The ascendancy of hotel franchise agreements.
Branded hotel franchise agreements continue their rise to dominance in the hotel landscape. Hotel management agreements are not dead, but the advantages of having a hotel operator independent of the brand have been widely recognized and continue to propel the franchise model. (The considerations of branding and using branded (versus independent) management are discussed at length in "When should you choose a brand for your hotel? And when should the brand manage your hotel?")
What's really negotiable in a franchise agreement?
The most common question we hear from clients is, "What's really negotiable in a franchise agreement?"
Franchisees are told by the brand that the franchise agreements are not negotiable, but then they hear that someone else has been able to negotiate at least one or two contract terms. Potential franchisees don't want to waste time chasing something they cannot get, but the contracts seem so one-sided, and they want to get as much substantive relief as they can.
Based on our experience with hundreds of hotel franchise agreements, JMBM's Global Hospitality Group® knows that there is plenty of wiggle room to get some important concessions if you know what to go for and don't waste your effort where it won't do any good.
One of the biggest mistakes owners make when trying to negotiate a franchise
One of the biggest mistakes we see is owners trying to negotiate the franchise terms themselves. Their lack of experience shows that they are amateurs, and the brands quickly realize that they don't have to give much by way of concessions.
While we don't recommend negotiating your franchise agreement without an experienced advisor, hotel lawyer Bob Braun has laid out a few areas where we have been able to help owners improve their contract terms. Depending upon your circumstances, there may be significant other opportunities.
Most branded hotel properties are operated under franchise agreements which are long documents with lots of fine print. They are usually presented to owners as "non-negotiable." This brand position is justified on the basis of need for uniformity in agreements and insuring that hotel guests will have a consistency of amenities, operations and experience in all hotels bearing the same flag.
However, hotel owners seeking a franchise also have legitimate interests, and there needs to be some recognition of these needs and the unique circumstances of every situation. In fact, our experience shows that, within certain limits, some provisions of these franchise agreements can be negotiated to address franchisee concerns. Franchise agreements are not nearly as negotiable as hotel management agreements, so owners are well advised to understand what can and cannot be negotiated in order to realize the greatest value from their relationship with the brand.
We have negotiated hundreds of franchise agreements with every major traditional brand (and most of the others), and based on our experience, we believe there are key franchise agreement terms that hotel owners should normally be able to accomplish.
Here are 8 of the most common franchise terms we are seeing negotiated today:
- Franchise and Royalty Fees. While it's unlikely that franchise fees will be reduced for the entire term of the agreement, a "ramp up" in fees over the initial years of the agreement, particularly for a newly built hotel, can often be achieved. While other chain fees are more difficult to negotiate, it can be possible to get some temporary relief there as well.
- Area of Protection or Non-Competition. Hotel owners are properly concerned about the brand opening a competing hotel within their property's market area. If it's not offered, a franchisee should ask during the negotiations for a geographic area of protection or non-competition. The length and breadth of the restriction varies, but some protection is usually granted.
- Ownership Transfer. Most franchise agreements are still based on a simple ownership model, contemplating a single owner (or investment group) of a single hotel. Our experience is that more complicated owners (including REITs, private equity groups, real estate funds and other institutional investors) are increasingly focused on hotel investments. As a result, the transfer provisions should consider the structure of the owner and flexibility for transfers to certain related parties. In that regard, while a sale of a hotel often precipitates a property improvement plan or PIP, the owners should not trigger a new franchise agreement negotiation, set of franchise application fees and PIP when the transfer is to a related corporate entity or to another family member or trust set up for estate planning purposes.
- Independent Management and Changes in Management. The essence of franchise structure is providing the power of a brand with the greater flexibility and responsiveness of an independent operator (i.e. an operator unrelated to the brand). A good independent operator can provide an owner with a valuable buffer to the brand's demands for operating and capital expenditures, implementation of new and expensive brand standards, property improvement plans, and certain brand programs that may not make sense for a given property. While brands are, understandably, concerned that an operator must have the experience to run the property, the management company should be the owner's choice, and should have primary loyalty to the owner, not the brand. Thus, it's important to prevent a franchisor from having veto power over change in management of the hotel.
- Liquidated Damages. Liquidated damage provisions in the franchise agreement give the franchisor the ability to collect damages on the early termination of the franchise agreement. They can be a key inhibitor to the owner's ability to maximize the value of the property on sale, because liquidated damages have ballooned in recent years to as much as five times the average combined franchise fees and reimbursements paid to the franchisor. There are usually ways to both reduce the amount of the damages as well as restrict the potential transactions that might trigger payment.
- Capital Investments. Franchise agreements usually give the brands the ability to require substantial additional capital investments by owners to meet new physical brand requirements. There are a number of ways to reduce an owner's exposure, including restricting time periods and clarifying the types of capital improvements that can be required. This is particularly the case for a newly built property or an acquired property that may have recently undergone renovation.
- Personal Guarantees. Most franchisors require guarantees. Owners should seek to eliminate, or at least restrict the scope, of guarantees. As more and more owners are institutional, this requirement is less and less meaningful.
- Key Money. For the last several years, many brands have been willing to provide key money as a means of securing franchise agreements. While owners are typically excited about the prospect of getting additional funds, they should remember two things: First, key money is typically only paid after the hotel opens; it doesn't provide funds for construction. Second, and more importantly, key money is probably the most expensive money an owner will get; in return for key money, brands typically will be even less willing to negotiate important franchise agreement provisions.
While there are limited areas that an owner can expect to successfully negotiate with a brand in a franchise agreement, changes in these limited areas can make a big difference in the value of the brand to the owner.