Written by Keith R. Miller
Do franchise owners really own a business? That is a very important question. The franchise industry talks about franchise owners as independent business people, working for yourself, but not by yourself. But, what does ownership mean? Usually, if you own something, you have value, or equity, that you can sell. Historically, most franchise agreements contained a “first right of refusal” clause. In most cases, if a franchise owner found a buyer for their franchise, they would first have to offer that to the franchisor under the same terms and conditions. Unfortunately, for franchise owners, that has taken on a whole new life of its own, with new clauses that eliminate most, if not all, of the equity they have worked to gain in the franchise. For example, the following is contained in a franchise agreement.
“In the event the Franchisee wishes to transfer the” … “business carried on at the Premises pursuant to this Agreement, the Franchisee shall do so only by first offering to resell the” … “business to the Franchisor at the depreciated value of the furniture, equipment, signs and improvements. For the purposes hereof, depreciated value shall be” … “calculated on a declining balance basis of accounting at the rate of twenty percent (20%) per annum with respect to the Development Value of the assets, furniture, fixtures, equipment and signs.”
So, let’s step back and literally analyze what the above clause means. Before you sell you franchise, you MUST offer it to your franchisor at the depreciated value that you invested in hard assets on your businesses. Every year, that decreases by 20%. In simple terms, you can NEVER recoup what you invested in your business, and after 5 years, that value could be zero. While much of the value of a business usually includes the cash flow you have worked so hard to create, in this case, it has created no value for the franchise owner. A franchise owner only receives the operating positive cash flow, if any, but also assumes all the risk for any losses. This situation may be worse than being an employee, managing an outlet, who at least is guaranteed some wages, and didn’t have to invest large amounts of capital in the business.
Another issue with this type of terms in a franchise agreement is how lenders will view it. Loans usually require some level of estimated cash flow, and collateral, to obtain a loan. If you sell your business, the bank wants to ensure that any proceeds first pay off the note. However, in this case, there is not likely sufficient proceeds to satisfy the note.
Many in the industry will argue the franchisees signed the agreement, they need to live with it. Two comments on that. First, the agreement containing this clause may be on renewal, so what choice do you have in signing? If you don’t sign it, you lose any equity, if you sign it, you lose any equity. Second, how can you argue the franchisee actually owns a business if they can’t ever monetize their efforts. Even the International Franchise Association (IFA), in their Statement of Guiding Principles, agrees that franchisees shall be given the opportunity to monetize their franchise prior to termination or expiration of the franchise.
In my personal opinion, clauses such as above, undermine the franchise industry. It completely destroys any understanding that a franchisee actually owns a business. No matter how hard they work, no matter how successful they are, they have no way to increase the equity in the business. As franchise owners, we must fight back. It is not acceptable, for the franchisor to reap all the benefits of our hard work, and in my opinion, steal any equity we have worked so hard to earn. Speak out against these type of actions by franchisors. Remaining silent may cost you.
Article by Keith R. Miller, Principal – Franchisee Advocacy Consulting