How business property is held in franchise relationships varies. Here property expert, Andrew Worley examines the advantages and disadvantages to a Franchisor, of the three most common approaches.
1.The Franchisor (or a subsidiary of the Franchisor) takes a Head Lease or purchases the freehold and grants lease/sub-lease to the Franchisee
- You retain control of the location, so that in the event of a poor performance or breach you can remove and replace the Franchisee or take over operation yourself.
- You will usually have a greater financial covenant strength than a new Franchisee, creating the potential for a wider choice of options and often the ability to avoid the payment of rent deposits.
- Landlords of shopping malls and complexes will often be more willing to lease properties to an established brand name as opposed to a 'start-up' franchisee.
- You will be ultimately liable to the Landlord for any breaches of the lease covenants (including dilapidations) in the event that the franchisee fails to properly maintain the property and observe lease repair obligations.
- You will have an additional administrative burden and cost in managing the property, ensuring the franchisee is complying with the lease covenants, collecting rent and service charge etc. You are also exposed in the event that the franchisee is unable to pay its rent.
- Possible stamp duty land tax issues on freehold purchases and long leases.
2.The Franchisee or their trading company takes a Lease
- You are not financially liable to the Landlord for any breaches of the lease covenants, dis-repair, non-payment of rent etc, which reduces your potential financial burden in respect of the location.
- Avoids additional administrative burden and cost of any lease management issues.
- Unless your franchisees have a trading history and sufficient covenant strength you may find that there are fewer properties available in desirable locations: this could impact significantly on the success of the franchise and the growth of the franchise brand nationally.
- You lose control of the location in the event that the franchisee performs poorly and the lease is forfeited by the Landlord.
- Step in rights are more difficult to enforce.
Some of these disadvantages can be resolved by the third option, but they also create additional operational considerations.
3.The Franchisee or their trading company takes a Lease but this contains an option for the Franchisee to enter into a new lease or for the Lease to be assigned without Landlord's consent
- This overcomes the main disadvantage of option 2, in that you retain an element of control.
- This has an advantage over Option 1 in that you do not have the additional administrative burden and cost of managing the property.
- Avoids immediate and unnecessary stamp duty charges (where applicable).
- Unless the franchisor and franchise brand is well established, the Landlord may seek some form of guarantee from the franchisor, particularly if the franchisee is a new company with little or no trading history. This has the result of the franchisor being financially liable if the franchisee breaches the Lease.
This list isn't exhaustive, but it covers 3 key ways to hold property within a network. Above all property options should be revisited as the franchise network grows, as the best option available at the outset is likely to change as the network expands