International expansion: using franchising to grow your brand abroad

Pret’s recent announcement of its new strategic partnership in the United States is a good example of a well-known brand expanding internationally. For other companies looking to expand overseas, what do they need to consider?

Typically, a brand with global aspirations has two main options: organic growth or growth via third party relationships. While organic growth has a number of attractions – most notably control and 100 per cent of the financial upside - only those companies with the deepest of pockets can afford to expand on a global scale. For most brands this leaves growth via third party relationships as the only realistic option for international expansion. While licensing, agency and distribution are all valid international growth models, for brands that want to build a common global identity, a consistent consumer experience and ultimately a profitable business, franchising if correctly planned, implemented and executed is a good way to achieve these goals.

There are a number of models available to companies to achieve international expansion such as strategic partnership arrangements, pure franchising, joint venture franchising or various hybrids. A strategic partnership agreement based on a franchise model, is a tried and tested route to international expansion. In fact, it’s becoming increasingly popular, even in sectors many would not expect to use such a model.

To begin with, an international franchise expansion programme requires planning, resources and an experienced team, both internal to the brand and in terms of the brand’s advisers. It is therefore important for any brand looking to franchise internationally that its advisers are genuine experts with an international footprint themselves.

An international brand management strategy covering not only trade marks but also domain names, is a key building block to the expansion program. Depending on the brand and the sector in which it operates, consideration will need to be given as to the wider portfolio of intellectual property rights that defines both the brand and its product and service offering. The IP that a hotel concept will license to a franchisee will be very different from that of a fashion concept, a restaurant, a healthcare provider, an education concept and so on.

The key point for all brands is to ensure that their intellectual property is properly protected and ideally in advance of its international expansion. In addition, where any intellectual property is developed during the term of the franchise agreement (e.g., developments in the brand’s products, service offering, system or even delivery channels), the brand needs to work with its advisors to ensure that this intellectual property is correctly captured, protected and capable of being licensed to all of its franchisees.

Given the increasing importance of e-commerce, online delivery, and the use of different social media platforms for brand promotion, consideration must also need to be given as to how the brand translates in certain international markets and the scope of protection required.

For strategic partnership arrangements, particularly those involving corporate relationships like joint ventures, the structuring of the legal relationship will be critical. The relationship between the brand and its chosen partner will typically be a long-term one. It is essential that any corporate relationship interwoven into the franchise arrangement works for both parties in the chosen market or markets – not only at the outset, but also if (or when) either party wishes to exit or take on third party investment. Here, experienced corporate counsel who fully understand the interplay between the corporate relationship and the franchise model as well as the international regulatory framework around tax and foreign direct investment restrictions, will play an important role in designing such a structure.

Key questions for structuring joint ventures include the following:

  • Ownership – How will the joint venture be owned? Joint ventures can be equally owned (i.e., 50% – 50%) which implies an equal role in the running of the business. Alternatively, one party may acquire a majority interest and manage the venture, with the minority partner taking a smaller role. In either case, appropriate legal protections will be required for both parties. These may include representation on the board of directors, consent or veto rights over significant corporate actions and access to information about the business (such as financial information and measurement of key performance indicators). The brand owner will expect robust protection in the event that the joint venture fails to grow the business as expected, if poor management results in underperformance or if reputational issues arise;

  • Financing - How will the joint venture be financed? It is common for joint ventures to be funded by a mixture of equity and debt, but it is important to seek structuring advice at an early stage to ensure that the joint venture is set up in a tax efficient manner, both for the joint venture itself and for the shareholders. It is generally preferable for the funding to be made in line with the proposed shareholding in the joint venture, but where this is not the case, appropriate mechanisms or penalties need to be included to cover a scenario where one party fails to fund;

  • Management - How will the joint venture be managed? Who will lead the board and who will have day-to-day operational control of the joint venture? In addition, what decisions will require shareholder approval (or minority shareholder approval only)?

  • Exit - How long will the joint venture last and what happens if one party wants to exit? Often, it is envisaged from the outset that one party will build the business and then exit at an agreed point in time in the future. For example, a franchisee in a joint venture may want to sell the business back to the corporate brand owner and conversely the corporate brand owner may want the right to buy back the joint venture if the counterparty wishes to exit. In either case, the parties will usually need to agree on how the valuation will be determined (e.g., a multiple of EBITDA) or otherwise agree on the price at that time and, if they cannot agree on a price, obtain an independent valuation. Similarly, an operator may also want the right to purchase the entire joint venture if the corporate brand owner wishes to sell its interest, while ensuring that the necessary franchising arrangements remain in place so the business can continue to operate.

 

In addition to the considerations around the potential corporate structure, those brands looking to expand rapidly will need to consider the impact and implications of local franchise or intellectual property authority regimes will impose. These regimes will be applied either on the brand itself, the franchise agreement, or the ability for the brand, in some markets, to issue binding heads of terms or take an initial payment with a partner looking to secure a new territory.

It is common in a number of international markets – hence the need for advisers with international reach – to:

  • require brands to disclose quite a significant amount of corporate information to potential partners;
  • publicly register certain information with the local franchise or IP authority;
  • allow, following the signing of a franchise arrangement, the partner a period in which they can withdraw from the arrangement without penalty;
  • require documents to be provided in dual language format; and impose mandatory terms into the legal arrangements.

All these need to be factored into both the timings and costings for agreeing the deal.

While the corporate agreements will govern the parties respective shareholder rights, capital contributions and corporate governance, the franchise agreement will, in addition to licensing the intellectual property and know-how to be used in the business, provide both a commercial and operational framework for the parties, while at the same time governing the parties’ respective legal rights and obligations to each other.

Not only does the franchise agreement need to dovetail with the corporate agreements, it will also need to work with any operational documents such as the operating manual, brand guidelines and construction manuals, as well as any financial security arrangements such as a corporate guarantee from the partner’s parent company and/or a standby letter of credit, for example, if the partner purchases products from the brand.

In addition to the above it will be important that the franchise agreement clearly sets out the following:

  • Whether the rights granted are exclusive
  • What sales channels the partner can and can’t operate in
  • How long the parties will be in the relationship for as well as any conditions to the extension of this
  • What support the franchisor will provide
  • Any technology requirements to be imposed on the partner
  • The operating criteria, standards and parameters for the partner including choice and construction of location and branded premises
  • Any minimum financial and performance targets and the consequences of not achieving these
  • The financial terms of the relationship
  • Termination rights and what happens thereafter

Strategic partnership arrangements encompassing both a corporate and a franchise relationship is a tried and tested route for international growth and expansion. It can provide access to local market expertise and investment with a quicker return on investment than a simple corporate expansion. It reduces to some extent the burden on the brand in terms of local market regulatory compliance, but it must be concluded within a local legally compliant framework. Our international franchise law tracker provides a comparison of franchise-specific laws across multiple jurisdictions.

These advantages do need to be balanced against factors including loss of a degree of control, a lower margin than a corporately owned operation and possibly a different management style adopted by the local partner. However, when all these factors are taken into account, and provided it is properly planned and executed, it has proven time and again to be a very rewarding path to international growth.

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