Talking mumbo jumbo – legal risks and rewards of multi-unit, multi-brand franchising
Locations
Multi-unit, multi-brand operators (aka "MUMBOs") have been a long-established feature of more mature franchising markets, such as the United States. MUMBOs have often honed their skills by operating a single brand for a number years, developing their understanding of the franchise model and evolving their managerial and operational infrastructure. They are professional franchisees, with the necessary operational skills to implement the franchisor's system rather than possessing the skills more relevant to the franchisor, such as concept innovation, recruitment, training and management of franchisees. It is common that a MUMBO will have started as a family-run business, and by the time second generation is ready to take over the reins, they are looking to expand the business both with their original franchise and by diversifying and taking on additional, non-competitive franchises.
Diversification is a sensible decision, particularly in these uncertain times. By operating a number of different brands, a MUMBO can protect its overall investment from the adverse effects of economic downturns or changes in consumer demand by operating franchised brands in different sectors or sub-sectors. A number of established MUMBOs in the UK operate coffee shops, QSR food outlets, gyms and hotels. Operating a diverse portfolio can enable a MUMBO to build up and sustain a real estate portfolio, supply chain and maintain a multi-skilled workforce.
Of course, there is another category of MUMBO, which is exemplified by the likes of SSP, Welcome Break and Sodexo, which are specialists in "closed" or "captive" retail environments such as airports, train stations, university campuses and sporting venues. The origins and structures of these types of MUMBOs is different from the first category identified above, but the risks and rewards in partnering with either category of MUMBO are broadly the same.
In this article, we will look at these risks and rewards from the perspective of both parties.
1. The Franchisor perspective.
The rewards include:
- MUMBOs provide franchisors with access to experienced operators, familiar with the needs of operating a franchise system and possessing an established infrastructure and financial resources. Their operational efficiencies and cost reductions due to shared facilities allow for greater profitability and more rapid expansion. Appointing MUMBOs can be particularly beneficial to foreign brands looking to establish themselves in the UK, or domestic brands which hitherto have grown through corporate expansion but which now wish to accelerate their growth through franchising.
- The inclusion of MUMBOs reduces the number of individual franchisees in the network, requiring less training/support from the franchisor, without diminishing the rate of expansion. The increased professionalism of the MUMBO's management team (as compared to a single unit/single brand operator) should provide comfort to the franchisor.
- MUMBOs may achieve critical mass by acquiring poor performing franchisees or corporately owned stores, which in turn should increase revenue and profitability.
The risks include:
- A MUMBO's increased influence and bargaining power can disrupt the traditional franchisor/franchisee dynamic (at least domestically). For some brands, MUMBOs have become almost "too big to fail", so conversations over breach need to be approached differently. Franchisors should consider placing limits on unit growth and alternative remedies to termination, such a requiring divestment or withdrawing incentives.
- An increased risk that trade secrets/know-how will leak out of the system and be used to advance other similar businesses. Confidentiality provisions need to be carefully considered.
- Potential adverse effects if the MUMBO's other operations create controversy and/or encounter financial difficulties. Is there a sufficiently strong contractual "firewall" between the MUMBO's operation of the franchisor's brands and other franchised operations?
- Conflicts of interest between the different brands, particularly in terms of the allocation of resources between them in areas such as personnel, site selection and capital. Consider requiring approval rights over any future brands that the MUMBO might operate. Consider imposing clear site requirements, to ensure the franchisor's brand is given access to the best locations, thereby preventing the MUMBO from favouring other brands on site selection. Consider requiring that the MUMBO makes an agreed amount of capital available throughout the term for investment in the brand, to avoid capital being directed towards its other brands.
- Pressure to use a MUMBO's own supply chain or in-house procurement (such as supply of products and designing stores) may lead to compromises over brand standards.
- The requirement to make the shift from a unit franchise agreement to a multi-unit development structure require careful though and planning.
In addition to the points mentioned above, other aspects which need to be recognised and reflected in the agreement include:
- A binding development schedule which is usually tied to some form territorial exclusivity.
- Incentives for growth, such as reduced fees, costs and rebates.
- Increasingly complex funding and investments arrangements can affect the typical contractual positions, which regulate personal guarantees, changes of control, transfers of interest and business sales. Some MUMBOs might even be contemplating floating on a public stock exchange (which has happened in the US), and the impacts of a listing on the brand and the franchisor's own share price need to be considered.
- Requirements for unit-level and group level key performance indicators.
- Any obligations requiring the franchisee to devote its full time and attention to the franchisor's brand must be relaxed, recognising that the franchisee's management will be operating additional franchise systems. Any non-compete clauses must be reviewed and, potentially, relaxed to ensure only specific competing businesses are covered.
- Cross default provisions which enable a franchisor to terminate all stores if one or a number of units are not operating in compliance with the agreement.
2. The MUMBO's perspective
The rewards include:
- Operating multiple brands allows the franchisee to diversify its position and become less reliant on a single brand.
- Fixed costs and overheads can be spread or shared over multiple locations, increasing unit profitability. Aggregated sales should qualify for rebate/incentive purposes.
- The potential ability to move employees between different brands, and gain insights into different operating systems and carry over/internalise operational innovations. There is more opportunity for career progression and savings in recruitment costs.
- Ability to cross promote brands.
The obvious risks include:
- Increased reliance on different layers of management means that a MUMBO owner cedes control and raises the risk of a rogue employee putting the business in breach. By creating a large work force, a MUMBO may achieve the unintended effect of becoming less entrepreneurial. The different between a corporately owned business and a franchised business is often said to be epitomised by what happens at closing time - the franchisee will stay open just that little bit later to serve the last customer, whereas the employee will be keener to pull down the blinds and go home – the bigger a MUMBO becomes, does it lose that competitive edge?
- An overzealous cross default clause could mean the business is occasionally faced with the threat of termination.
- Ensuring there is adequate protection before investing the capital to grow. Has the MUMBO secured exclusive rights or other territorial protections? Is there sufficient growth opportunity in the allocated territory?
- Greater personal liability – as the portfolio grows, personal exposure to banks in the form of secured lending and franchisors in form the personal guarantees can mean that individual shareholders taken on a significant level of personal risk should the MUMBO ever find itself in financial difficulty. Consider alternative forms of guarantees, and/or caps on personal liability.
Conclusion
Multi-unit, multi-brand franchising is here to stay and it is a sign of a maturing franchise market. However, franchisors should approach it strategically and be mindful of the risks of stumbling into some the situations outlined above, which can end up acting as a brake on growth and innovation. Creativity is a requisite for both sides as these types of relationships often challenge the one-sided norms of traditional unit franchising.
A version of this article was first published by Global Franchise Magazine and can be found here.