Key legal considerations to help you grow to multiple franchise units
There are many important things you should consider as you explore franchising as a path to business ownership. The franchise business model allows you to be a small business owner in your local community, with the support and system of a strong brand behind you.
Beyond deciding what type of franchise you’d like to own, whether it’s a brick and mortar, home-based, or mobile business, and in what category, you should also have a strong sense of the specific franchise model you’d like to explore before you make a final investment decision.
What are my franchising options?
Single-unit franchising: Many franchisees choose to start with single-unit franchising, which means they purchase a single franchise location. In this case, a franchisee signs a franchise agreement for that location, usually assigned to a specific area, or territory.
Multi-unit franchising: A single-unit franchisee can then choose to purchase an additional franchise unit to become a multi-unit owner. They can purchase another unit in the same franchise system, or they can purchase a unit in a different system, which is a newer trend in franchising. There’s even a term for this: MUMBO (multi-unit multi-brand operators).
Area development: You can, however, also choose to purchase more than one franchise unit right from the get-go. In an area development agreement, a franchisee signs on to develop multiple franchise units within the same territory. This method is often used as a way for franchise systems to expand into new territories, as it allows them to rely on the franchisee’s familiarity with the territory and local connections.
Ready to learn more about multi-unit franchising? Let’s explore some of the legal considerations, with insights from Allan Dick, Partner, Litigation Group with Sotos LLP. Dick has extensive experience with multi-unit franchising, and outlines what you need to know as you explore expansion to more than one franchise location.
What are the benefits of owning multiple franchise units?
Dick notes that many operational efficiencies come with operating multiple units within the same brand, including reducing management expenses for each unit, having access to additional trained employees as you need them, and reducing training expenses as you add more units. You also have the benefit of investing in a brand you already know and can increase your chances of success by choosing additional locations based on your experience in the system.
Other major advantages include “increasing your influence in the franchise system when adding units in the same system, and potentially increasing negotiating power when dealing with the franchisor and suppliers,” explains Dick. “Franchisees may also be able to negotiate reduced initial fees when buying multiple units.”
When it comes to adding units from different brands, Dick says this provides diversification, which helps to reduce the risks associated with operating a franchise. When you invest in multiple brands, you also have the advantage of learning best practices from different systems, and can apply this knowledge across all of your units.
Finally, adding more units “increases the value of the entire enterprise, including for purposes of obtaining loans and investment,” notes Dick.
What are the challenges I may face as a multi-unit franchisee?
While there are clearly many advantages to expanding to multiple units, there can also be drawbacks. For example, while the franchise head office will provide extensive training before you open your initial location, they often won’t include multi-unit franchising as part of the training curriculum. This means you’ll need to determine your own best path forward and develop your own leadership style.
While you can be very hands-on with your original franchise location, it’s impossible to give each location that same amount of attention after expansion. As it’s impossible to be in all locations at once, you’ll need to learn to divide your time between locations and to rely on your managers, instead of just on yourself.
Dick also notes that there’s a general requirement from franchisors with additional franchise agreements in the same system that requires the franchisee to accept cross-default provisions. “A franchisee is at risk of losing all units if only one fails,” explains Dick, noting that this provision should be negotiated by a franchisee. “There are genuine reasons why franchisors include cross-default provisions, but often one location will fail for reasons that are not reflective of the operator’s abilities, financial situation, or attitude to the system. A franchisee should not be dependent on the good graces of the franchisor not to act on a cross-default provision in these circumstances.”
When should I consider whether I want to own multiple units?
Dick advises that prospective franchisees should have clearly defined goals before they start on the path toward expansion. For many, this should come before they even make their initial investment decision, when they should know if they plan to purchase multiple units in the form of an area development agreement, or will be looking to purchase additional individual units.
“For the single operator looking to expand, the operator should have a first unit that is very successful and would continue to be with reduced owner presence,” advises Dick.
Dick also notes that franchisees should proceed with caution when purchasing an additional unit. “When buying failed or distressed units or units for sale in the system, an investigation needs to be made into whether the market that the unit is servicing is strong and hasn’t been soured by previous bad operations,” he explains, adding that “It is very hard to turn around a business, even ‘under new management,’ if previous management damaged the market.”
How do I know if I have what it takes to operate multiple franchise locations?
Generally, Dick says, successful multi-unit franchisees look a lot like successful single-unit operators – they have excellent management skills, take an interest in their customers, have a good relationship with their franchisor, and follow systems well.
“In addition, they are able to develop and manage an excellent management team capable of overseeing each location in the absence of ownership presence, who have earned the confidence of staff.”
Dick adds that successful multi-unit franchisees focus on building value across their entire enterprise, and need to have access to capital and cash reserves. Plus, “for the multi-unit operator that has outside investors, it is critical that their internal legal agreements are prepared by experienced, sophisticated counsel.”
What does a multi-unit franchise agreement look like? Will I receive a different agreement for each location?
According to Dick, there are different ways to address multi-unit ownership. “The area development is its own type of agreement where the franchisee commits to opening a number of locations within a specific area within a specific time,” he says. “In some cases, there is a general development agreement and individual agreements for each unit. In other systems, one agreement will cover the prospect of additional locations being added. Usually, each location will have its own agreement to provide for the necessary length of time for each location to operate.”
Dick also notes that depending on the jurisdiction, a franchisee may expect to receive disclosure for each additional unit within the same system. There are six provinces with franchise disclosure in place: British Columbia, Alberta, Manitoba, Ontario, New Brunswick, and Prince Edward Island.
Is there anything else I should know before I finalize my plan for franchise expansion?
It’s common for multi-unit operators to try to expand to a certain number of units with a plan to then sell or transfer the units. Dick explains that franchisees can face two obstacles with this plan. The first is that if the units are acquired over time, they may each have a different expiration date.
“It is very important that when looking to amass units for this purpose, the franchisee has negotiated franchisee-friendly option/renewal rights, and may even have limited the franchisor’s rights relating to transfers,” says Dick. “Full-time and attention clauses need to be reviewed. They will be inapplicable.”
The second obstacle is that purchasing a single franchise unit is like buying a job for a specified time. The typical franchise agreement, he says, is drafted based on the premise that the franchisee will operate its unit for the term and isn’t expecting to make a gain from a later transfer of the business.
“A person looking to invest in multiple units is more likely to view the acquisitions as investments, which may and should include an exit plan. It is critical for the prospective multi-unit investor to have the benefit of sophisticated franchise counsel to ensure that the investor’s longer-term aspirations are achievable within the particular system under consideration, and that those expectations are reflected in the business arrangement between franchisor and franchisee,” explains Dick.
Stay tuned for the next article in our “Expanding Your Franchising Horizons” series, which will focus on the financial aspects of multi-unit expansion!