Emerging brands aim to keep out of courtroom
There are some in franchising who say litigation is inevitable, especially when a system gets large enough, but there are ways to avoid the courtroom while growing a successful franchise.
From including accurate financial representations in the FDD and the franchise agreement itself to ensuring sales compliance and documenting, well, everything, young franchisors can do plenty to protect themselves and properly support their franchisees.
It’s that proper support that can make or break a franchise relationship, says Lane Fisher, partner at FisherZucker. A franchise attorney who’s seen it all, Fisher says franchisors may be tempted to “buckshot growth around the country, rather than growing out from its existing base in a manner that capitalizes on the goodwill of the trademark and is within easy reach to support franchisees.”
“Long term, we see two or three major players and we felt CPR would be the best fit for our franchisees.” — Levi Dinkla, Digital Doc
Word of caution
Emerging franchisors must also be mindful of agreeing to unreasonable changes to their standard offer in order to make a sale, continues Fisher. “This often leads to tying up productive territory or burdening the system in other ways.”
Even with the right contracts, infrastructure and franchisees in place, sometimes the unexpected happens, such as when a franchisor sells the system to a competitor. That’s exactly what happened at Digital Doc, one of this year’s Living Large companies and now part of CPR Cell Phone Repair. Communication with ‘zees will be crucial as the transition unfolds.
Over at DMK Burger Bar and Huey Magoo’s, franchisee selection is paramount to staying lawsuit-free, those brands’ executives believe.
Digital Doc to rebrand
Three years after acquiring Digital Doc from its founders, Highland Ventures sold the franchise to CPR Cell Phone Repair in a move that will also result in the rebranding of all 37 Digital Doc locations as CPR stores.
Levi Dinkla, Digital Doc’s president who is staying with Highland Ventures, says the company views the sale as an opportunity for its franchisees to be part of a national network and for Highland Ventures to refocus more of its attention on “internal initiatives.” The privately held Glenview, Illinois-based company is the largest franchisee of Marco’s Pizza and owns Family Video, along with other businesses.
“For us, we saw the industry going the way of consolidation,” says Dinkla. “Long term, we see two or three major players and we felt CPR would be the best fit for our franchisees.”
CPR operates more than 400 locations but Dinkla says there’s minimal footprint overlap with existing Digital Doc stores. CPR, he continues, “is in as good or better position to help our franchisees get what they want out of owning a franchise.”
In a press release Josh Sevick, CEO of CPR, says the acquisition was a “no-brainer for us, particularly because our goals and core values align so closely with those of the Digital Doc management team.”
There’s often a lot of uncertainly for franchisees following the sale of their system, especially when it’s a competing company that’s buying the brand. Still, says
attorney Brian Schnell, no franchisee should be surprised when it happens.
Schnell, who’s not involved in the Digital Doc-CPR deal but represents franchisors as chairman of the franchise practice at Faegre Baker Daniels, notes a typical franchise agreement gives the franchisor the right to sell, merge or otherwise combine with a business that’s similar to it, and unless a franchisee has negotiated otherwise they don’t have the right to exit the system because of a sale.
“We try to communicate and listen to our franchisees—and pick the right ones who believe in what we’re doing.” — Andy Howard, Huey Magoo’s
Don’t bet on CEO alone
“Prudent franchisees need to understand it’s a possibility and make sure they’re making a decision based on the system, the unit economics, and not just on the leadership or a big personality CEO because that can all change,” says Schnell.
And lawsuits, continues Schnell, usually don’t get franchisees the leverage they expect. “In my view, franchisees are better off marshaling their resources to get to know the buyer and to get to know the new leadership,” he says. “And for franchisors, my best practice tip is it’s important for the buyer to take a leadership role in the conversation because if they don’t, those conversations are going to happen anyway.”
Be an open book
Andy Howard advocates a personal touch and as much face-to-face time as he and his sales team can get with franchise candidates, saying the foundation for a strong relationship starts with those early interactions.
Steering clear of legal issues later on means “doing your homework and being careful about who you pick as your partners,” says Howard, CEO of seven-unit Huey Magoo’s Chicken Tenders.
“We try to communicate and listen to our franchisees—and pick the right ones who believe in what we’re doing,” continues Howard. “And we ask our franchise partners to do their due diligence.”
