network composed of hundreds of franchisees is probably too large.

End Franchisee Relationships Early

There are two ways to end franchisee relationships early. You can:

  1. terminate franchisees if they breach their franchise agreements; or
  2. negotiate with franchisees to mutually and voluntarily terminate the franchise relationship.

You may be tempted to ‘clean up’ your franchise network by claiming that multiple franchisees have breached their agreements. However, this course of action is not advisable. Your underlying motives will quickly become clear to the network, and then even genuine breaches may be viewed as motivated by the desire to terminate franchisees.

Instead, you should negotiate with some franchisees to voluntarily terminate their franchise relationships. You could allow the ex-franchisee to re-brand, and any restraint of trade could be waived to encourage them to leave. Even though you will lose a site by doing so, this may be preferable to waiting years (or even decades in some cases) for the franchise agreement to come to an end.

Assess Your Buy Back Options

Your buy back options will likely depend on whether there is a buy back clause in your franchise agreementsFranchise agreements:

  • with buy back clauses allow you to buy back at a set price or multiple of earnings. A multiple of earnings is calculated by multiplying the business’ annual revenue by a set amount. You must have the financial and practical capability to trigger the buy backs in these agreements; and
  • without buy back clauses must be sold or terminated before you can act. There should be a first right of refusal in the agreement which allows you to buy the business when it comes on the market for sale. Alternatively, you should be able to buy back the assets of the business when the franchise agreement comes to an end. If the franchise agreement contains an option to renew the franchise term, it might be a long time before you can become a fully company owned network.

Balance Confidentiality With Informing Relevant Stakeholders

You should handle the transition process carefully. You will need to maintain confidentiality, but also provide sufficient information to relevant people and organisations.

For example, your internal discussions will involve confidential conversations with legal or other specialists. From those discussions, you may decide what, how and when to communicate to your franchisees directly. You may wish to communicate through a:

  • confidential meeting;
  • formal letter; or
  • phone call.

If franchisees find out about your plans earlier than planned, they may attempt to sell their franchises back to you at an unrealistic cost. This can complicate the buy back process. You should conduct individual, strictly confidential negotiations with key franchisees at the first opportunity.

The information will become public so it is important to be clear with franchisees internally on when you plan to announce the transition. This will help you to maintain control over the situation.

Moving away from a franchise model may attract close monitoring by the Australian Competition and Consumer Commission (ACCC). The Franchising Code of Conduct requires your procedures to be fair. Seek advice from your legal team on how to communicate appropriately with the industry watchdog.

Manage the Transition Process

The internal review you conducted in earlier stages should have helped to identify a strategy for transitioning your franchisees. Complications to this process might include differences between:

  • agreement end dates;
  • agreement structures; and
  • the wishes of franchisees.

It is essential to plan for all potential outcomes of the transition process. For example, if:

  • any franchise agreements need to be extended, varied or terminated, make sure you have the correct legal documents required and store these safely;
  • you are negotiating with franchisees for a commercial outcome, ensure the ongoing process is clear and complies with the franchise agreement and relevant laws. Any offers you make should be appropriately valued in the circumstances; and
  • you are employing any franchisees, finalise the terms of their employment and any other details before the transition occurs.

Preparation will allow you to pre-empt and deal with any complications. However, it is still important to create and follow effective dispute resolution procedures.

Run Your Company Owned Business

Transitioning your business may take a few months or even years, but you should still prepare to run your business in its new form.

You may need to:

  • hire new management personnel;
  • implement new company-wide procedures; and
  • invest resources into retraining staff, especially if they are former franchisees.

You may want to arrange for a separate team to work on this later stage in collaboration with the transition team to ensure a smooth start.

Key Takeaways

Franchising is still a popular option for many businesses. However, changing to a company owned model might benefit your business by providing:

  • increased control over your business direction;
  • better flexibility in making strategic changes to your business;
  • improved damage control for business losses; and
  • more effective compliance with regulations, reducing your risk of liability and reputational damage.

Transitioning your franchised business requires patience and collaboration, but it can be done. The most important steps to take are to:

  • assemble your transition team;
  • build your resources;
  • plan your approach;
  • if possible, end franchisee relationships early;
  • assess your buy back options;
  • manage public information;
  • prepare for complications; and
  • prepare to run your company owned business.

If you would like to speak to our team about transitioning your franchise to a company owned structure, you can contact LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.

About LegalVision: LegalVision is a tech-driven, full-service commercial law firm that uses technology to deliver a faster, better quality and more cost-effective client experience.
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