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Trends in the Franchise Legal Market: 2015

In a time of global economic uncertainty, franchise systems are seen as prudent business models, offsetting some of the risks traditionally associated with opening or expanding a business. Reports indicate that the industry is continuing to show significant growth in both mature and emerging markets. It is an ever-expanding global practice with an increasingly sophisticated and diverse range of franchisors and franchisees. Law firms are thus said to be growing their franchise offerings and rapidly adapting to keep pace with market developments.

Post-crisis franchising

In 2015, the franchise sector is expected to grow twice as fast as the broader economy in the US for the fifth consecutive year, according to the International Franchise Association (IFA). The IFA president, in turn, described franchising as “a vital engine of economic expansion”. The numbers are not just encouraging for the US either. The IFA reported that, of the 200 largest US-based franchisors, more than one-third of their units were internationally based – this is expected to reach more than half by the end of the decade. Similarly, the Entrepreneur’s Franchise 500 found that its listed franchisors added 16,229 new units and over half of these were outside the US.

The growth of franchise brands in the already mature US market and abroad is a result of several key factors. Typically respondents highlight the increased access to financing for franchise businesses. Financial institutions now have a strong appetite for lending under a franchise model, especially in an environment that is generating more success than failure. Not so long ago a franchise business was seen as a riskier investment than a company-owned model, not least because it is based on the performance of many different entities, which breed uncertainty in stakeholders. Today this perceived weakness is now its most endearing quality, as conveyed by the massive growth in venture capital and private equity investment.

Private equity acquisitions of franchises are now a well-established trend and new deals are being closed all the time. Franchise systems are increasingly seen by investors as vehicles for fast and efficient growth, where a popular brand can be advanced by professional franchisees with local market experience. Established brands have strong clout with the consumer and in a race for market position, franchise businesses are winning more often than not. These factors, along with historically low interest rates, are fostering an appetite among private equity investors. In return, private equity offers promising brands a pathway to even faster growth and commercial success.

Crucially, easier access to financing also applies to professional franchisees. Traditionally a franchisee was often a budding entrepreneur, backed by either family money or a bank loan, looking to purchase a single unit; today, more than half of all franchise units are run by multi-unit operators, some with hundreds of units and revenues in the tens of millions. Multi-unit operators are also increasingly taking on more than one brand, as their operations become increasingly sophisticated and push the boundaries of growth. Investor demand has spilled over into these larger operators: with strong cash flows and affordable debt, multi-unit operators are prime leverage buyout targets.

On the other hand, the growth of franchising and levels of investment in the industry have caused western markets to saturate, which partly explains why so many US franchisors are setting up units abroad. When combined with the globalisation of business in general, as well as the spread of technology, the growth of the middle class in emerging nations and the relaxation of trade barriers, international expansion strategies are now significantly more viable. Indeed, respondents report that a majority of franchise businesses in the US and Europe are looking to expand their portfolios in a select number of emerging markets.

Brands both large and small are acutely aware that over three-quarters of the world’s population live in emerging market nations and there is only so much saturation western markets can take before international expansion is a necessity for continued growth. The World Trade Organization suggests that strong GDP growth has a profound correlation with investment in new businesses. As such, China and Indonesia are popular destinations in Asia; while Colombia and Peru’s rapid rise in consumer spending is enticing international franchisors. Countries in the Arabian Peninsula have established an appetite for Western brands, while relaxations of licences for foreign franchisors in South Africa and Nigeria are promising steps for future development in Africa.

However, respondents warn that several key factors need to be taken into account before choosing a destination for international expansion. Seeking out consultancy advice on the feasibility of particular cross-border expansion strategies is advocated, while there are myriad legal issues to consider in countries where trademark laws and franchise agreements are not strongly entrenched. The need for a franchisor to identify knowledgeable and experienced local counsel in target jurisdictions is imperative. Law firms, particularly local firms and boutiques, are continuously building a strong referral network, which is considered an invaluable asset to their internationally facing clients. Meanwhile, international firms are attempting to tighten up the knowledge of their own practitioners in emerging market jurisdictions so that they can present a comprehensive network of franchise expertise to current and prospective clients.