Huey Magoo’s doesn’t resort to restrictive timeframes or high-pressure sales tactics to sign franchisees, instead letting prospects take their time and ask questions.
One of those questions is usually why Huey Magoo’s doesn’t provide financial performance information in Item 19 of its franchise disclosure document.
“It’s a question that always comes up,” Howard acknowledges, and something the company is evaluating, but for now prospective franchisees are encouraged to talk to existing owners in the system.
“They can say different things than we can,” says Howard of ‘zees who are free to talk about the sales at their locations. “There’s obviously no guarantees you’re going to be profitable from day one.”
The company recommends a minimum of $250,000 in liquid assets and a net worth of $750,000.
Once a franchisee signs the agreement they’re invited to observe in-store operations and pick the brains of anyone in the restaurant, even before official training.
“We’re really an open book,” says Howard.
“Our question was always, what’s best for the franchisee? In order for us to be profitable, our franchisees have to be profitable.” — David Morton, DMK Burger Bar
Put the franchisee first
“The only people who win lawsuits are lawyers,” says David Morton. The co-owner of DMK Burger Bar and its parent DMK Restaurants says his company has been litigation-free since its inception in 2009, “a function of how we do things in general and our reputation.”
As he prepared to franchise his craft burger concept the first step for Morton was to hire a top-tier advisory firm to better understand how the model could work as a franchise.
“Our question was always, what’s best for the franchisee?” says Morton. “In order for us to be profitable, our franchisees have to be profitable.”
DMK’s franchise agreement includes geographic protections for franchisees and as the system grows—it has four company restaurants in Chicago and one franchisee signed for three—Morton believes in being transparent, fair and flexible. Flexibility, of course, has its limits and maintaining brand standards in line with DMK’s premium positioning is important, says Morton. Franchisees agree to certain standardized processes and Morton’s goal is to make training “easy to execute and easy to subscribe to.”
“We want franchisees to feel good about following the rules,” he says, and to feel their input is valued.
DMK Burger Bar’s franchise disclosure document doesn’t include financial performance representations in its Item 19, a strategic decision Morton says was made “in order to work with franchisees to develop forecasts that are most appropriate for the sites that we select.
“We don’t want to compare, say, DMK in Lakeview to DMK at Soldier Field,” says Morton, naming the burger bar’s flagship location and its spot inside the Chicago Bears football stadium. Instead, the plan is to work side-by-side with franchisees to create financial projections based on specific markets.
Something unique that DMK does include in its franchise agreement is a stipulation that franchisees “participate in the philanthropic, community and charitable causes that we require for the purpose of enhancing the goodwill, presence and reputation of the marks and system.”
During specified periods, franchisees are required to contribute sales proceeds from a menu item to a nonprofit organization in their local community.
It’s a meaningful part of the brand, Morton says, and so far there’s been no pushback from franchise candidates. And if there were, “they might not be the best fit,” says Morton.
Laura Michaels, managing editor, follows three emerging franchisors through a year’s worth of challenges, and collects best practices from others in her LinkedIn group, Franchise Times Insights. Reach her at email@example.com.
What the experts say
Focus on careful selection. A common misstep for young franchise brands is not being careful enough abo ut the early franchisees they select because of a strong desire to grow quickly, says Elizabeth Sigety, a partner at Fox Rothschild and chairperson of the firm’s Franchise & Distribution Group. This doesn’t seem related to the legal side, “but that is where the problems usually start,” says Sigety, commenting in the Franchise Times Insights group on LinkedIn. “Also, making concessions to early franchisees in order to close the sale.”
It starts with the FDD. Avoiding litigation begins with franchise sales compliance and documenting the compliance, says Lane Fisher, partner at FisherZucker, on LinkedIn.
Specifically, not only must franchisors obtain and retain signed FDD receipts, but franchisors must have a protocol for documenting, compiling and retaining extensive records of your pre-sale communications with prospects.”
Accurate representation. A franchisor must ensure financial performance representations are properly made in Item 19, continues Fisher, and that no representations are made beyond what’s presented in Item 19. “Ideally, franchisors should also have a franchisee complete and sign off on a compliance certification that affirms proper disclosure and that no undocumented promises were made. Use of an experienced and well-trained sales team will help drive compliance.”
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