Asian fusion quick service restaurant (QSR) Wrapchic fell into administration in 2019 after shareholders refused to lend further funds as it continued to make losses.
Wrapchic is one of a number of recent casualties in the UK food and beverage sector. However, unlike some of the more high-profile casual dining brands which have suffered a similar fate, Wrapchic was almost entirely franchised and operated in the generally more resilient QSR segment of the sector. So why did it fail and what lessons can franchisors learn?
While there may have been innate issues with the Wrapchic concept and wider macroeconomic factors which contributed to its demise, a recent statement by the administrators revealed two distinct issues:
- Wrapchic held a number of leases and sublet to franchisees. A number of franchisees defaulted and ceased to trade, meaning that Wrapchic was exposed to the full ongoing liability under the leases for poorly selected sites.
- Wrapchic operated a central production unit, which generated high overhead costs compared with the margins that the company was making.
One of the key benefits of franchising is that the growth of the network is funded by the franchisee's investment in human and capital resources, and franchisees consequently take the risk associated with that. By entering into headleases with landlords and subleasing to franchisees, Wrapchic was shifting a significant risk back onto itself.
Real estate strategy
It is not uncommon for franchisors to take on headleases, particularly where a landlord may require a stronger covenant or the franchisor wishes to exert more control. However, franchisors should adopt a flexible approach wherever possible to allow them to hedge their risks more effectively. For example, franchisors should consider the following guidance:
- Franchisors should take headleases only for key sites where they are confident that they can step in and operate or sell on the lease in the event that the franchisee is unsuccessful. Lease terms should be kept as flexible as possible – it may be worth paying a little more in rent to secure regular break options.
- Subfranchisees should be allowed to enter into leases directly with landlords, but consider putting in place a real estate procurement service (in-house or outsourced to property agents) which ensures that there is a robust site selection criteria and systemised legal process.
- As a halfway house between taking control of the lease and not having any involvement in the landlord-tenant relationship, franchisors could consider agreeing a step-in deed with landlords prior to the franchisee entering into the lease. This would give the franchisor the option (but not the obligation) to take over the site on termination.
- Franchisors should consider entering into a joint tenancy with the franchisee. The main advantage of this approach is that it will overcome the strength of covenant issue and it should be simpler to swap franchisees into the relationship than a headlease or underlease arrangement. The main disadvantage of this approach is that the franchisor will still have a direct liability to the landlord which the franchises will look to pass onto the franchisee (usually through a separate deed of agreement and power of attorney between the franchisee and franchisor).
- Depending on the nature of the business and the level of its maturity, offering a central production service may not be a suitable strategy. Franchisors should look at their supply chain in terms of core and non-core products or equipment and then consider whether they or a nominated third-party supplier are best placed to provide core products and equipment. Franchise agreements are long-term contracts and should contain in-built flexibility to ensure that a franchisor can exert more or less direct control over the supply chain, depending on the lifecycle of the business. It would appear in the case of Wrapchic that it was attempting to operate a supply chain model which did not fit with the relatively small size of the network.
- Walk before running. This is easy to say with the benefit of hindsight, but Wrapchic's initial fast growth in the United Kingdom and internationally suggests that the concept was not sufficiently developed before it was franchised or that the business was overstretched or distracted by international expansion when its focus should have been on its domestic market.
- Play the long game. Businesses can be too eager to embrace the franchise model or respond to a flattering enquiry from overseas (and both of these reactions are entirely understandable). However, a common theme among successful franchisors is that they invest in expert (legal and non-legal) advice early on, develop a clear strategy underpinned by robust legal agreements and crucially keep investing in their own system and regularly reviewing their strategy and associated agreements.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.