The Franchisor and Franchisee Relationship

The well-publicised “joint-employer” debate is perhaps the most pervasive issue in franchising at the moment. As the US is seen as the “bellwether of franchising trends”, this argument is a global concern and is mentioned by practitioners across most jurisdictions in our research. The National Labor Relations Board’s move to make McDonald’s liable for the employees of its franchisees has, in the words of the IFA’s president,  “upend[ed] decades of law and practice” and “endangered” the entire business model. The decision is based on the fast-food chain’s perceived interference in the labour-related activities of its franchisees, which in turn violated the rights of its employees. This is a hotly contested viewpoint and many of our respondents are particularly concerned that there is “a genuine lack of knowledge and understanding towards the basic nature of the franchise relationship” among the authorities.

Further fuel was added to the fire by the NLRB through a recent memorandum. The subject was whether Freshii, a healthy fast-food franchisor, was a joint employer with its franchisee Nutritionality, Inc. According to the memo, Freshii is not a joint employer because it did not “share or co-determine those matters governing the essential terms and conditions of employment”, which is due, in part, to its carefully worded franchise agreement that states that the franchisee alone will “determine to what extent, if any, these policies and procedures might apply” to its restaurant operations. These policies and procedures, which are defined in the agreement and includes advice on human resources, can effectively be ignored if the franchisee so chooses. The newly expanded factors used to establish joint-employer status by the NLRB is seen as a slight retrenchment from the board’s hardened position last year and offers a “glimmer of hope” for franchising. Significantly, it highlights the need to use carefully constructed language in franchise agreements to avoid the possibility of joint-employer status.

A final decision on the McDonald’s hearing is not expected before 2016; until then, the topic will be ever present in the minds of franchisors, franchisees and their legal counsel. 

Impact on the Legal Market

Law firms are expanding their franchising capabilities to capture the growing number of franchisors and franchisees, both large and small, in a greater number of sectors and in a greater number of countries. This is having a tangible effect on the legal market. Since the recession the number of lawyers in our guide has almost doubled, increasing at an average of 23 per cent every two years.

The number of law firms has also grown significantly, while our latest edition features 21 more jurisdictions than it did in 2009. A large part of these statistics represents the growing number of local counsel who have developed franchise law expertise, often from a foundation in intellectual property law, through increasing amounts of referral work. There are certainly a growing number of firms in South America and Asia who now boast expertise in franchise law; however, many practitioners temper this expansion of knowledge with a warning that, in reality, there remains a relatively small pool of experience outside the major markets. This is exhibited by the fact that 78 per cent of jurisdictions in this guide have less than five practitioners listed as leading experts. Ultimately, the development of a truly international franchise market is still in its infancy, but many jurisdictions in Eastern Europe, Latin America and the Far East can now claim to have a number of lawyers who are extensively experienced in franchise matters. 

These statistics also reflect the fact that the developed markets in the US, Canada, Australia and Western Europe are seeing a rise in franchise as a specialism. The increasing sophistication and financial strength of large franchisees is creating a greater level of depth in the franchisee side of the legal market, which is in turn generating more work for franchisor lawyers – both in the commercial and disputes segments of the industry. Franchise agreements are increasingly complex and varied, demanding a greater level of creativity and accuracy from legal counsel to ensure that commercial success can be achieved and costly battles with franchisees can be avoided. The results of the McDonald’s hearing next year may have significant consequences for the industry, but for the moment at least franchising remains a positive business model backed by substantial investment and growing international demand for lucrative brands.

Ultimately, while globalisation is not so much a trend as a matter of fact for most business sectors, a unique combination of factors in the post-crisis era has propelled franchising as a driving force behind international business expansion. This is an incredible achievement for an industry that was almost exclusively the preserve of North Americans for decades.

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W11 1QQ, UK