By David N. Kornhauser, MBA, LL. B, Partner, Loopstra Nixon LLP

Master franchising is a business model in which a franchisor grants to a master franchisee (also known as the sub-franchisor) the right to develop the franchisor’s brand within a specified territory. This is accomplished by the franchisor permitting the master franchisee the ability to grant to others (sub-franchisees) the right to operate sub-franchises.

Essentially, the master franchisee assumes the role of the franchisor within a specific territory, including recruiting new sub-franchisees, finding locations, signing leases, providing training and support, ensuring that sub-franchisees adhere to the franchisor’s standards and guidelines, and day-today administrative duties.  The master franchisee benefits from the franchisor’s established brand, business model, and operational support, while the franchisor expands its market presence with reduced direct involvement in the day-to-day operations of individual franchises.  The business operated by the master franchisee is called the master franchised business. 

Benefits of Master Franchising

Master franchising offers several significant benefits for both franchisors and master franchisees, especially in the context of international expansion.  For franchisors, master franchising allows for rapid expansion into new territories without the need for substantial capital investment. The master franchisee assumes the financial risk and responsibility for developing the franchise network within a specified area, which can include a city, province, or even an entire country. This arrangement enables the franchisor to leverage the local knowledge and expertise of the master franchisee, facilitating smoother market entry and growth.

For master franchisees, the benefits include the opportunity to operate a proven business model with the support and brand recognition of an established franchisor. Master franchisees typically receive comprehensive training and ongoing support from the franchisor, which can include marketing plans, operational systems, and continuous advice. This support helps to mitigate the risks associated with starting a new business and increases the likelihood of success.

The Principal Components of a Master Franchise Agreement

The relationship between a franchisor and a Master Franchisee is set forth in a master franchise agreement.  The principal components of a master franchise agreement include the following:

1. Term/Renewal Term – Like any unit franchise agreement, this provision will address the number of years that the master franchisee has to operate the master franchised business.  It will also address renewal terms, if any, and the conditions for renewal of the master franchise agreement.   

• Territory – The franchisor will need to have a fundamental understanding of the kind of market penetration that a successful master franchisee should be able to achieve.  The territory granted will obviously have to be large enough to allow the master franchisee to properly develop the master franchised business.  The size of the territory will also tie into the development schedule and the territory acquisition fee (see items 3 and 4 below).

• Development Schedule – The franchisor will want to impose quotas or thresholds to ensure that the master franchisee adequately exploits the territory.   These quotas or thresholds which can be measured by store openings, gross revenues, no store closings etc., within certain time frames require that the master franchisee achieve and maintain objective standards to measure the master franchisee’s performance.  Quotas can be further broken down so that there are consequences other than termination if the quotas are not met (see item 4 below)

• Remedies for Non-Compliance with Development Schedule – The franchisor may not want to terminate the master franchise agreement if the master franchisee does not achieve and/or maintain the development schedule.   Remedies, other than termination can include a reduction in the size of the territory, an opportunity to cure, a loss of exclusivity, a different fee sharing arrangement than what was originally set forth in the master franchise agreement, etc. 

• Master Franchised Business Territory Acquisition Fee – What fee does the master franchisee have to pay to acquire the master franchised business.  Generally, the territory acquisition fee payable by the master franchisee will also affect the fee sharing arrangement that is ultimately agreed to by the parties.  A franchisor may defer payment of a premium associated with a particular territory by taking a larger share of the franchisee fees (see item 6 below).  Consideration will also have to be given to the amount of working capital that the master franchisee will need during the initial stages of the development of the territory, including the obligation to open and operate the first unit location in the territory (see item 7 below).

• Fee Sharing Between Franchisor and Master Franchisee – The parties will have to decide on how they will apportion the various fees that are payable by sub-franchisees to the master franchisee.  These fees include the initial sub-franchise fee, ongoing royalty fees, advertising contributions, transfer fees, renewal fees, development fees, etc. (collectively, franchisee fees). 

• Operation of a Unit Location by Master Franchisee – Almost all master franchise agreements require that the master franchisee operate its own location prior to being able to grant sub-franchises to sub-franchisees.  The purpose of this obligation is to ensure that the master franchisee understands the franchised business and can provide practical, experienced-based advice and support to sub-franchisees. As well, it also provides the master franchisee with a training facility to train its sub-franchisees.

• Preparation of an FDD by Master Franchisee – The master franchisee will have to prepare its own unit franchise disclosure document (FDD) for delivery to prospective sub-franchisees in those provinces which have franchise legislation.

• Various Other Rights – Each party may also negotiate various other rights, including in favour of the master franchisee, rights of first refusal for other brands, or for other territories, renewal rights, etc.  In respect of the franchisor, these include a right to buy back the master franchised business under certain circumstances, exclusions from exclusivity, etc. 

Comparison With Other Arrangements

Master franchising is not the only vehicle for franchise expansion, whether inside Canada, or outside of Canada. Other structures may be used in combination with, or in place of, a master franchising. These arrangements are: 

1.         Area Development: An area development arrangement adds a multi-unit component to the direct unit franchising that is a stalwart of all franchise systems.  The franchisor and the “area developer” enter into an area development agreement which requires the area developer to establish a certain number of unit franchises within a territory according to a development schedule. Each unit franchise is typically evidenced by, and operated under, a separate unit franchise agreement between the parties.   

2.         Hybrid Development Agreement/Master Franchise Arrangements: In a hybrid arrangement, the master franchisee is also obligated to develop and operate a certain number of unit locations directly i.e. more than just the one-unit location, often before granting franchises to third party sub-franchisees. Theoretically affords the master franchisee greater operational expertise and a greater ability to provide operational support to sub-franchisees.  This relationship not only requires the master franchisee to develop and support sub-franchisees but also requires the master franchisee to maintain the human and capital resources to operate unit locations.

3.         Joint Ventures: In a joint venture (JV), the franchisor invests directly in a JV corporation with a JV partner.  The JV is the first step in a relationship that uses another one of the above-mentioned agreements (including the master franchise agreement) as a basis for the relationship.   A JV relationship might be appropriate in circumstances in which you have a motivated local person who does not have the capital necessary to develop and exploit the territory or where the franchisor wishes to exercise more control over or secure a direct interest in the profits generated in, the territory, but does not have the legal right, resources or expertise to operate the market entirely on its own. In those circumstances, the franchisor may retain its investment in the JV entity indefinitely.

Obligation to Deliver an FDD to the Master Franchisee

Master franchising is defined in the various Canadian franchise law statutes.  This means that a franchisor wanting to enter a master franchise agreement with a master franchisee in a province that has franchise legislation must provide a compliant FDD.  While certain of the information is the same as the franchisor would provide to its unit franchisees, obviously there are several provisions in the FDD that is to be prepared for the master franchisee that will be different. 

Conclusion

Master franchise agreements, and other similar contractual relationships, afford a franchisor the potential to further develop and exploit territories which may be more difficult to penetrate through the grant of individual unit locations by leveraging the franchisor’s brand system with the human and capital resources of a local partner.  Of course, franchisors considering entering master franchise agreements, or other similar contractual relationships, will need to ensure that they retain counsel with the experience to address the myriads of issues arising in these complex contractual arrangements.