Business / Commercial

Joint Ventures in Franchising - Proceed with Caution

It is becoming increasingly common to see franchisors using a joint venture model for their franchises. Specsavers is a well known example. A joint venture (JV) structure can have distinct benefits for the franchisor but it also comes with its own challenges.

So how does the joint venture model work in franchising?

When a Franchisor uses the joint venture model it usually involves the franchisor (or its related company) and an individual (called an Owner Operator) becoming shareholders in a company which has been specifically incorporated to operate the franchise business. The parties enter into an agreement called a Joint Venture Agreement or a Shareholders Agreement which sets out their respective rights and obligations.

So why do Franchisors use a joint venture model?

  1. To assist someone (e.g. an existing employee) who may not have the required level of funding to buy a franchise business.
  1. To secure qualified and highly skilled individuals who would otherwise be in short supply. An example of this is Specsavers - in their case there are only a small number of optometrists who qualify every year and this model provides a way for Specsavers to secure the graduates as franchisees.
  1. To accelerate the development of a Master Franchise Territory. We have seen this used where a Master Franchisee has a large Master Territory which it is struggling to find franchisees for.
  1. To provide the Franchisor with an increased level of control over the operation of the business. By having a shareholding and a directorship in the JV company the Franchisor is assured to have an intimate knowledge of the company and control over its operations and direction.
  1. To assist a struggling franchisee. By taking a shareholding and having a say in the day to day operation of the company the Franchisor can support the Franchisee to its potential and transfer its shares back to the Owner Operator when the time is right.

What are the challenges?

  1. The relationship - Being a joint venture partner is a different role to that of a traditional Franchisor. The Franchisor will be required to work more closely with the Franchisee and the relationship will be more akin to a partnership than a traditional Franchisor and Franchisee relationship.
  1. Extra paperwork – Franchisors will need to give serious consideration and take advice on how the JV will work for them in practice. They will need to make sure that the Joint Venture Agreement provides them with the flexibility and control they require and also the protections that an Owner Operator will invariably require to make a joint venture an attractive option for them.
  1. Personal liability – it is likely that a Franchisor will want to appoint a director to the board of the JV company. Special consideration will need to be given to the fact that a director can be held personally liable in some situations – for example; under legislation such as the Health and Safety at Work Act 2015, Companies Act 1993 and the Employment Relations Act 2000.

What are the structure considerations?

One of the benefits of a JV structure is that it can be tailored to meet the needs of the Franchisor.  Franchisors will need to consider how they will structure their JV.  Will the Franchisor be the JV partner or will they have related company specifically incorporated for this purpose? If the Franchisor is not the JV partner how will the JV company be given the rights to operate the franchise business – by entry into a franchise agreement or a more simple licence agreement?

The JV company can be structured so that there are two classes of shares. One class is held by the Franchisor and the other by the Owner Operator. The reason for the different classes of shares is to provide the Franchisor with extra rights that the Owner Operator does not have or vice versa. These different rights may include:

  • The right to share in the distribution of profits (in some cases the Franchisor will not have a right to any distributions);
  • The right to have a casting vote if there is a deadlock between the parties; and
  • The right to veto the appointment of new directors or the transfer of shares.

It is also possible for the Franchisor and the Owner Operator to have the same class of shares but for the parties to be allocated special rights under the Joint Venture Agreement. For example, the Franchisor may have drag along rights (which give the Franchisor the right to force the Owner Operator to sell its shares to a third party purchaser of the Franchisor's shares) and/or a call option (which gives the Franchisor the right to purchase the Owner Operator's shares at any time, for any reason or only on the occurrence of certain events e.g. default by the Owner Operator).

If the business is premises based then the Franchisor will also need to give consideration to the leasing structure.  Will the JV Company hold the lease or will another Franchisor entity hold the lease and then sublease to the JV Company? What about any bank guarantees and personal guarantees required by the Landlord? Who will provide these?

Proceed with caution

If you are Franchisor contemplating a JV structure – take your time and get advice. Make sure that every scenario is carefully thought through and your JV Agreement gives you the flexibility you need. Your accountant and your lawyer are the people you need to make sure that this structure is right for you and will work in the way you anticipate.

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