Despite the pandemic, franchising remains a popular option for many business owners. Franchising enables franchisors to rapidly expand a successful business model, while franchisees can take advantage of an established brand. A recent virtual roundtable hosted by Lusthaus Law brought together industry insiders to discuss the risks and rewards of multi-unit franchising and how it has been affected by COVID-19. Sharing their insights were Julie Lusthaus, Esq., Lusthaus Law; Michael Iannuzzi, CPA, CFE, Partner & Co-Practice Leader, Franchising, Citrin Cooperman; Steven Gardner, founder of QSR Franchise Development Group, Fitwell Advisors and EnergiZ; and Alex Perez, COO Of fresh&co.
Generally, multi-unit franchising can refer to 3 different types of arrangements: Area Representative, Master Franchise, and Area Development. These types of franchises cut across industries. They often involve parties with some franchise experience who are interested in the potential for accelerated growth. More sophisticated investors are also attracted to multi-unit franchising. However, there are important issues to consider before moving forward. The roundtable speakers addressed these from both the franchisor’s and franchisee’s perspectives.
Attorney, Julie Lusthaus explained each type of multi-unit franchise arrangement as well as the benefits to franchisors and franchisees. In terms of legal issues, franchisors should be aware that while a Franchise Disclosure Document (FDD) is needed for all franchise models, additional documents and disclosures are required for multi-unit franchises. For example, Julie discussed the unique issues involved with area development arrangements. This franchise model requires three documents – the Franchise Disclosure Document, the Franchise Agreement, and the Area Development Agreement.
Both parties need to understand how their rights and obligations may differ in multi-unit franchising. Getting good legal advice in negotiations is essential, particularly with respect to issues such as territory protections, royalties and fees, opening schedules, and liability among other concerns.
Michael Iannuzzi discussed financial issues. Franchisors must ensure their financial statements comply with federal rules as well as those in states where the franchisor wants to sell franchises. Existing franchisors must also pay attention to new rules regarding recognition of franchise fees. During COVID, these rules were put on hold, but there may be changes next year.
From the franchisee/developer perspective, Michael offered examples of what type of organizational structure might be best for a multi-unit franchise. In addition, he noted that if a private equity transaction is contemplated, then it is important to look at the quality of the earnings report. Investors want to determine the normal profitability of the business beyond launch.
Franchisors often need assistance with developing their initial business plan as well as the details of their franchise system. Steven Gardner discussed the outsourced franchise development services that are available to help emerging brands. These include strategic planning, marketing, and preparation of operations, training and pre-opening manuals among others.
From the franchisee/developer perspective, he noted the importance of negotiating a realistic development schedule, and carefully considering site selection and analyzing target markets. Developers also must choose the best brands to work with.
Finally, Alex Perez brought his perspective to the table as a franchisor. He recommended franchisors surround themselves with industry professionals until they gain knowledge and experience. Further, they should have realistic expectations. Franchising takes time to be successful and franchisors must be patient. He also shared that with multi-unit franchising, franchisors are looking for franchisees with industry experience, but not someone who is a direct competitor.
The Impact of COVID-19 on Franchising
Some legal rules were changed in consideration of COVID-19. Depending on the jurisdiction, Julie noted that there were extensions to filing deadlines, acceptance of electronic filing, amendments to notary laws and other temporary changes. She also advised franchisors to talk with an attorney about whether they have made any material changes to the business that must be disclosed in the FDD and consider what they may want to do next year.
Michael spoke to PPP loan forgiveness. Currently, the law provides that businesses cannot deduct business expenses if they used their PPP money to pay those expenses, but that could change next year.
Alex shared that many landlords seem to be willing to negotiate temporarily reduced rates, so it is worth raising the issue. He also felt that this was a good opportunity for businesses to look at their operations and see if they can be more efficient and profitable.
Finally, Steven felt that while some businesses continue to be heavily affected by COVID-19, in the last 2 months, he has seen improvement in the prospect pool across industries.
If you are considering multi-unit franchising, contact Lusthaus Law to learn how we can help you.