Gordon Drakes June 1 2021 Talking mumbo jumbo: legal risks and rewards of multi-unit, multi-brand franchising Fieldfisher | Franchising - United Kingdom Gordon Drakes Franchising IntroductionFranchisors' perspectiveMUMBOs' perspectiveCommentIntroductionAccording to the latest British Franchise Association-NatWest survey of the franchising sector in the United Kingdom, around one-third of franchisees now run more than one franchise business, compared with just one-quarter in 2013. The trend is not just towards multi-unit franchising, but also towards multi-unit and multi-brand franchising.Multi-unit, multi-brand operators (MUMBOs) are a long-established feature of more mature franchising markets, such as the United States. MUMBOs have often honed their skills by operating a single brand for a number of years, developing their understanding of the franchise model and evolving their managerial and operational infrastructure. They are professional franchisees, which possess the operational skills necessary to implement the franchisor's system rather than the skills more relevant to the franchisor, such as concept innovation, recruitment, training and management of franchisees. MUMBOs often start as family-run businesses, and by the time the second generation is ready to take over the reins, they are looking to expand the business both with their original franchise and by diversifying and taking on additional, non-competitive franchises.Diversification is a sensible decision, particularly in these uncertain times. By operating a number of different brands, MUMBOs can protect their overall investment from the adverse effects of economic downturns or changes in consumer demand by operating franchised brands in different sectors or sub-sectors. A number of established MUMBOs in the United Kingdom operate coffee shops, quick-service food outlets, gyms and hotels. Operating a diverse portfolio can enable a MUMBO to build up and sustain a real estate portfolio and supply chain and maintain a multi-skilled workforce.Another category of MUMBO – exemplified by the likes of SSP, Welcome Break and Sodexo – are specialists in closed or captive retail environments, such as airports, train stations, university campuses and sporting venues. The origins and structures of these types of MUMBO are different from the first category identified above, but the risks and rewards in partnering with either category of MUMBO are broadly the same.This article examines these risks and rewards from the perspective of both parties.Franchisors' perspective RewardsFor franchisors, the rewards include the following:MUMBOs provide franchisors with access to experienced operators, familiar with the needs of operating a franchise system and possessing an established infrastructure and financial resources. Their operational efficiencies and cost reductions due to shared facilities allow for greater profitability and more rapid expansion. Appointing MUMBOs can be particularly beneficial to foreign brands looking to establish themselves in the United Kingdom or domestic brands which hitherto have grown through corporate expansion but which now wish to accelerate their growth through franchising.The inclusion of MUMBOs reduces the number of individual franchisees in the network, requiring less training and support from the franchisor, without diminishing the rate of expansion. The increased professionalism of the MUMBO's management team (compared with a single-unit or single-brand operator) should provide comfort to the franchisor.MUMBOs may achieve critical mass by acquiring poor performing franchisees or corporately owned stores, which in turn should increase revenue and profitability.RisksFor franchisors, the risks include the following:A MUMBO's increased influence and bargaining power can disrupt the traditional franchisor/franchisee dynamic (at least domestically). For some brands, MUMBOs have become almost 'too big to fail', so conversations over breach must be approached differently. Franchisors should consider placing limits on unit growth and alternative remedies to termination, such as requiring divestment or withdrawing incentives.There is an increased risk that trade secrets or know-how will leak out of the system and be used to advance other similar businesses. Confidentiality provisions must be carefully considered.If the MUMBO's other operations create controversy or encounter financial difficulties, this could have adverse effects. Is there a sufficiently strong contractual 'firewall' between the MUMBO's operation of the franchisor's brands and other franchised operations?Conflicts of interest may exist between the different brands, particularly in terms of the allocation of resources between them in areas such as personnel, site selection and capital. The franchisor should consider requiring approval rights over any future brands that the MUMBO might operate. It should also consider imposing clear site requirements to ensure that the franchisor's brand is given access to the best locations, thereby preventing the MUMBO from favouring other brands on site selection. Finally, the franchisor should consider requiring that the MUMBO make an agreed amount of capital available throughout the term for investment in the brand to avoid capital being directed towards its other brands.Franchisors may be pressured to use a MUMBO's own supply chain or in-house procurement (eg, supply of products and designing stores), which may lead to compromises over brand standards.The requirement to make the shift from a unit franchise agreement to a multi-unit development structure needs careful thought and planning.Other considerationsOther aspects which must be recognised and reflected in the agreement include:a binding development schedule, which is usually tied to some form of territorial exclusivity;incentives for growth, such as reduced fees, costs and rebates;requirements for unit-level and group-level key performance indicators; andcross-default provisions which enable the franchisor to terminate all stores if one or a number of units are not operating in compliance with the agreement.Further, increasingly complex funding and investment arrangements can affect the typical contractual positions, which regulate personal guarantees, changes of control, transfers of interest and business sales. Some MUMBOs might even be contemplating floating on a public stock exchange (which has happened in the United States), in which case the impacts of a listing on the brand and the franchisor's own share price must be considered.Finally, any obligations requiring the franchisee to devote its full time and attention to the franchisor's brand must be relaxed, recognising that the franchisee's management will be operating additional franchise systems. Any non-compete clauses must be reviewed and, potentially, relaxed to ensure that only specific competing businesses are covered.MUMBOs' perspectiveRewardsFor MUMBOs, the rewards include the following:Operating multiple brands allows the franchisee to diversify its position and become less reliant on a single brand.Fixed costs and overheads can be spread or shared over multiple locations, increasing unit profitability. Aggregated sales should qualify for rebate and incentive purposes.There is a potential ability to move employees between different brands, gain insights into different operating systems and carry over or internalise operational innovations. There is more opportunity for career progression and savings in recruitment costs.It is possible to cross-promote brands.RisksThe obvious risks for MUMBOs include the following:Increased reliance on different layers of management means that a MUMBO owner cedes control and raises the risk of a rogue employee putting the business in breach. By creating a large workforce, a MUMBO may achieve the unintended effect of becoming less entrepreneurial. The difference between a corporately owned business and a franchised business is often said to be epitomised by what happens at closing time - the franchisee will stay open just that little bit later to serve the last customer, whereas the employee will be keener to pull down the blinds and go home. Do MUMBOs lose their competitive edge as they grow?An overzealous cross-default clause could mean that the business is occasionally faced with the threat of termination.It is important to ensure that there is adequate protection before investing the capital to grow. Has the MUMBO secured exclusive rights or other territorial protections? Is there sufficient growth opportunity in the allocated territory?As the portfolio grows, personal exposure to banks in the form of secured lending and franchisors in the form of personal guarantees can mean that individual shareholders take on a significant level of personal risk should the MUMBO find itself in financial difficulty. It is important to consider alternative forms of guarantees and caps on personal liability.CommentMulti-unit, multi-brand franchising is here to stay and is a sign of a maturing franchise market. However, franchisors should approach it strategically and be mindful of the risks of stumbling into some the situations outlined above, which can end up acting as a brake on growth and innovation. Creativity is a requisite for both sides as these types of relationship often challenge the one-sided norms of traditional unit franchising.For further information on this topic please contact Gordon Drakes at Fieldfisher LLP by telephone (+44 20 7861 4000) or email ([email protected]). The Fieldfisher LLP website can be accessed at www.fieldfisher.com.An earlier version of this article was first published by Global Franchise Magazine.