Q2 2014

Franchising is a proven route to the successful international cooperation between F&B businesses such as restaurants and coffee shops and local real estate investors such as owners of hotels and shopping centres.

Global brands such as Jamie’s Italian or Costa Coffee have used franchise and management agreements to successfully grow in both traditional economies and emerging markets.

A tasty way of doing business

Franchising is an established way of expanding a business internationally. Annually it accounts for turnover of USD$300 billion in Europe, USD$850 billion in America and USD$130 billion in Australia. Together with management agreements, it is the preferred form of international expansion for many successful restaurant and leisure brands.

The success of F&B franchising in the USA has demonstrated that international franchising works for the sector.

Benefits for Franchisor and Franchisee

Franchising works because it offers real benefits, not only to the brand owner but also to its local partner. It offers a number of clear advantages to hotel owners looking to improve their F&B offering and it is at the same time attractive to the restaurant owner.

For the Restaurateur or celebrity chef, it removes the need to invest capital and other substantial resources in creating a new restaurant abroad.

A franchise strategy will see the local partner place the restaurant in his existing property and make the bulk of the investment into fit out and decoration whilst benefiting from the know-how, good name and quality assurance program of the company acting as franchisor.

Franchising enables restaurant companies to access the required capital and grow the business internationally by partnering with high quality local investors such as hotel owners.

These investors are highly sophisticated and have a great incentive to make the project a success in their local market. They also have a strong understanding of the local F&B market.

So franchising enables the hotel owner to have access to the blueprint of a strong proven concept with a known reputation.

Few local owners have the resource and time to research their own specialist know how to put together an innovative and successful F&B concept for the local market that would generate attractive levels of income without the trial and error that goes into building a successful new F&B business.

Adding spice to the mix

In order to take advantage of the potential that franchising offers, one needs to plan the approach carefully.

It is important to be discerning as some would be franchisors will not have the structure in place to support a local opening.

A franchise which has been well planned, structured and executed can have a substantial positive impact on a business but one that has been done as a response to an opportunistic approach can be catastrophic.

Key preparatory steps include due diligence on the partner to ensure that there is a good match between franchisor and franchisee as regards to business philosophy, approach to operational standards and cooperation.

The Franchisor should be open to appropriate local adjustments such as modification of menu items, alcohol policies and opening hours and the franchisee should be prepared to accept that the franchise system must be followed correctly.

Franchisees that refuse to invest in training, regular renovations and brand upgrades are typically less successful in the medium term than others.

The reality is that on those relatively rare occasions where international franchises fail, this is usually due to lack of due diligence regarding the right partner.

Expert advice

Before entering into an arrangement with a restaurant partner you need to ensure the F&B brand is fully protected by way of trademark registrations in the target market and that any franchise fees or royalties are structured tax efficiently.

That requires some expert professional advice before negotiations start. There are countries where the registration of a trademark can take between two and four years. This can result in promising negotiations aborting because the trademark situation is unclear until registration has been achieved. Early planning is therefore key.

It is important to get good support from specialist franchise lawyers when negotiating the franchise agreement. This begins at the LOI stage.

Whilst the LOI is non-binding, it can be extremely difficult to negotiate against a signed LOI. It is a common mistake not to take legal advice on the LOI and this can result in significant difficulty and additional legal fees at the contractual stage.

Key provisions to focus on as regards the legal agreement would be:

  • the duration of the franchise agreement 
  • investment in brand standard updates, and 
  • provisions regarding step-in.

The duration should be long enough to allow the fra nchisee a return on investment and there should be a renewal right.

Brand standard updates are necessary but there should be limits on the frequency and costs.

Step-in rights have become an area of controversy. Many Franchisors require the right to take over the business of the franchisee on termination at book value. Whilst franchisors often have no intention of exercising this right, there has been a recent trend to impose very onerous step-in clauses on franchisees. Such clauses are best resisted.

This piece also appeared in Perspective: The people and ideas shaping hospitality in the Middle East